Stock
Encyclopedia
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security
Security (finance)
A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into:* debt securities ,* equity securities, e.g., common stocks; and,...

 for the creditors of a business since it cannot be withdrawn to the detriment of the creditors. Stock is different from the property and the assets of a business which may fluctuate in quantity and value.

Shares

The stock of a business is divided into multiple share
Share (finance)
A joint stock company divides its capital into units of equal denomination. Each unit is called a share. These units are offered for sale to raise capital. This is termed as issuing shares. A person who buys share/shares of the company is called a shareholder, and by acquiring share or shares in...

s, the total of which must be stated at the time of business formation. Given the total amount of money invested in the business, a share has a certain declared face value, commonly known as the par value
Par value
Par value, in finance and accounting, means stated value or face value. From this comes the expressions at par , over par and under par ....

 of a share. The par value is the de minimis
De minimis
De minimis is a Latin expression meaning about minimal things, normally in the locutions de minimis non curat praetor or de minimis non curat lex .In risk assessment it refers to a level of risk that is too small to be concerned with...

(minimum) amount of money that a business may issue and sell shares for in many jurisdictions and it is the value represented as capital in the accounting of the business. In other jurisdictions, however, shares may not have an associated par value at all. Such stock is often called non-par stock. Shares represent a fraction of ownership
Ownership
Ownership is the state or fact of exclusive rights and control over property, which may be an object, land/real estate or intellectual property. Ownership involves multiple rights, collectively referred to as title, which may be separated and held by different parties. The concept of ownership has...

 in a business. A business
Business
A business is an organization engaged in the trade of goods, services, or both to consumers. Businesses are predominant in capitalist economies, where most of them are privately owned and administered to earn profit to increase the wealth of their owners. Businesses may also be not-for-profit...

 may declare different types (classes) of shares, each having distinctive ownership rules, privileges, or share values.

Ownership of shares is documented by issuance of a stock certificate
Stock certificate
In corporate law, a stock certificate is a legal document that certifies ownership of a specific number of stock shares in a corporation...

. A stock certificate is a legal document that specifies the amount of shares owned by the shareholder
Shareholder
A shareholder or stockholder is an individual or institution that legally owns one or more shares of stock in a public or private corporation. Shareholders own the stock, but not the corporation itself ....

, and other specifics of the shares, such as the par value, if any, or the class of the shares.

Usage

Used in the plural, stocks is often used as a synonym for shares. Traditionalist demands for the plural stocks to be used only when referring to stocks of more than one company are rarely heard nowadays.

In the United Kingdom
United Kingdom
The United Kingdom of Great Britain and Northern IrelandIn the United Kingdom and Dependencies, other languages have been officially recognised as legitimate autochthonous languages under the European Charter for Regional or Minority Languages...

, Republic of Ireland
Republic of Ireland
Ireland , described as the Republic of Ireland , is a sovereign state in Europe occupying approximately five-sixths of the island of the same name. Its capital is Dublin. Ireland, which had a population of 4.58 million in 2011, is a constitutional republic governed as a parliamentary democracy,...

, South Africa
South Africa
The Republic of South Africa is a country in southern Africa. Located at the southern tip of Africa, it is divided into nine provinces, with of coastline on the Atlantic and Indian oceans...

, and Australia
Australia
Australia , officially the Commonwealth of Australia, is a country in the Southern Hemisphere comprising the mainland of the Australian continent, the island of Tasmania, and numerous smaller islands in the Indian and Pacific Oceans. It is the world's sixth-largest country by total area...

, stock can also refer to completely different financial instruments
Financial instruments
A financial instrument is a tradable asset of any kind, either cash; evidence of an ownership interest in an entity; or a contractual right to receive, or deliver, cash or another financial instrument....

 such as government bonds
Bond (finance)
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...

 or, less commonly, to all kinds of marketable securities.

Types of stock

Stock typically takes the form of shares of either common stock
Common stock
Common stock is a form of corporate equity ownership, a type of security. It is called "common" to distinguish it from preferred stock. In the event of bankruptcy, common stock investors receive their funds after preferred stock holders, bondholders, creditors, etc...

 or preferred stock
Preferred stock
Preferred stock, also called preferred shares, preference shares, or simply preferreds, is a special equity security that has properties of both an equity and a debt instrument and is generally considered a hybrid instrument...

. As a unit of ownership, common stock typically carries voting rights that can be exercised in corporate decisions. Preferred stock
Preferred stock
Preferred stock, also called preferred shares, preference shares, or simply preferreds, is a special equity security that has properties of both an equity and a debt instrument and is generally considered a hybrid instrument...

 differs from common stock in that it typically does not carry voting rights but is legally entitled to receive a certain level of dividend
Dividend
Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business , or it can be distributed to...

 payments before any dividends can be issued to other shareholders. Convertible preferred stock is preferred stock that includes an option
Option (finance)
In finance, an option is a derivative financial instrument that specifies a contract between two parties for a future transaction on an asset at a reference price. The buyer of the option gains the right, but not the obligation, to engage in that transaction, while the seller incurs the...

 for the holder to convert the preferred shares into a fixed number of common shares, usually anytime after a predetermined date. Shares of such stock are called "convertible preferred shares" (or "convertible preference shares" in the UK)

New equity issues may have specific legal clauses attached that differentiate them from previous issues of the issuer. Some shares of common stock may be issued without the typical voting rights, for instance, or some shares may have special rights unique to them and issued only to certain parties. Often, new issues that have not been registered with a securities governing body may be restricted
Restricted stock
Restricted stock, also known as letter stock or restricted securities, refers to stock of a company that is not fully transferable until certain conditions have been met. Upon satisfaction of those conditions, the stock becomes transferable by the person holding the award.One type of restricted...

 from resale for certain periods of time.

Preferred stock may be hybrid by having the qualities of bonds of fixed returns and common stock voting rights. They also have preference in the payment of dividends over common stock and also have been given preference at the time of liquidation over common stock. They have other features of accumulation in dividend.

Stock derivatives

A stock derivative
Derivative (finance)
A derivative instrument is a contract between two parties that specifies conditions—in particular, dates and the resulting values of the underlying variables—under which payments, or payoffs, are to be made between the parties.Under U.S...

 is any financial instrument which has a value that is dependent on the price of the underlying
Underlying
In finance, the underlying of a derivative is an asset, basket of assets, index, or even another derivative, such that the cash flows of the derivative depend on the value of this underlying...

 stock. Futures
Futures contract
In finance, a futures contract is a standardized contract between two parties to exchange a specified asset of standardized quantity and quality for a price agreed today with delivery occurring at a specified future date, the delivery date. The contracts are traded on a futures exchange...

 and options
Option (finance)
In finance, an option is a derivative financial instrument that specifies a contract between two parties for a future transaction on an asset at a reference price. The buyer of the option gains the right, but not the obligation, to engage in that transaction, while the seller incurs the...

 are the main types of derivatives on stocks. The underlying security may be a stock index or an individual firm's stock, e.g. single-stock futures
Single-stock futures
Single-stock futuresIn finance, a single-stock futures is a type of futures contracts between two parties to exchange a specified number of stocks in company for a price agreed today with delivery occurring at a specified future date, the delivery date. The contracts are traded on a futures exchange...

.

Stock futures are contracts where the buyer is long
Long (finance)
In finance, a long position in a security, such as a stock or a bond, or equivalently to be long in a security, means the holder of the position owns the security and will profit if the price of the security goes up. Going long is the more conventional practice of investing and is contrasted with...

, i.e., takes on the obligation to buy on the contract maturity date, and the seller is short, i.e., takes on the obligation to sell. Stock index futures are generally not delivered in the usual manner, but by cash settlement.

A stock option is a class of option. Specifically, a call option
Call option
A call option, often simply labeled a "call", is a financial contract between two parties, the buyer and the seller of this type of option. The buyer of the call option has the right, but not the obligation to buy an agreed quantity of a particular commodity or financial instrument from the seller...

 is the right (not obligation) to buy stock in the future at a fixed price and a put option
Put option
A put or put option is a contract between two parties to exchange an asset, the underlying, at a specified price, the strike, by a predetermined date, the expiry or maturity...

 is the right (not obligation) to sell stock in the future at a fixed price. Thus, the value of a stock option changes in reaction to the underlying stock of which it is a derivative
Derivative (finance)
A derivative instrument is a contract between two parties that specifies conditions—in particular, dates and the resulting values of the underlying variables—under which payments, or payoffs, are to be made between the parties.Under U.S...

. The most popular method of valuing stock options is the Black Scholes model. Apart from call options granted to employees
Employee stock option
An employee stock option is a call option on the common stock of a company, issued as a form of non-cash compensation. Restrictions on the option attempt to align the holder's interest with those of the business shareholders. If the company's stock rises, holders of options generally experience a...

, most stock options are transferable.

History

During Roman
Ancient Rome
Ancient Rome was a thriving civilization that grew on the Italian Peninsula as early as the 8th century BC. Located along the Mediterranean Sea and centered on the city of Rome, it expanded to one of the largest empires in the ancient world....

 times, the empire contracted out many of its services to private groups called publicani. Shares in publicani were called "socii" (for large cooperatives) and "particulae" which were analogous to today's Over-The-Counter shares of small companies. Though the records available for this time are incomplete, Edward Chancellor states in his book Devil Take the Hindmost that there is some evidence that a speculation in these shares became increasingly widespread and that perhaps the first ever speculative bubble
Stock market bubble
A stock market bubble is a type of economic bubble taking place in stock markets when market participants drive stock prices above their value in relation to some system of stock valuation....

 in "stocks" occurred.

The first company to issue shares of stock after the Middle Ages
Middle Ages
The Middle Ages is a periodization of European history from the 5th century to the 15th century. The Middle Ages follows the fall of the Western Roman Empire in 476 and precedes the Early Modern Era. It is the middle period of a three-period division of Western history: Classic, Medieval and Modern...

 was the Dutch East India Company
Dutch East India Company
The Dutch East India Company was a chartered company established in 1602, when the States-General of the Netherlands granted it a 21-year monopoly to carry out colonial activities in Asia...

 in 1602. The innovation of joint ownership made a great deal of Europe
Europe
Europe is, by convention, one of the world's seven continents. Comprising the westernmost peninsula of Eurasia, Europe is generally 'divided' from Asia to its east by the watershed divides of the Ural and Caucasus Mountains, the Ural River, the Caspian and Black Seas, and the waterways connecting...

's economic growth
Economic growth
In economics, economic growth is defined as the increasing capacity of the economy to satisfy the wants of goods and services of the members of society. Economic growth is enabled by increases in productivity, which lowers the inputs for a given amount of output. Lowered costs increase demand...

 possible following the Middle Ages
Middle Ages
The Middle Ages is a periodization of European history from the 5th century to the 15th century. The Middle Ages follows the fall of the Western Roman Empire in 476 and precedes the Early Modern Era. It is the middle period of a three-period division of Western history: Classic, Medieval and Modern...

. The technique of pooling capital to finance the building of ships, for example, made the Netherlands
Netherlands
The Netherlands is a constituent country of the Kingdom of the Netherlands, located mainly in North-West Europe and with several islands in the Caribbean. Mainland Netherlands borders the North Sea to the north and west, Belgium to the south, and Germany to the east, and shares maritime borders...

 a maritime
Shipping
Shipping has multiple meanings. It can be a physical process of transporting commodities and merchandise goods and cargo, by land, air, and sea. It also can describe the movement of objects by ship.Land or "ground" shipping can be by train or by truck...

 superpower
Superpower
A superpower is a state with a dominant position in the international system which has the ability to influence events and its own interests and project power on a worldwide scale to protect those interests...

. Before adoption of the joint-stock corporation, an expensive venture such as the building of a merchant ship could be undertaken only by governments or by very wealthy individuals or families.

Economic historians find the Dutch stock market of the 17th century particularly interesting: there is clear documentation of the use of stock futures, stock options, short selling
Short selling
In finance, short selling is the practice of selling assets, usually securities, that have been borrowed from a third party with the intention of buying identical assets back at a later date to return to that third party...

, the use of credit to purchase shares, a speculative bubble that crashed in 1695, and a change in fashion that unfolded and reverted in time with the market (in this case it was headdresses instead of hemline
Hemline
The hemline is the line formed by the lower edge of a garment, such as a skirt, dress or coat, measured from the floor.The hemline is perhaps the most variable style line in fashion, changing shape and ranging in height from hip-high to floor-length...

s). Dr. Edward Stringham
Edward Stringham
Edward Peter Stringham is the L.V. Hackley Endowed Professor for the Study of Capitalism and Free Enterprise at Fayetteville State University.He received a B.A. in economics from College of the Holy Cross and his Ph.D...

 also noted that the uses of practices such as short selling continued to occur during this time despite the government passing laws against it. This is unusual because it shows individual parties fulfilling contracts that were not legally enforceable and where the parties involved could incur a loss. Stringham argues that this shows that contracts can be created and enforced without state sanction or, in this case, in spite of laws to the contrary.

Shareholder

A shareholder (or stockholder) is an individual
Individual
An individual is a person or any specific object or thing in a collection. Individuality is the state or quality of being an individual; a person separate from other persons and possessing his or her own needs, goals, and desires. Being self expressive...

 or company (including a corporation
Corporation
A corporation is created under the laws of a state as a separate legal entity that has privileges and liabilities that are distinct from those of its members. There are many different forms of corporations, most of which are used to conduct business. Early corporations were established by charter...

) that legally owns one or more share
Share (finance)
A joint stock company divides its capital into units of equal denomination. Each unit is called a share. These units are offered for sale to raise capital. This is termed as issuing shares. A person who buys share/shares of the company is called a shareholder, and by acquiring share or shares in...

s of stock in a joint stock company
Joint stock company
A joint-stock company is a type of corporation or partnership involving two or more individuals that own shares of stock in the company...

. Both private and public traded companies have shareholders. Companies listed at the stock market
Stock market
A stock market or equity market is a public entity for the trading of company stock and derivatives at an agreed price; these are securities listed on a stock exchange as well as those only traded privately.The size of the world stock market was estimated at about $36.6 trillion...

 are expected to strive to enhance shareholder value
Shareholder value
Shareholder value is a business term, sometimes phrased as shareholder value maximization or as the shareholder value model, which implies that the ultimate measure of a company's success is the extent to which it enriches shareholders...

.

Shareholders are granted special privileges depending on the class of stock, including the right to vote on matters such as elections to the board of directors
Board of directors
A board of directors is a body of elected or appointed members who jointly oversee the activities of a company or organization. Other names include board of governors, board of managers, board of regents, board of trustees, and board of visitors...

, the right to share in distributions of the company's income, the right to purchase new shares issued by the company, and the right to a company's assets during a liquidation
Liquidation
In law, liquidation is the process by which a company is brought to an end, and the assets and property of the company redistributed. Liquidation is also sometimes referred to as winding-up or dissolution, although dissolution technically refers to the last stage of liquidation...

 of the company. However, shareholder's rights to a company's assets are subordinate to the rights of the company's creditors.

Shareholders are considered by some to be a partial subset
Subset
In mathematics, especially in set theory, a set A is a subset of a set B if A is "contained" inside B. A and B may coincide. The relationship of one set being a subset of another is called inclusion or sometimes containment...

 of stakeholders, which may include anyone who has a direct or indirect equity interest in the business entity or someone with even a non-pecuniary interest in a non-profit organization
Non-profit organization
Nonprofit organization is neither a legal nor technical definition but generally refers to an organization that uses surplus revenues to achieve its goals, rather than distributing them as profit or dividends...

. Thus it might be common to call volunteer contributors to an association
Voluntary association
A voluntary association or union is a group of individuals who enter into an agreement as volunteers to form a body to accomplish a purpose.Strictly speaking, in many jurisdictions no formalities are necessary to start an association...

 stakeholders, even though they are not shareholders.

Although directors and officers of a company are bound by fiduciary duties to act in the best interest of the shareholders, the shareholders themselves normally do not have such duties towards each other.

However, in a few unusual cases, some courts have been willing to imply such a duty between shareholders. For example, in California
California
California is a state located on the West Coast of the United States. It is by far the most populous U.S. state, and the third-largest by land area...

, USA
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...

, majority shareholders of closely held corporations have a duty to not destroy the value of the shares held by minority shareholders.

The largest shareholders (in terms of percentages of companies owned) are often mutual funds, and, especially, passively managed exchange-traded fund
Exchange-traded fund
An exchange-traded fund is an investment fund traded on stock exchanges, much like stocks. An ETF holds assets such as stocks, commodities, or bonds, and trades close to its net asset value over the course of the trading day. Most ETFs track an index, such as the S&P 500 or MSCI EAFE...

s.

Application

The owners of a company may want additional capital to invest in new projects within the company. They may also simply wish to reduce their holding, freeing up capital for their own private use.

By selling shares they can sell part or all of the company to many part-owners. The purchase of one share entitles the owner of that share to literally share in the ownership of the company, a fraction of the decision-making power, and potentially a fraction of the profits, which the company may issue as dividend
Dividend
Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business , or it can be distributed to...

s.

In the common case of a publicly traded corporation, where there may be thousands of shareholders, it is impractical to have all of them making the daily decisions required to run a company. Thus, the shareholders will use their shares as votes in the election of members of the board of directors
Board of directors
A board of directors is a body of elected or appointed members who jointly oversee the activities of a company or organization. Other names include board of governors, board of managers, board of regents, board of trustees, and board of visitors...

 of the company.

In a typical case, each share constitutes one vote. Corporations may, however, issue different classes of shares, which may have different voting rights. Owning the majority of the shares allows other shareholders to be out-voted – effective control rests with the majority shareholder (or shareholders acting in concert). In this way the original owners of the company often still have control of the company.

Shareholder rights

Although ownership of 50% of shares does result in 50% ownership of a company, it does not give the shareholder the right to use a company's building, equipment, materials, or other property. This is because the company is considered a legal person, thus it owns all its assets itself. This is important in areas such as insurance, which must be in the name of the company and not the main shareholder.

In most countries, boards of directors
Board of directors
A board of directors is a body of elected or appointed members who jointly oversee the activities of a company or organization. Other names include board of governors, board of managers, board of regents, board of trustees, and board of visitors...

 and company managers have a fiduciary responsibility to run the company in the interests of its stockholders. Nonetheless, as Martin Whitman
Martin J. Whitman
Martin J. Whitman is an American investment advisor and a strong critic of the direction of recent changes in Generally Accepted Accounting Principles in the U.S...

 writes:
...it can safely be stated that there does not exist any publicly traded company where management works exclusively in the best interests of OPMI [Outside Passive Minority Investor] stockholders. Instead, there are both "communities of interest" and "conflicts of interest" between stockholders (principal) and management (agent). This conflict is referred to as the principal/agent problem. It would be naive to think that any management would forgo management compensation, and management entrenchment, just because some of these management privileges might be perceived as giving rise to a conflict of interest with OPMIs.


Even though the board of directors runs the company, the shareholder has some impact on the company's policy, as the shareholders elect the board of directors. Each shareholder typically has a percentage of votes equal to the percentage of shares he or she owns. So as long as the shareholders agree that the management (agent) are performing poorly they can elect a new board of directors which can then hire a new management team. In practice, however, genuinely contested board elections are rare. Board candidates are usually nominated by insiders or by the board of the directors themselves, and a considerable amount of stock is held or voted by insiders.

Owning shares does not mean responsibility for liabilities. If a company goes broke and has to default on loans, the shareholders are not liable in any way. However, all money obtained by converting assets into cash will be used to repay loans and other debts first, so that shareholders cannot receive any money unless and until creditors have been paid (often the shareholders end up with nothing).

Means of financing

Financing a company through the sale of stock in a company is known as equity
Ownership equity
In accounting and finance, equity is the residual claim or interest of the most junior class of investors in assets, after all liabilities are paid. If liability exceeds assets, negative equity exists...

 financing. Alternatively, debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...

 financing (for example issuing bond
Bond (finance)
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...

s) can be done to avoid giving up shares of ownership of the company. Unofficial financing known as trade financing usually provides the major part of a company's working capital
Working capital
Working capital is a financial metric which represents operating liquidity available to a business, organization or other entity, including governmental entity. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital. Net working capital is...

 (day-to-day operational needs).

Trading

The shares of a company may in general be transferred from shareholders to other parties by sale or other mechanisms, unless prohibited. Most jurisdictions have established laws and regulations governing such transfers, particularly if the issuer is a publicly-traded entity.

The desire of stockholders to trade their shares has led to the establishment of stock exchange
Stock exchange
A stock exchange is an entity that provides services for stock brokers and traders to trade stocks, bonds, and other securities. Stock exchanges also provide facilities for issue and redemption of securities and other financial instruments, and capital events including the payment of income and...

s. A stock exchange is an organization that provides a marketplace for trading shares and other derivatives and financial products. Today, investors are usually represented by a stock broker
Stock broker
A stock broker or stockbroker is a regulated professional broker who buys and sells shares and other securities through market makers or Agency Only Firms on behalf of investors...

 who buys and sells shares of a wide range of companies on the exchanges. A company may list its shares on an exchange by meeting and maintaining the listing requirements of a particular stock exchange. In the United States, through the inter-market quotation system, stocks listed on one exchange can also be traded on other participating exchanges, including the Electronic Communication Network
Electronic Communication Network
An electronic communication network is the term used in financial circles for a type of computer system that facilitates trading of financial products outside of stock exchanges. The primary products that are traded on ECNs are stocks and currencies. The first ECN, Instinet, was created in 1969...

s (ECNs), such as Archipelago or Instinet.

Many large non-U.S companies choose to list on a U.S. exchange as well as an exchange in their home country in order to broaden their investor base. These companies must maintain a block of shares at a bank in the US, typically a certain percentage of their capital. On this basis, the holding bank establishes American Depositary Shares and issues an American Depository Receipt (ADR) for each share a trader acquires. Likewise, many large U.S. companies list their shares at foreign exchanges to raise capital abroad.

Small companies that do not qualify and cannot meet the listing requirements of the major exchanges may be traded over the counter
Over-the-counter (finance)
Within the derivatives markets, many products are traded through exchanges. An exchange has the benefit of facilitating liquidity and also mitigates all credit risk concerning the default of a member of the exchange. Products traded on the exchange must be well standardised to transparent trading....

 (OTC) by an off-exchange mechanism in which trading occurs directly between parties. The major OTC markets in the United States are the electronic quotation systems OTC Bulletin Board
OTC Bulletin Board
The OTC Bulletin Board or OTCBB is an interdealer electronic quotation system in the United States that displays real-time quotes, last-sale prices, and volume information for many over-the-counter equity securities that are not listed on the NASDAQ stock exchange or a national securities exchange...

 (OTCBB) and the Pink OTC Markets (Pink Sheets
Pink Sheets
OTC Markets Group, Inc., informally known as "Pink Sheets", is a private company that provides services to the U.S. over-the-counter securities market including electronic quotations, trading, messaging, and information platforms. According to the U.S. Securities and Exchange Commission, OTC...

) where individual retail investors are also represented by a brokerage firm and the quotation service's requirements for a company to be listed are minimal. Shares of companies in bankruptcy proceeding are usually listed by these quotation services after the stock is delisted from an exchange.

Buying

There are various methods of buying and financing stocks. The most common means is through a stock broker
Stock broker
A stock broker or stockbroker is a regulated professional broker who buys and sells shares and other securities through market makers or Agency Only Firms on behalf of investors...

. Whether they are a full service
Full service
Full service is a term that has many different uses. In general the term implies that the customer will receive as much service as is reasonably possible.-Gas station:...

 or discount
Discounts and allowances
Discounts and allowances are reductions to a basic price of goods or services.They can occur anywhere in the distribution channel, modifying either the manufacturer's list price , the retail price , or the list price Discounts and allowances are reductions to a basic price of goods or services.They...

 broker, they arrange the transfer of stock from a seller to a buyer. Most trades are actually done through brokers listed with a stock exchange.

There are many different stock brokers from which to choose, such as full service brokers or discount brokers. The full service brokers usually charge more per trade, but give investment advice or more personal service; the discount brokers offer little or no investment advice but charge less for trades. Another type of broker would be a bank
Bank
A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...

 or credit union
Credit union
A credit union is a cooperative financial institution that is owned and controlled by its members and operated for the purpose of promoting thrift, providing credit at competitive rates, and providing other financial services to its members...

 that may have a deal set up with either a full service or discount broker.

There are other ways of buying stock besides through a broker. One way is directly from the company itself. If at least one share is owned, most companies will allow the purchase of shares directly from the company through their investor relations
Investor relations
Investor Relations is a strategic management responsibility that integrates finance, communication, marketing and securities law compliance to enable the most effective two-way communication between a company, the financial community, and other constituencies, which ultimately contributes to a...

 departments. However, the initial share of stock in the company will have to be obtained through a regular stock broker. Another way to buy stock in companies is through Direct Public Offerings which are usually sold by the company itself. A direct public offering is an initial public offering
Initial public offering
An initial public offering or stock market launch, is the first sale of stock by a private company to the public. It can be used by either small or large companies to raise expansion capital and become publicly traded enterprises...

 in which the stock is purchased directly from the company, usually without the aid of brokers.

When it comes to financing a purchase of stocks there are two ways: purchasing stock with money that is currently in the buyer's ownership, or by buying stock on margin. Buying stock on margin means buying stock with money borrowed against the stocks in the same account. These stocks, or collateral
Collateral (finance)
In lending agreements, collateral is a borrower's pledge of specific property to a lender, to secure repayment of a loan.The collateral serves as protection for a lender against a borrower's default - that is, any borrower failing to pay the principal and interest under the terms of a loan obligation...

, guarantee that the buyer can repay the loan
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....

; otherwise, the stockbroker has the right to sell the stock (collateral) to repay the borrowed money. He can sell if the share price
Share price
A share price is the price of a single share of a number of saleable stocks of a company. Once the stock is purchased, the owner becomes a shareholder of the company that issued the share.-Behavior of share prices:...

 drops below the margin requirement, at least 50% of the value of the stocks in the account. Buying on margin works the same way as borrowing money to buy a car or a house, using a car or house as collateral. Moreover, borrowing is not free; the broker usually charges 8–10% interest.

Selling

Selling stock is procedurally similar to buying stock. Generally, the investor wants to buy low and sell high, if not in that order (short selling
Short selling
In finance, short selling is the practice of selling assets, usually securities, that have been borrowed from a third party with the intention of buying identical assets back at a later date to return to that third party...

); although a number of reasons may induce an investor to sell at a loss, e.g., to avoid further loss.

As with buying a stock, there is a transaction fee for the broker's efforts in arranging the transfer of stock from a seller to a buyer. This fee can be high or low depending on which type of brokerage, full service or discount, handles the transaction.

After the transaction has been made, the seller is then entitled to all of the money. An important part of selling is keeping track of the earnings. Importantly, on selling the stock, in jurisdictions that have them, capital gains tax
Capital gains tax
A capital gains tax is a tax charged on capital gains, the profit realized on the sale of a non-inventory asset that was purchased at a lower price. The most common capital gains are realized from the sale of stocks, bonds, precious metals and property...

es will have to be paid on the additional proceeds, if any, that are in excess of the cost basis.

Stock price fluctuations

The price of a stock fluctuates fundamentally due to the theory of supply and demand
Supply and demand
Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers will equal the quantity supplied by producers , resulting in an...

. Like all commodities in the market, the price of a stock is sensitive to demand. However, there are many factors that influence the demand for a particular stock. The fields of fundamental analysis
Fundamental analysis
Fundamental analysis of a business involves analyzing its financial statements and health, its management and competitive advantages, and its competitors and markets. When applied to futures and forex, it focuses on the overall state of the economy, interest rates, production, earnings, and...

 and technical analysis
Technical analysis
In finance, technical analysis is security analysis discipline for forecasting the direction of prices through the study of past market data, primarily price and volume. Behavioral economics and quantitative analysis incorporate technical analysis, which being an aspect of active management stands...

 attempt to understand market conditions that lead to price changes, or even predict future price levels. A recent study shows that customer satisfaction, as measured by the American Customer Satisfaction Index
American Customer Satisfaction Index
The American Customer Satisfaction Index is an economic indicator that measures the satisfaction of consumers across the U.S. economy. It is produced by the American Customer Satisfaction Index, a private company based in Ann Arbor, Michigan....

 (ACSI), is significantly correlated to the market value of a stock. Stock price may be influenced by analyst's business forecast for the company and outlooks for the company's general market segment. Stocks can also fluctuate greatly due to pump and dump
Pump and dump
"Pump and dump" is a form of microcap stock fraud that involves artificially inflating the price of an owned stock through false and misleading positive statements, in order to sell the cheaply purchased stock at a higher price....

 scams.

Share price determination

At any given moment, an equity's price is strictly a result of supply and demand. The supply, commonly referred to as the float
Public float
The float of a company whose stock is publicly traded has different default meanings depending on the presumed context.Without a qualifier it may refer to the entire market capitalization of the company or only its publicly traded equity....

, is the number of shares offered for sale at any one moment. The demand is the number of shares investors wish to buy at exactly that same time. The price of the stock moves in order to achieve and maintain equilibrium
Economic equilibrium
In economics, economic equilibrium is a state of the world where economic forces are balanced and in the absence of external influences the values of economic variables will not change. It is the point at which quantity demanded and quantity supplied are equal...

. The product of this instantaneous price and the float at any one time is the market capitalization
Market capitalization
Market capitalization is a measurement of the value of the ownership interest that shareholders hold in a business enterprise. It is equal to the share price times the number of shares outstanding of a publicly traded company...

 of the entity offering the equity at that point in time.

When prospective buyers outnumber sellers, the price rises. Eventually, sellers attracted to the high selling price enter the market and/or buyers leave, achieving equilibrium between buyers and sellers. When sellers outnumber buyers, the price falls. Eventually buyers enter and/or sellers leave, again achieving equilibrium.

Thus, the value of a share of a company at any given moment is determined by all investors voting with their money. If more investors want a stock and are willing to pay more, the price will go up. If more investors are selling a stock and there aren't enough buyers, the price will go down.
  • Note: "For Nasdaq
    NASDAQ
    The NASDAQ Stock Market, also known as the NASDAQ, is an American stock exchange. "NASDAQ" originally stood for "National Association of Securities Dealers Automated Quotations". It is the second-largest stock exchange by market capitalization in the world, after the New York Stock Exchange. As of...

    -listed stocks, the price quote includes information on the bid and ask prices for the stock."


Of course, that does not explain how people decide the maximum price at which they are willing to buy or the minimum at which they are willing to sell. In professional investment circles the efficient market hypothesis
Efficient market hypothesis
In finance, the efficient-market hypothesis asserts that financial markets are "informationally efficient". That is, one cannot consistently achieve returns in excess of average market returns on a risk-adjusted basis, given the information available at the time the investment is made.There are...

 (EMH) continues to be popular, although this theory is widely discredited in academic and professional circles. Briefly, EMH says that investing is overall (weighted by a Stdev) rational; that the price of a stock at any given moment represents a rational evaluation of the known information that might bear on the future value of the company; and that share prices of equities are priced efficiently, which is to say that they represent accurately the expected value
Expected value
In probability theory, the expected value of a random variable is the weighted average of all possible values that this random variable can take on...

 of the stock, as best it can be known at a given moment. In other words, prices are the result of discounting expected future cash flows.

The EMH model, if true, has at least two interesting consequences. First, because financial risk is presumed to require at least a small premium on expected value, the return on equity
Return on equity
Return on equity measures the rate of return on the ownership interest of the common stock owners. It measures a firm's efficiency at generating profits from every unit of shareholders' equity . ROE shows how well a company uses investment funds to generate earnings growth...

 can be expected to be slightly greater than that available from non-equity investments: if not, the same rational calculations would lead equity investors to shift to these safer non-equity investments that could be expected to give the same or better return at lower risk. Second, because the price of a share at every given moment is an "efficient" reflection of expected value, then—relative to the curve of expected return—prices will tend to follow a random walk
Random walk
A random walk, sometimes denoted RW, is a mathematical formalisation of a trajectory that consists of taking successive random steps. For example, the path traced by a molecule as it travels in a liquid or a gas, the search path of a foraging animal, the price of a fluctuating stock and the...

, determined by the emergence of information (randomly) over time. Professional equity investors therefore immerse themselves in the flow of fundamental information, seeking to gain an advantage over their competitors (mainly other professional investors) by more intelligently interpreting the emerging flow of information (news).

The EMH model does not seem to give a complete description of the process of equity price determination. For example, stock markets are more volatile than EMH would imply. In recent years it has come to be accepted that the share markets are not perfectly efficient, perhaps especially in emerging markets or other markets that are not dominated by well-informed professional investors.

Another theory of share price determination comes from the field of Behavioral Finance
Behavioral finance
Behavioral economics and its related area of study, behavioral finance, use social, cognitive and emotional factors in understanding the economic decisions of individuals and institutions performing economic functions, including consumers, borrowers and investors, and their effects on market...

. According to Behavioral Finance, humans often make irrational decisions—particularly, related to the buying and selling of securities—based upon fears and misperceptions of outcomes. The irrational trading of securities can often create securities prices which vary from rational, fundamental price valuations. For instance, during the technology bubble of the late 1990s (which was followed by the dot-com bust of 2000–2002), technology companies were often bid beyond any rational fundamental value because of what is commonly known as the "greater fool theory". The "greater fool theory" holds that, because the predominant method of realizing returns in equity is from the sale to another investor, one should select securities that they believe that someone else will value at a higher level at some point in the future, without regard to the basis for that other party's willingness to pay a higher price.
Thus, even a rational investor may bank on others' irrationality.

Arbitrage trading

When companies raise capital by offering stock on more than one exchange, the potential exists for discrepancies in the valuation of shares on different exchanges. A keen investor with access to information about such discrepancies may invest in expectation of their eventual convergence, known as arbitrage
Arbitrage
In economics and finance, arbitrage is the practice of taking advantage of a price difference between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices...

 trading. Electronic trading
Electronic trading
Electronic trading, sometimes called etrading, is a method of trading securities , foreign exchange or financial derivatives electronically...

 has resulted in extensive price transparency (efficient market hypothesis
Efficient market hypothesis
In finance, the efficient-market hypothesis asserts that financial markets are "informationally efficient". That is, one cannot consistently achieve returns in excess of average market returns on a risk-adjusted basis, given the information available at the time the investment is made.There are...

) and these discrepancies, if they exist, are short-lived and quickly equilibrated.

See also

  • Arrangements between railroads
    Arrangements between railroads
    Railway companies can interact with and control others in many ways. These relationships can be complicated by bankruptcies.-Operating:Often, when a railroad first opens, it is only a short spur of a main line. The owner of the spur line may contract with the owner of the main line for operation of...

  • Boiler room
    Boiler room (business)
    In business, the term boiler room refers to a busy centre of activity, often selling questionable goods by telephone. It typically refers to a room where salesmen work using unfair, dishonest sales tactics, sometimes selling penny stock or committing outright stock fraud...

  • Bucket shop
    Bucket shop (stock market)
    As defined by the U.S. Supreme Court a Bucket shop is "[a]n establishment, nominally for the transaction of a stock exchange business, or business of similar character, but really for the registration of bets, or wagers, usually for small amounts, on the rise or fall of the prices of stocks, grain,...

  • Buying in (securities)
    Buying in (securities)
    In the securities market buying in refers to a process by which the buyer of securities, whose seller fails to deliver the securities contracted for, can 'buy in' the securities from a third party with the defaulting seller to make good....

  • Concentrated stock
    Concentrated stock
    Concentrated stock is an equity making up a substantial part of the investor's portfolio. The major risk associated with such a portfolio is a lack of diversification; concentrated stock makes a large portion of the investor's wealth dependent on the performance of one particular stock...

  • Direct Registration System
  • Equity investment
  • Exchange-traded fund
    Exchange-traded fund
    An exchange-traded fund is an investment fund traded on stock exchanges, much like stocks. An ETF holds assets such as stocks, commodities, or bonds, and trades close to its net asset value over the course of the trading day. Most ETFs track an index, such as the S&P 500 or MSCI EAFE...


  • GICS
    Global Industry Classification Standard
    The Global Industry Classification Standard is an industry taxonomy developed by MSCI and Standard & Poor's for use by the global financial community. The GICS structure consists of 10 sectors, 24 industry groups, 68 industries and 154 sub-industries into which S&P has categorized all major...

  • Golden share
    Golden Share
    A Golden Share is a nominal share which is able to outvote all other shares in certain specified circumstances, often held by a government organization, in a government company undergoing the process of privatization and transformation into a stock-company....

  • House stock
    House stock
    The term house stock usually refers to a stock that the management of a brokerage firm has instructed all brokers working for it to promote. The brokerage firm or its owners might be receiving an undisclosed profit from the sale of the house stock....

  • Insider trading
    Insider trading
    Insider trading is the trading of a corporation's stock or other securities by individuals with potential access to non-public information about the company...

  • Money managers
  • Naked short selling
    Naked short selling
    Naked short selling, or naked shorting, is the practice of short-selling a financial instrument without first borrowing the security or ensuring that the security can be borrowed, as is conventionally done in a short sale. When the seller does not obtain the shares within the required time frame,...

  • Penny stock
    Penny stock
    In the United States, penny stocks are common shares of small public companies that trade at less than $1.00. In some countries, similar shares of stock are known as cent stocks.-Concerns for investors:...


  • Scripophily
    Scripophily
    Scripophily is the study and collection of stock and bond certificates. A specialized field of numismatics, scripophily is an interesting area of collecting due to both the inherent beauty of some historical documents as well as the interesting historical context of each document. Some stock...

  • Stock and flow
    Stock and flow
    Economics, business, accounting, and related fields often distinguish between quantities that are stocks and those that are flows. These differ in their units of measurement. A stock variable is measured at one specific time, and represents a quantity existing at that point in time , which may have...

  • Stock dilution
    Stock dilution
    Stock dilution is a general term that results from the issue of additional common shares by a company. This increase in common shares of a stock can result from a secondary market offering, employees exercising stock options, or by conversion of convertible bonds, preferred shares or warrants into...

  • Stock valuation
    Stock valuation
    In financial markets, stock valuation is the method of calculating theoretical values of companies and their stocks. The main use of these methods is to predict future market prices, or more generally potential market prices, and thus to profit from price movement – stocks that are judged...

  • Stub (stock)
    Stub (stock)
    A stub is the stock representing the remaining equity in a corporation left over after a major cash or security distribution from a buyout, a spin-out, a demerger or some other form of restructuring removes most of the company's operations from the parent corporation...

  • Tracking stock
    Tracking stock
    Tracking stock or targeted stock are specialized equity offerings issued by a company that is based on the operations of a wholly owned subsidiary of a diversified firm. Therefore, the tracking stock will be traded at a price related to the operations of the specific division of the company being...

  • Voting interest
    Voting interest
    Voting interest in business and accounting means the total number of votes entitled to be cast on the issue at the time the determination of voting power is made, excluding a vote which is contingent upon the happening of a condition or event which has not occurred at the time.This notion is...



External links

The source of this article is wikipedia, the free encyclopedia.  The text of this article is licensed under the GFDL.
 
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