Stock Markets Guide and Advice

By TM on Apr 09, 2009 with Comments 0

The need to raise money to pay for business ventures remains a principle reason for a company to sell stock, and the promise of large increases in the value of a stock is the primary reason for an individual or institution to buy stock. The stock market is a crucial factor in economic growth on a large scale, because it allows businesses to grow more rapidly than they could if they were funded privately, and because it allows investors to make larger amounts of money than they could by placing their money in bank accounts.

For a business to be listed (to have its stock made available for trading) on a stock exchange, it has to meet certain requirements. Each stock exchange establishes its own requirements, usually relating to a business’s financial soundness and the amount of capital (money and other assets) that it has, and when a company meets these requirements, it can choose to go public on one of the world’s stock exchanges. Going public refers to the transition that a business makes from being a privately owned organization to being a business owned by the public, or stockholders. When a company makes its stock available for purchase for the first time, this is called an initial public offering (IPO). Once it has sold all shares of its stock, a business has access to the money raised in this process. The leaders of the company are no longer answerable only to themselves at this point. They must answer to shareholders, the true owners of the company.

In the stock market prices fluctuate according to the law of supply and demand. As demand for a stock increases, its price increases, and vice versa. Demand is created or lessened for a stock, of course, when a company is known to be profitable or known to be struggling. Demand can additionally be affected based on any positive or negative news about a stock. Stock markets are thus vulnerable to human psychology. For instance, when large numbers of people get enthusiastic about a stock and decide to buy it, they can greatly inflate the stock price in a short period of time.

Sometimes the price of a stock rises so high that it loses its correlation to company earnings. This happened on a large scale in the late 1920s and also in the late 1990s. The 1929 stock market crash, like the lesser and more gradual crash that occurred in 2001–02, started when investors widely understood that the inflated value of stock prices could not last. Investors sold off stocks in large numbers, stock prices dropped across the market, and many people who had invested heavily in stocks lost a great deal of money.

While the stock market offers investors the potential to multiply their money more quickly than they might be able to do by other means, it is also inherently risky. Most financial professionals advise investors to resist the temptation to make quick profits. Those who invest with an eye toward long-term profit often balance investment in risky stocks (frequently these are stocks in untested companies, or companies specializing in new technologies) with investment in larger companies less subject to volatility. Since World War II the U.S. stock market has increased in value by an average of 10 percent a year, in spite of dramatic fluctuations from year to year and decade to decade.

People are still able to invest in government debt as well. They do so usually by buying items commonly called government bonds, which are traded not in the stock market but in the bond market. The bond market includes other types of bonds in addition to government bonds and works in a similar way to stock markets. One key difference between stocks and government bonds is that the value of government bonds is largely risk-free, meaning that as long as the issuing country itself continues to exist and is not in a severe financial crisis, the bondholder can expect repayment. Bonds can generally be expected to increase in value at a steady rate, but they are unable to match the explosive growth sometimes offered by stocks.