How Money Really Works, Part 8: How the Stock Market Works

7. What do you really own when you buy a share

Every share is a small piece of a real company. Here is how the stock market works, in seven parts. Number seven: what do you really own when you buy a share? A market regulator's investor guide says stocks give stockholders a share of ownership in a company.

Stocks are also called equities, the same guide says. An industry regulator's guide says your return depends on the success or failure of that company. The market also puts a value on the whole company. That value is called market capitalization: the price of one share times the number of shares outstanding, the market regulator's guide says.

The industry guide calls market cap one measure of a company's size. It says a small company might be valued at less than $2 billion, and a large one at over 10 billion. It adds that there are no fixed cutoff points, and the numbers might be twice those amounts. Which companies you can buy, and how, depends on the rules where you live.

Companies choose to sell those pieces, and number six shows why. Subscribe for the next parts of this series: every source here is an official investor guide, linked below.

6. Why would a company sell pieces of itself

Number six: why would a company sell pieces of itself? To get money, a market regulator's guide says, for things like paying off debt or launching new products. It also lists expanding into new markets or regions, and enlarging facilities or building new ones. One kind of public offering is the initial public offering, or IPO, the same guide says.

A company is commonly considered public when its shares trade on public markets, the market regulator's guide says. And when it regularly shares business and financial information with the public. Public companies must keep their shareholders informed on a regular basis, the guide adds. That regulator makes those reports public, without charge.

Annual reports include financial statements audited by an independent audit firm, the same guide says. Listing and offering rules differ where you live. Once shares are sold, they change hands between investors, and number five shows how.

5. How does your order to buy a share actually get filled

Number five: how does your order to buy a share actually get filled? Many investors who trade online assume they connect straight to the market, but they don't, a market regulator's guide says. When you place an order online, it goes to your broker, who decides which market to send it to. Trade execution is usually seamless and quick, the guide says, but it does take time.

And prices can change quickly, especially in fast-moving markets. By the time your order reaches the market, the guide says, the price could be slightly or very different. Your broker may send the order to an exchange, or to a firm called a market maker. A market maker stands ready to buy or sell a stock listed on an exchange at publicly quoted prices.

To buy individual stocks, an industry regulator's guide says, you almost always need an account at a brokerage firm. That holds whether you use an app, trade online or give orders to an investment professional. The few exceptions include buying or selling shares directly from a company. Buying that way, without a broker, saves on commissions, a market regulator's guide says.

You may still pay other fees, it adds. Discount brokerage firms offer fewer services but generally charge less to execute your orders, the industry guide says. You also choose the kind of order. A market order buys or sells right away, but it does not guarantee the price, the market regulator's guide says.

A limit order buys or sells only at a price you set or better. In the guide's own example, an investor wants a stock for no more than $10. That limit order only goes through if the price is $10 or lower. Fees and order rules differ between brokers and where you live.

Once you own the share, its price keeps moving, and number four shows what moves it.

4. Why does a share's price go up and down all day

Number four: why does a share's price go up and down all day? Stocks are bought and sold constantly throughout each trading day, an industry regulator's guide says. And their prices change all the time, it adds. Strong demand, with many investors wanting to buy, tends to push a share's price up.

Investor demand typically reflects the prospects for the company's future performance, the guide says. If the company is not profitable, or investors are selling rather than buying, shares may be worth less than you paid. A single stock is also affected by what is happening in the stock market in general, the guide says. For example, if interest rates go up, some investors might sell stock to buy bonds.

Political uncertainty, energy or weather problems, or soaring company profits can move markets as well. Defensive stocks, the guide says, are in industries that offer what people need, however the economy is doing. Its examples are filling medical prescriptions, using electricity and buying groceries. Cyclical stocks, like travel and luxury goods, are very sensitive to economic ups and downs.

Their share prices can rebound sharply when the economy gains strength, the guide says. A common share's price can rise and fall by just a few cents or by several dollars. A measure called beta above 1.0 means a stock swings more than the overall market, the guide says. At a certain point, it says, prices get low enough to attract investors again.

That pattern of strength and weakness recurs continually, though the schedule is not predictable. Trading hours and market rules differ where you live. That's four of the seven, and one idea makes the last three easier: a share is a piece of a company. Owning that piece can also pay you along the way, and number three shows how.

3. What do you get back for owning a share

Number three: what do you get back for owning a share? Owners can gain in two main ways, dividends and capital gains, an industry regulator's guide says. A dividend is a portion of a company's profit paid to shareholders, a market regulator's glossary says. Companies that pay dividends usually do so on a fixed schedule, it adds.

You can take dividends in cash or reinvest them to buy more shares in the company. Capital gains come when a share's price rises enough to cover any trading fees and you sell at a profit. Growth stocks rarely pay dividends, the market regulator's guide says, and investors buy them in the hope the price rises. Income stocks pay dividends consistently, it adds.

Blue-chip stocks are shares in large, well-known companies with a solid history of growth, and they generally pay dividends. Owners of common stock can also vote at shareholder meetings, the market regulator's guide says. Preferred stockholders usually do not vote, but they receive dividends before common stockholders do. A company does not have to pay a dividend, and it can cut or stop one, the industry guide adds.

How dividends and gains are taxed differs where you live. If you want the full picture on prices, the video on protecting your money from inflation is linked on screen. In one breath: a share is a piece of a company, sold to raise money, priced by demand, with two ways to gain. Prices go down as well as up, and number two shows how often.

2. How often do share prices fall

Number two: how often do share prices fall? Stock prices move down as well as up, a market regulator's guide says. Large company stocks as a group have lost money on average about one out of every three years, it says. By our count, that leaves about two years out of three without a loss, on average.

Even when companies are not in danger of failing, their price may go up or down, the market regulator's guide says. If you sell on a day when the price is below what you paid, you lose money on that sale. That is why an industry regulator's guide says stocks for a short-term goal can be risky. When buyers come back, it says, prices tend to rise and can reverse the paper losses of those who stayed in.

A price can move on things inside the company, like a faulty product, or on events it does not control. Market rules and protections differ where you live. So time matters, and here is a question before number one. How many years do you think the market regulator's guide names for staying in stocks?

1. What helps shares grow your money over time

Number one: what helps shares grow your money over time? Over the long haul, stocks offer the greatest potential for growth, a market regulator's guide says. It adds that investors who stick with stocks over long periods, say fifteen years, generally have been rewarded with strong, positive returns. There's no guarantee a company you own will grow and do well, the market regulator's guide says.

By our count, at one losing year in three, fifteen years averages about ten years without a loss. An industry regulator's guide adds that stocks have historically outperformed bonds over the long term. If the company does well with what it sells, its stock price is likely to reflect that success, that guide says. The market regulator's guide says the risks can be offset in part by investing in a number of different stocks.

Investing in other assets, such as bonds, is another way to offset some of the risks. Stocks usually are one part of an investor's holdings, it says. The industry guide says stocks and stock funds, such as mutual funds and exchange-traded funds, can be an important part of a portfolio. The industry guide describes stock funds as a cost-effective way to diversify stock investments.

So the guides point to two things: time, and spreading your money across different stocks. Rules, fees and taxes on investing differ where you live. And that is how the stock market works: pieces of companies, priced by demand, held over time. So, seven parts: what a share is, why companies sell them, how your order is filled and what moves the price.

Then what owners get, how often prices fall, and how time and spreading help. Today, you can open a market regulator's guide to stocks, linked below, and read how it explains ownership. Which of the seven surprised you most? Tell us the number in the comments.

Results vary, rules differ where you live, and this is information only, not financial advice. This is Wealth Filings. If you want to see part nine, subscribe now: it shows how funds spread your money across many companies. Next on Wealth Filings, How Money Really Works, part nine: how funds spread your money.