What are stocks?

When you hear people speak about trading or investing, most likely they'll be talking about stock trading – one of the most popular and traditional ways to access the financial markets. Particularly among individual investors.

As we saw in the previous lesson, if you've got a pension plan, the chances are you're already investing in stocks in some capacity. But what are stocks? And how do they work?

A stock is a unit of ownership in a company.

So, if a particular company is worth $10,000 and has issued 2000 stocks, each stock would be worth $5 (10,000 ÷ 2000).

As the stock price fluctuates, so does the value of the company. Investors who buy stocks in a company are hoping it will grow in value, enabling them to sell the stocks at a higher price.

Why do companies offer stocks?

To raise money

By allowing investors to buy part of the company, the management are able to raise capital to put back into the business. For example, they may need extra cash to expand into other territories, or launch a new line of products.

If the funds are used wisely and the company becomes more profitable as a result, the value of the stock price – and therefore the business – should rise.

This means the company and its shareholders are heavily reliant on each other. The company needs shareholders to raise funds, and the shareholders hope the company will use their investment to grow the business – so they can make a profit.

Why do stock prices move?

Stock prices can stay fairly stable for months, or move rapidly. The amount a stock fluctuates is known as its volatility.

Whether a stock price moves up or down is based fundamentally on the laws of supply and demand. Essentially, if more people want to buy a stock than sell it, the price will rise because the stock is more sought-after (the 'demand' outstrips the 'supply'). Conversely, if supply is greater than demand then the price will fall.

How levels of supply and demand move prices

Supply and demand can be influenced by many factors, but the main two are:

Earnings

These are the profits a business makes. If the earnings are better than expected, the stock price generally rises. If the earnings disappoint, the stock price is likely to fall. Companies tend to release earnings announcements for a specific time period, usually a quarter, half or full year. The firm's stock price can be particularly volatile immediately before and after the announcement, especially if the figures are significantly better or worse than anticipated.

You can use IG's economic calendar to see when certain companies are releasing earnings results.

Sentiment

This is perhaps the most complex and important factor in a stock price. Stock prices tend to react strongly to expectations of the company's future performance. These expectations are built on any number of factors, such as upcoming industry legislation, public faith in the company's management team, or the general health of the economy.

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