Stocks 101 – Understanding the Basics and Terminology

Definition

A stock is a security that represents a fractional ownership in a company. When you buy a company’s stock, you’re purchasing a small piece of that company, called a share.

Investors purchase stocks in companies they think will go up in value. If that happens, the company’s profit increases in value as well. The stock can then be sold for a profit.

When you own stock in a company, you are called a shareholder because you share in the company’s profits.

How does it work

Public companies sell their stock through a stock market exchange, like the Nasdaq or the New York Stock Exchange. (Here’s more about the basics of the stock market.) For companies, issuing can be a way to raise money to pay off debt, launch new products, or expand their operations, according to the SEC.

For investors, investing in stocks is a way to grow your money and outpace inflation over time. When you’re a shareholder, you can make money when prices rise, you may earn dividends when the company distributes earnings, and some shareholders can vote at shareholder meetings.

Investors can buy and sell shares through stockbrokers. The exchanges track the supply and demand of each company’s, which directly affects the stock’s price.

» Learn more: Read our detailed tutorial on how to buy stocks.

Stock prices fluctuate throughout the day, but investors who own it hope that over time, it will increase in value. Not every company or stock does so, however: Companies can lose value or go out of business completely. When that happens, investors may lose all or part of their investment. That’s why it’s important for investors to diversify. A good rule of thumb is to spread your money spread their money around, buying stock in many different companies rather than focusing on just one.

If you have a 401(k), you probably already own stock, though you might not realize it. Most employer-sponsored retirement plans invest in mutual funds, which can hold a large number of company stocks pooled together.

» Dive deeper: How to diversify your investment portfolio

How to make money

Stocks carry more risk than some other investments, but also have the potential to reap higher rewards. Stock investors earn money in two main ways:

1. If the price of a stock goes up during the time you own it, and you sell it for more than you paid for it.

2. Through dividends. Dividends are regular payments to shareholders. Not all stocks pay dividends, but those that do typically do so on a quarterly basis.

» Interested in dividend income? View our list of high-dividend stocks.

Over the last century, the market has posted an average annual return of 10%. The word “average” is important here: Not only is that return an average for the market as a whole — rather than a specific individual stock — but in any given year, the market’s return can be lower or higher than 10%. for more details.

You can buy individual stocks through an online broker. The process of opening a brokerage account is similar to opening a bank account. The commissions charged by online brokers for trades vary, so it’s important to shop around. See NerdWallet’s picks for the best brokers for stock investors for more details.