How Do Stocks Work- When you sell stock, you are no longer an owner of your company. That means cashing out your investment, which is why so many people are anxious to sell stocks for cash. Cash is always valuable. Stocks can be valuable too, but they’re also more volatile than currency so first it makes sense to know how selling stock works. This general post will give you a better understanding of stocks and what happens on the other side when someone buys or sells stocks for cash.
So, you’ve decided to sell your stock. There are several factors that will determine whether or not the company will approve the sale. Factors include the current holding period requirements, any covenants set forth in agreements, and much more. Understanding how buying and selling stocks works is especially important if you have shorted stocks in your portfolio.
Companies sell shares in their business to raise money. They then use that money for various initiatives: A company might use money raised from a stock offering to fund new products or product lines, to invest in growth, to expand their operations or to pay off debt.
“Once a company’s stock is on the market, it can be bought and sold among investors.”
Companies typically begin to issue shares in their stock through a process called an initial public offering, or IPO. (You can learn more about IPOs in our guide.) Once a company’s stock is on the market, it can be bought and sold among investors. If you decide to buy a stock, you’ll often buy it not from the company itself, but from another investor who wants to sell the stock. Likewise, if you want to sell a stock, you’ll sell to another investor who wants to buy.
» Learn more: The stock market and how it works
These trades are handled through a stock exchange, with a broker representing each investor. Many investors these days use online stockbrokers, buying and selling stocks through the broker’s trading platform, which connects them to exchanges. If you don’t have a brokerage account, you’ll need one to buy stocks. Here’s how to open one.
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What does it mean when you own stocks?
Most investors own what’s called common stock, which is what is described above. Common stock comes with voting rights, and may pay investors dividends. There are other kinds of stocks, including preferred stocks, which work a bit differently. You can read more about the different types of stocks here.
Again, owning a stock doesn’t mean you carry a lot of weight within the company, or that you get to rub elbows with company bigwigs. It also doesn’t mean that you own a piece of the company’s assets — you aren’t entitled to a parking spot in the company lot or a desk at the company’s headquarters.
What you own, essentially, is a share in the company’s profits — and, it should be said, its losses. The goal, of course, is for the value of the company — and as a result, the value of its stock — to go up while you’re a shareholder.
But while stocks overall have a history of high returns, they also come with risk: It’s entirely possible that a stock in your portfolio will go down in value instead. Stock prices fluctuate for a variety of reasons, from overall market volatility to company-specific events, like a communications crisis or a product recall.
Many long-term investors hold on to stocks for years, without frequent buying or selling, and while they see those stocks fluctuate over time, their overall portfolio goes up in value over the long term. These investors often own stocks through mutual funds or index funds, which pool many investments together. You can buy a large section of the stock market — for example, a stake in all of the companies in the S&P 500 — through a mutual fund or index fund.
Types of Stock
While there are two main types of stock—common and preferred—the term equities is synonymous with common shares, as their combined market value and trading volumes are many magnitudes larger than that of preferred shares.
The main distinction between the two is that common shares usually carry voting rights that enable the common shareholder to have a say in corporate meetings (like the annual general meeting or AGM) where matters such as election to the board of directors or appointment of auditors are voted upon while preferred shares generally do not have voting rights. Preferred shares are so named because preferred shareholders have priority over common shareholders to receive dividends as well as assets in the event of a liquidation.2
Common stock can be further classified in terms of their voting rights. While the basic premise of common shares is that they should have equal voting rights—one vote per share held—some companies have dual or multiple classes of stock with different voting rights attached to each class. In such a dual-class structure, Class A shares, for example, may have 10 votes per share, while the Class B subordinate voting shares may only have one vote per share. Dual- or multiple-class share structures are designed to enable the founders of a company to control its fortunes, strategic direction, and ability to innovate.
Today’s corporate giant likely had its start as a small private entity launched by a visionary founder a few decades ago. Think of Jack Ma incubating Alibaba (BABA) from his apartment in Hangzhou, China, in 1999, or Mark Zuckerberg founding the earliest version of Facebook (now Meta), from his Harvard University dorm room in 2004. Technology giants like these have become among the biggest companies in the world within a couple of decades.
However, growing at such a frenetic pace requires access to a massive amount of capital. In order to make the transition from an idea germinating in an entrepreneur’s brain to an operating company, they need to lease an office or factory, hire employees, buy equipment and raw materials, and put in place a sales and distribution network, among other things. These resources require significant amounts of capital, depending on the scale and scope of the business startup.
Raising Capital
A startup can raise such capital either by selling shares (equity financing) or borrowing money (debt financing). Debt financing can be a problem for a startup because it may have few assets to pledge for a loan—especially in sectors such as technology or biotechnology, where a firm has few tangible assets—plus the interest on the loan would impose a financial burden in the early days, when the company may have no revenues or earnings.
Equity financing, therefore, is the preferred route for most startups that need capital. The entrepreneur may initially source funds from personal savings, as well as friends and family, to get the business off the ground. As the business expands and capital requirements become more substantial, the entrepreneur may turn to angel investors and venture capital firms.
When a company establishes itself, it may need access to much larger amounts of capital than it can get from ongoing operations or a traditional bank loan. It can do so by selling shares to the public through an initial public offering (IPO).
This changes the status of the company from a private firm whose shares are held by a few shareholders to a publicly-traded company whose shares will be held by numerous members of the general public. The IPO also offers early investors in the company an opportunity to cash out part of their stake, often reaping very handsome rewards in the process.
Once the company’s shares are listed on a stock exchange and trading in it commences, the price of these shares fluctuates as investors and traders assess and reassess their intrinsic value. There are many different ratios and metrics that can be used to value stocks, of which the single-most popular measure is probably the price-to-earnings (PE) ratio. The stock analysis also tends to fall into one of two camps—fundamental analysis, or technical analysis.
Conclusion
It’s nice to know what you’re investing in, but unless you understand how stocks are sold, you are probably missing out on making the most money from the stock market. There are various reasons why stocks are created, or how they work.