The Basic Principles Behind Buying And Selling Stocks

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Many people do not fully understand the process of buying and selling stock. Who sets the price on a corporation's stock? An amateur investor may naturally assume that the price is set by the management of the issuing corporation.

But this is true only when the company that issues the stock is doing the selling, and such sales make up only a small percentage of the total volume of stock sold. In the great bulk of transactions, the seller is a stockholder who has his own reasons for wanting to sell some shares. The issuing company knows nothing about these sales until a dealer turns in the old stock certificate, with a request for the company to issue a new certificate in the name of the new owner.

A comparison with the sale of automobiles may help here. An automobile manufacturer sells a new car to a dealer, who in turn sells it to a user. Some time later the user sells this car, now a used car, to a dealer. Most likely the price of the secondhand car becomes part of the user's payment for another car, and this complicates the transaction. But the manufacturer has no direct part in the selling of a used car. How much a dealer pays for a used car depends mainly on what some other customer will pay the dealer for it. A car may be bought and sold through dealers several times before it is junked.

Some major differences between the sale of a used automobile and a share of corporate stock are these: First, the price of a "used" share of stock may be either higher or lower than when "new." On the stock of a successful, established company, the price is apt to rise, as the company grows larger and older. A share of stock does not go to the "junk yard" unless the issuing corporation goes out of business.

Second, each share of common stock has the same market value as any other share issued by the same corporation, and a certificate of ownership can be mailed readily over great distances. How far apart a buyer and a seller are physically is of no consequence. The price of stock is set by the consensus of opinion of all the people who are either offering or bidding for stock of that company at that time. All dealers are likely to quote close to the same price at any one time.

Contrary to the usual conditions discussed above, in some corporations a buyer always receives newly issued stock, and instead of selling he turns in his shares for redemption by the company. The principal group of such corporations are the open-end investment companies, usually called mutual funds. The price of a share in a mutual fund is set automatically by the total market value of all the stocks and other property that the fund owns.

An investment in a car is almost always going to depreciate in value, unless it is a classic or a model that is no longer being made. A stock, on the other hand, can increase or decrease in value as we discussed, and it is up to the individual stockholder and his broker to decide where the safest or most profitable investments lie.

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