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Stock Trading: How Do Stocks Work?

May 9, 2022Priyanka Adhikary
A man teaching basics of stock trading to another man using his laptop.

Stocks, also known as equities, represent the units of ownership of a company, which investors can trade (buy and sell) at a stock market. When you buy shares (units of stocks are known as shares) of a company, it means you have also purchased a partial ownership stake of that company. By buying shares of a company, you are entitled to a portion of the company’s assets and profits. The value of these benefits is equivalent to the number of stocks you own.

Investing in shares is a popular way for investors to diversify their investment portfolios. If you too are planning to invest in shares, then knowing the basics of stock trading and how stocks work can help in creating a well-balanced and organized investment portfolio.

Benefits and Limitations of Buying Stocks

There are several reasons why investing in stocks can be beneficial for investors. However, before we proceed to know why, you might want to learn why companies sell shares or stocks. Companies do so to raise capital and to expand their operations and businesses. They list their shares or stocks in the stock exchanges of stock markets, which can then be purchased by individuals and brokers. When the shares or stocks are bought by individuals, they gain fractional ownership of that company as well as privileges. The value of the privileges is dependent on the types of shares purchased. Some of these privileges are as follows:

Voting Rights:

When you buy the shares or stocks of a company, not only are you entitled to a portion of its assets and profits, but you may also get the voting rights. So, you can exercise your rights in the company’s annual shareholder meetings.


Typically, most companies pay dividends to the shareholders. So, what are dividends? Dividends are payments that a company makes to its shareholders from its revenue. These dividends are usually issued periodically.

Capital Appreciation:

If the stock prices of the company increase, the value of the stocks purchased will increase too. You can then even opt to sell those stocks to gain profit.

While you may enjoy several benefits of investing in stocks, there can be some drawbacks too. Check out some of the downsides that are mentioned below:


There are risks associated with buying stocks. If you own the stocks of a company that has not performed well and you want to sell the stocks, then you might have to do so at a price that is lower than your original buying price. This can make you lose a part of your initial investment.

Unguaranteed Returns:

While stocks may offer high returns when the company performs well, there is no guarantee that the situation will stay the same. So, expecting them to perform well at all times may not be ideal.

Market Volatility:

It is a known fact that a stock market keeps fluctuating. If the market goes down due to any reason, it may affect your returns and investment.

What Are the Different Kinds of Stocks?

There are different types of stocks that you can purchase. Some of the most common types are mentioned below:

Common Stocks and Preferred Stocks

Common stocks are stocks that allow investors to obtain a partial ownership stake in a company. Most companies usually issue more common stocks as they are sold more widely on stock exchanges than preferred stocks. When investors buy common stocks, they also get the right to vote at the shareholders’ meetings. These types of stocks can also offer significant returns over time depending on the growth and expansion of the company. However, if a company does not do well, it can get challenging for common shareholders to receive a portion of the company’s assets. In cases when there’s no asset left, the common shareholders may have to incur losses.

Preferred stocks are slightly different from common stocks. When investors buy preferred stocks, they get more preference than common shareholders. Preferred shareholders are also entitled to receive dividend payments before common shareholders. Preferred stocks may also yield more dividends. In case the company has to stop operating, preferred shareholders can make a greater claim to get a portion of the money back. However, preferred shareholders are not entitled to any voting rights. Some companies even issue convertible preferred stocks that can be converted to common stocks by investors under certain circumstances.

Dividend Stocks and Non-dividend Stocks

Dividend stocks are stocks through which an investor can earn a portion of the company’s profit. Dividend stocks may offer regular income to the investors who purchased them. If the company keeps profiting, then the investor can earn income from such stocks without selling them. However, it is to be noted that a company can stop giving dividends if it faces any financial crunch or any other reason. Investors may also have to pay taxes on the dividends earned from the company.

Non-dividend stocks are stocks of companies that do not pay dividends to the investors. Companies that issue non-dividend stocks usually reinvest the money. If the company profits, the price of the non-dividend stocks may also increase. Investors can then sell the stocks to earn profit.

IPO (Initial Public Offering) Stocks

IPO stocks represent the stocks of companies that have been newly listed on a stock exchange. If you want to invest in the stocks of companies that look promising and are already making a wave in the market, then you may want to consider IPO stocks. Once the stocks are listed on the stock exchange, investors can buy and sell these stocks. Stocks can retain their status as IPO stocks for a maximum of up to 4 years.

How to Buy Stocks?

Investing smartly in stocks can be tricky, especially if you are new to investing. To help you get an overall idea about how to invest in stocks, we have listed a few options below:

Know the Various Ways of Investing:

Before you invest, you must first determine the approach that you are planning to take. You can opt to do either active or passive investing. When an investor is an active investor, he/she engages dedicatedly in the buying and selling of stocks. He/she will also monitor and track the investments actively to gain profits by grabbing opportunities whenever they arise. Active investors also need to keep track of the movement of stock prices throughout the day. On the other hand, passive investing is a long-term investment strategy wherein the investors do not trade as frequently as active investors. Passive investors typically buy and hold their investments with the aim of achieving their long-term goals. Investing in mutual funds is one of the best examples of passive investing.

Know the Amount You Want to Invest:

While investing in stocks can help you diversify your portfolio and grow your wealth, there are also risks involved as markets are never stagnant and can be volatile. It is recommended to not invest all your money but to also save a portion to fulfil personal requirements, such as funding the education of your child, planning a vacation, and so on.

Diversify Your Portfolio

Instead of putting all your money into similar kinds of stocks, you may want to diversify your portfolio by investing in different types of stocks. Doing so can help you diversify your risks.

Frequently Asked Questions

Why do people buy stocks?

People buy stocks to gain potential returns and dividends that will help them grow their wealth. Investors also buy stocks to diversify their investment portfolios.

While investing in stocks can facilitate the growth of your wealth, it also comes with some downsides. Buying stocks can be risky and it is not necessary that they will provide high returns. So, before you invest, you may want to first assess your risk appetite and the type of investment that you want to indulge in to get the most out of your investments.

What are the things to keep in mind while investing in stocks?

Some of the things that you may want to keep in mind while investing in stocks are as follows:

  • Map out your goals and financial requirements
  • You may want to do your research about the stocks you want to invest your money in
  • Evaluate your risk appetite
  • You may want to diversify your portfolio

What are the different kinds of stock?

Some of the different kinds of stocks are as follows:

  • Common Stocks and Preferred Stocks
  • Value Stocks and Growth Stocks
  • Large-cap Stocks, Mid-cap Stocks, and Small-cap Stocks
  • IPO Stocks
  • Dividend Stocks and Non-dividend Stocks
  • Blue-chip Stocks

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