How stocks work is a matter of confusion for most
How does the stock market work?
Stocks are essentially pieces of ownership of a company or other sort of financial entity. For more details on what a stock is check out common stock definition. The shares of a company are publicly traded on an open market, but first they must be offered to the public in what is called an initial public offering (IPO). The point of the IPO is to raise funds to expand the business. Once the shares of the company are on the open market they can be traded at whatever price a buyer and seller agree on.
What determines the price of the stock? If there are more buyers than sellers, then you price of the stock will go up. Likewise, if there are more sellers than buyers, then the price of the stock will go down. When you look at a price quote for a stock, you're seeing the last agreed-upon trade that happened.
How come we're able to make money off of stocks?
The stock market seems like a magic money tree to many people. All I need to do is shake the tree and down comes the money! In reality, you can treat the stock market like a magic money tree by getting money out of it without truly understanding why the stock market creates wealth. If you don't care why it works, but just want to know how to take advantage of it check out the best way to invest money. But, if you're curious about understanding the stock market, read on...
When we invest in the stock market, we're investing in the progress of mankind. Think about where our society was 30 years ago. There was no internet as we know it today. There were no cell phones. Materials science and medicine were primitive compared to today. Since then our society has advanced. And not just a little bit. Life is dramatically different. If you had put your money in a total US stock market index 30 years ago, you would've captured much of the profits that came about from those advancements. Yes, many ideas failed horribly, but the successes far outweighed the failures.
Now think about where society was 100 years ago. No planes, TV, radio, or cars. I find it extremely difficult to even imagine life without all those advancements. If an ancestor had put money in an index fund (assuming there was one) back 100 years ago, your gains on that money would have happened because of all the advancements since then.
Now think about 500 years ago! For 500 years humans have slowly, but surely, advanced society. I believe we will continue to advance society.
The more we advance, the easier it becomes to advance! Yes, there are setbacks, but by and large we grow faster every year. Also, American and international workers continue to be productive and come up with new and useful ideas that make our lives better. Therefore, I believe the stock market will continue to grow in the long-term. There will be temporary setbacks, but over long periods of time it will continue grow. That is why I'm optimistic about the long-term future. The short-term stock market future does not look good right now, but eventually it will recover and you want to be in stocks when it does -- even if it's not your entire portfolio.
On a smaller scale, when you invest in a single company, you capture the productive advancements of that company over the time period that you own the stock. The biggest problem with this method is you cannot be sure that single company will still be around in the long-term future. As a result, you take on extra risk, but have a higher potential for large gains. Also, it may take a while for the stock market to reflect the company's advancements in its price. Therefore, even if a company is doing awesome, it may take months or years for the stock price to catch up. But, it eventually does catch up, so be patient.
That is how the stock market works!
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