What is a Stock?

A stock is like a piece of ownership in a cupcake business...

Imagine that you want to own a cupcake shop, but you only have $1,000 to start. In order to buy the necessary supplies (e.g., flour, icing, cupcake tins), you might raise money from friends and family. Let’s pretend that four of your friends each kick in $1,000, so you have $5,000 total and you’re able to get the business off the ground. In exchange for their investment, you might agree to give each of them 20% of the business and its profits, but they would also participate in any losses the business may take. This is kind of how stocks work, except on a much larger level.

The Romans were the first to use a stock-like instrument as a way of ensuring their citizens had a vested interest in public works. Contractors who were hired by the state would sell an instrument resembling stock in their businesses to raise capital for projects. This was known as ‘lease holding.’

Fast forward to the 1600s and the time of the East India Company (EIC). Widely regarded as the first joint-stock company in the world, the EIC made its name from trading in commodities throughout the Indian Ocean region. Today’s limited liability company (LLC) is a descendant of the joint-stock company.

Bonds are different from stocks. Unlike stocks, bonds are debt-based, which means investors lend money to the company or government issuing the bond and in return, receive interest. The holder of a bond does not have ownership in the company — however, they may have more protection than a stockholder. Another difference between stocks and bonds is that stocks are usually traded on an exchange, whereas a bond is usually over the counter (the investor needs to deal directly with the issuing company, government, or other entity).

Futures and Options are different than stocks in that they are derivatives, which means that their value is based on another asset — such as commodities, shares, currencies, etc. They are contracts — based on the fluctuation of underlying assets — rather than ownership of the asset itself.

The ‘stock market’ is a broad term that encompasses a collection of markets where the regular buying, selling, and issuance of stocks in publicly held companies takes place.

The stock market is an umbrella term for these markets. The stock market is made up of various individual stock exchanges. The most well-known of these stock exchanges in the United States are: the New York Stock Exchange (NYSE), Nasdaq, the Better Alternative Trading System (BATS), and the Chicago Board Options Exchange (CBOE). These exchanges — along with several others — make up the U.S. stock market.

While it is called the ‘stock market’ (or the ‘equity market’), other financial instruments — such as bonds, commodities, currencies, and derivatives — are also traded on the stock market.

If you own stock in a company, often it will fall into this category. One of the key benefits of common stock is voting rights — with each share usually equating to one vote. Investors who hold common stock can attend annual general meetings and vote on corporate issues like electing people to the board, stock splits, or general company strategy.

Investors who do not need to vote on corporate issues and are interested in receiving a consistent dividend check may choose a preferred stock. There are many features that mirror that of a bond. For example, preferred stock can be repurchased by the company at an agreed price.

• Free/public float: Stock that has been released to the market and is traded publicly through an exchange.
• Stock splits: If a company wishes to make its stock price more accessible to investors, it will conduct a stock split. This will not change the market capitalization of the company — or the overall value of the shares you own — but it will increase the number of shares available.
• Stockholders equity: In its most basic form, it is the assets that remain in a company after covering all the bills (liabilities). This metric can be used to get a better understanding of the value of the stock.
• Short selling: When an investor wishes to speculate on a fall in the stock price, they can “short” a position. This requires borrowing the stock from either a broker or a financial institution. If the price drops, you can buy the stock at the lower price and make a profit. If the price of the stock rises and you buy it back later at the higher price, you will incur a loss.
• Stock purchase plan: An offer of discounted stock to an employee by an employer.
• Blue-chip stocks: Large, well-capitalized companies fall into the blue-chip category. They are usually traded on the main stock exchanges – such as the NYSE or the Nasdaq.
• Broker: A broker will execute trades on behalf of an investor/trader and typically receives a commission in return.
• Buying on margin: Buying on margin is borrowing money from an indivudal's securities firm to buy securities. The loan from the firm is secured by the securities that are purchased by the customer.
• Pink sheet stocks: Small companies that trade below the $5 threshold are usually referred to as ‘penny’ or ‘pink-sheet’ stocks. They are traded over the counter and can be high risk.
• Market/limit/stop orders: When opening a trade, an investor needs to choose between a range of order types. A market order is executed at the next available price and can be risky if the stock price has a wide spread (the difference between the buyers and sellers are offering). A limit order is an order to buy or sell a security at or better than a specified price – this can mean that the order may not always get filled, particularly if the market moves quickly. Stop orders allow investors to set a trigger price in the system, which will only execute in the event the price hits the desired level. When this stop price is reached, the order automatically turn into a market order.

Dividends are not guaranteed and must be authorized by the company's board of directors. Margin borrowing increases the level of market risk, as a result it has the potential to magnify both gains and losses.