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How Stocks Work

Scholarship Media

March 30, 2018

So you have a basic idea of how stocks work, at least in terms of prepping for retirement. You need to save money and invest in a 401(k) plan, have diverse holdings, hang on to stocks long-term, and so on. But what are you actually supposed to do with stocks? What are they, exactly? Yeah, they’re like owning a portion of the company, but it’s not like you can go into a company and fire people just because you’re “part owner,” right? What exactly is a stock, and why do stocks exist?

To understand why this is, let’s take a step back and explain what the point of stocks are from a company’s perspective.

Companies need money

Companies do not have to have stocks in the sense that we’re talking about here, of course. There is such a thing as a “private company,” which does not allow its shares to be publicly traded. If you were to found a company, you could keep all of it to yourself. But, of course, you would need some money to get your company started. And maybe you would need more money even after the company took off and became successful – money to grow, for instance, or to develop a new product.

Private versus public

You could, as the head of your company, look for investors. You could make the case that the company will increase in value over time, making shares a steal at the price you offer. If you convinced them, you might part with a portion of your company in exchange for the funds your company needs to grow. You’d be counting on that growth (and the company’s continued survival, of course) being enough to make up for the shares you parted with. And you could keep control simply by making sure that you help 51% of the shares – a “controlling interest.”

You could make private deals of this sort, but you could also offer shares on the stock market for public trading. You could raise a lot of cash this way for your company, and you’d also make your own wealth more “liquid,” allowing you to swap shares for the cash you need to build that mansion (go on, you earned it!).

It’s important to note that there are key differences between owning a stock and owning a company. For instance, companies own their own assets, so stock owners can’t just demand those assets as payment if the company goes belly-up. But, to simplify things, it doesn’t hurt to think of owning a stock as sort of like owning a company.

Of course, stocks have their drawbacks for companies, too. We individual investors are sharing risks as well as growth, but we may perhaps be less invested (literally) in the company’s success than, for instance, someone who owns half of it. Experts use advanced strategies like RSI trading strategies to swap stocks based on math, not emotions, and business owners who take their companies public will have to worry about pleasing Wall Street and avoiding a run on their stock. But the rewards are similarly large, and publicly traded companies can reap the rewards of big investments.