Stock Market 101: How It Works and How to Get Started

Maybe you never took Economics 101, and The Wall Street Journal might as well be written in a foreign language for all the sense it makes to you. But perhaps for the first time in your life you have some money saved, and the 2.5 percent interest you’re earning on it in your savings account isn’t enough. So you’re eyeing the stock market. Problem is you don’t know the first thing about it.

You’ve come to the right place. Let’s start at the beginning.

The stock market allows anyone to purchase a part of any publicly held company, that is, any company that sells stock to investors. In this way, the stock market raises capital a company can use to continue producing its product or offering its service. In return for the use of investors’ money, if the company does well, investors get to share in the profit. If the company does poorly, however, investors see a loss.

How Does the Stock Market Work?

Imagine there’s a company called Widget Inc. that makes all kinds of gadgets and toys you like to use. If you think it would be fun to own a part of that company, you can buy shares of Widget Inc. stock. As long as Widget Inc. is generating a profit, the shares you buy will probably increase in value. But if Widget or the toy market takes a downturn, the company may begin to lose money, and you’ll lose money right along with it, as other investors sell off their stocks and the value of your stock plummets.

Long ago stock owners figured it would be convenient if there was a central place they could go to trade stock with one another. The public stock exchange was born. A stock exchange is nothing more than a collection of buyers and sellers of stock securities. Market prices are efficiently established through a continuous auction process governed by the laws of supply and demand. A dedicated network of traders, brokers, and specialists ensures that buy and sell orders are executed in a timely and professional manner.

The New York Stock Exchange is home to some of the most venerable companies in the world. If you want to trade the stocks of these companies, you’ll need to use stockbrokers, discount brokers, or the Internet to do so.

Online brokers now represent a significant and growing percentage of the total market. Companies such as E-Trade, TD Ameritrade, Charles Schwab, and a host of others have essentially leveled the playing field for the small investor. Most of these online services allow you to open an account with a balance of $500 or less and also offer you a number of free trades to help you get started.

How Much Does It Cost to Buy and Sell Shares of Stock?

Most discount brokers charge between $7 and $25 to execute a trade. Because you pay this fee when you buy the stock and again when you sell it, you’ll need to factor both charges in when evaluating potential profit margins.

Who Offers Investing Advice?

Discount brokers generally are not in the business of advising investors. Full-service brokers do dispense advice and charge significantly higher fees for their services. Many investors, especially those with less disposable income to invest in the stock market, prefer to do their own research rather than pay the higher costs associated with full-service brokers. Most discount brokerage companies offer reliable trading systems and provide customer service free of charge. These companies may not help you make investing decisions but they are fully staffed to help you with the process of initiating and managing transactions online.

How Do I Pick an Online Brokerage?

With a little homework you can select an online service that is best for your needs. Check the minimum balance and transaction charges to determine which service fits your budget. Investigate the reputation of a brokerage by searching online for articles and testimonials and talking to colleagues who use the service.

The Securities and Exchange Commission offers an important set of warnings about online brokerages to help you distinguish the real services from the scams. Check out What You Can Do to Safeguard Your Money and Your Personal Information to learn how to avoid getting caught in “phishing” scams.

For a general overview of how stock trades are executed, check out How Do Stocks Trade?