Small and medium-sized companies are usually privately owned and have a limited number of stockholders or owners. But once a company grows to a certain size – in either profitability or assets – its owners may decide to list it on a stock exchange in order to access the capital they need for further growth. New stockholders buy stocks in the company in an Initial Public Offering (IPO), giving the company the cash it needs to continue or expand its operations.
Stocks confer ownership
Each stockholder becomes a part-owner of the company for as long as they hold at least one stock, although stocks are usually traded in much larger parcels than a single stock. Stockholders may receive regular distributions of a company’s profit, based on the number of stocks they hold, and these are called dividends.
How stocks are traded
Stocks can be bought and sold electronically on the stock exchange during every day that the stock exchange is open. The trading of stocks is carried out by an intermediary called a stockbroker or share broker (or simply a broker), on behalf of both buyers and sellers. Sellers can nominate a price at which they are prepared to sell a specified number of a particular company’s stocks, and buyers can nominate a price at which they are prepared to buy them. When the two prices correspond, a sales transaction can be completed, and a current market price for the stocks is established. A broker’s client may also agree to buy or sell at the prevailing market price rather than nominating a specific price.
Why stocks are traded
There are plenty of reasons why stocks are bought and sold every day:
Long-term stock investors
Stocks are a popular form of investment, in the hope of long-term asset growth and possibly dividend income. Long-term stockholders are likely to buy or sell stocks infrequently, and their activity is better classified as stock investment rather than stocks trading.
Gradual stock price movements
As a company’s profitability and assets increase, the value of an individual stock in the company will usually increase proportionately, and the market price of the stocks on the stock exchange will increase as a result. The converse is also true – companies with declining profitability usually see their stock price falling. Individual stock prices are also affected by supply and demand, and other factors.
Sudden stock price movements
External factors can affect individual, industry-wide, nationwide or even global stock prices. Such factors could include the release of profit results or profit forecasts by the company, a natural disaster, a major regulatory breach resulting in a large cash penalty, a sudden shift in consumer sentiment, a change in central bank interest rates, a large-scale war affecting national economies, or a global financial crisis or pandemic.
Short-term stock traders
Short-term stock traders try to predict or anticipate these more abrupt changes in the price of individual stocks, and aim make a profit by regularly buying fairly large parcels of stocks when they think the price is lower than it should be – or will soon be – and selling them when they are satisfied with the profit they have made or when they think the price has reached a temporary peak. “Day traders” may try to realise a profit by buying and selling a particular parcel of stocks within a day, or slightly longer.
Risks and rewards of stock investment and trading
Investing and trading in stocks is inherently risky. It’s not like depositing money in a bank account, where you can be reasonably confident that your investment will not grow particularly quickly (given current low interest rates) but nor will it shrink (except in the unlikely event of negative interest rates). Stock prices are volatile and can be affected by many factors, just a few of which have already been mentioned. This makes it possible for both investors and traders to lose significant sums.
Spreading the risk
The risk of loss from stock trading can be mitigated to some extent by having a diversified portfolio. That’s an elaborate way of saying “Don’t put all your eggs in one basket”. By spreading your investment or trades across a range of stocks in different companies and market sectors (e.g.financial, industrial, technology, retail, agricultural) you become less exposed to individual stock price fluctuations.
Another way to achieve this is to invest or trade in Exchange Traded Funds (ETFs), a type of tradable security that aggregates a range of stocks and other financial investments, creating an automatic spread of risk.
You can also choose to invest in units in a managed fund, a diversified portfolio chosen and administered by an investment advisor. Some managed funds may be listed on a stock exchange, but many are not.
Other types of tradable securities
“Stock trading” may be used as an umbrella term for trading in all types or securities or financial instruments listed on a stock exchange, which, as well as individual company stocks could include:
- Managed funds
- Options, futures, warrants and other derivatives
- Fixed income debt securities
Online stock trading platforms
You can buy and sell Canadian stocks and other securities without using a traditional broker if you use an online stock trading platform. Signing up to one of these is quick and easy, and they generally have low transaction fees, no account fees for a basic account, and low minimum trading amounts. Some of them offer access to overseas markets, such as the NYSE and NASDAQ in the US.
Online brokers typically offer two types of accounts:
- A free basic account with no monthly or annual fee, possibly market price trades only, limited analysis or guidance and delayed rather than real-time market information
- A premium, subscription-fee account, with additional reporting and guidance, live market data and options for setting a stock price at which you are prepared to buy or sell
Traditional full-service stock brokers
A full-service stockbroker may be more suited if you feel you need expert advice about buying and selling stocks and other securities. Traditional offline brokers will provide market and individual company research, make buy/sell recommendations and possibly create a tailored investment plan for you. As a result, they will usually charge higher fees for transactions and ongoing services.
Some full-service brokers also have an alternative online trading platform.
Cost of stock trading
Over and above the purchase price of the stocks you buy, there are other fees you may have to pay, including:
- A transaction fee each time you buy or sell a parcel of stocks (also called a ‘brokerage fee’ or ‘commission fee’). Transaction fee structures can vary (e.g. flat fee, or percentage of trade amount, or fees that vary according to the number of trades you make per month). Online platforms tend to be cheaper (e.g. between $5 and $30 per trade), compared with a traditional broker’s typical flat fee of $50+ or percentage fee of 2%+.
- Monthly or annual account fee charged by some brokers or online platforms for the provision of premium services.
- Cash withdrawal fees may be charged if you want to withdraw money from the special bank account you usually need to fund your trades.
- Foreign exchange fees or a foreign exchange margin will be payable if you need a foreign currency account to trade in overseas stocks.
- Inactivity fee, possibly charged if you make too few trades in a given period.
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