U.S. culture is replete with stories of those who made fortunes the stock market, as well as those who lost their life savings in the infamous "crashes" of 1929 and 1987. These extremes represent the basic advantage and disadvantage of trading stocks.
Stock is a company’s initial capital. A company “goes public,” meaning ownership moves from private individuals to whoever buys a share, when it splits this capital into units called shares and auctions them off. Shareholders have the advantage of owning a part of the profits of the company but also risk losing the money that they’ve invested if stock prices fall due to bad business decisions, a sour economy or bankruptcy.
While companies sell stock initially to investors, investors and brokers trade stocks with each other on the stock market. Many institutions such as investment banks and hedge funds buy and sell stocks on the stock market as well. Only licensed brokers can actually trade stocks; private investors trade through a broker, who can be a person with whom the investor has regular and personal contact, or through an online brokerage service. Brokers charge commissions on trades.
In the long run, putting your money in the stock market is a good investment. The stock market overall does increase wealth substantially but the growth is only consistent over decades. In the short term, it is possible to make a considerable amount of money trading stocks on a regular basis but this is a much riskier activity.
While the stock market tends towards substantial growth in the long term, this growth is incredibly volatile and inconsistent in the short term. Many investors lose money by selling their stocks when the market is down or have the misfortune to need access to their investments right after a large drop in the market. Furthermore, stock performance varies considerably from company to company. Investors may lose money if a company makes bad business decisions or encounters other problems and there is the possibility of losing their entire investment if a company goes bankrupt.
Stocks in History
Financial products similar to stock—and the agents and marketplaces that deal in them—have been around since before the Industrial Revolution. In medieval Italy, merchants used to outfit ships by selling rights to some of the ship’s future profits. Similar to today’s stock market, investors were attracted to these shares because ships returning to Italy with a cargo of spices and silks sold the cargo for many times more money than the cost of supplying an outgoing ship. However, these journeys took years, during which time many ships were lost due to storms, disease, pirates and other dangers. Hence, these investments carried a high risk of failure in exchange for the possibility of high profits, similar to the stock market today.
Calla Hummel is a doctoral student studying contraband in international political economy. She supplements her student stipend by writing about personal finance and working as a consultant, as well as hoping that her investments will pan out.