The basic idea of a stock exchange is incredibly simple. Think of it like a farmer’s market. Instead of fruits and vegetables, the people there sell securities. The exchange itself keeps track of who bought what, how much inventory is left, and that all the sales are done according to the law. Each country has its own exchange, or in most cases, several exchanges. In Germany, there’s the Frankfurt XETRA stock exchange, as well as Tradegate and a few others, while in France, there’s the Euronext Paris. Spain has the Bolsa de Madrid.
To gain access to the stock exchange, a retail investor needs an intermediary, a broker.
A broker is a company that has obtained all necessary licenses for the exchange, complies with its rules and pays the appropriate fees to the exchange. The broker gives private investors access to the stock exchange and charges them a commission for it. The investor opens an account with the broker, puts the money there and tells the broker what and how much should be bought or sold on the exchange with their money.
In the past, this all happened in person. This might be how you still picture a stock exchange: a bunch of people yelling over each other on a crowded trading floor. Now, it all happens online. You can choose a broker without leaving your home, sign a contract and get access to a stock exchange in 24 hours using software on your computer or smartphone.
There are many different departments on the stock exchange, called markets. At these markets, you can buy stocks, currency, precious metals and even agricultural commodities which, yes, includes soybeans.
To start, let’s focus on the market where shares are traded, called the stock market. Apart from company shares you can also buy ETFs and bonds here. Don’t worry, we’ll explain what all those are as well.
A bond is a name for a loan that a company or government takes out. If you buy a bond, you’re essentially lending money to the state or company, and getting interest on that loan.
Let's say a company wants to expand its production, and it needs money to do so. They place a bond in the market, which you, the investor buys. Each bond is a small part of that loan. It says how much money you’re lending the company, when you’ll get your money back, and what kind of interest rate you’ll get.
Bonds are usually beneficial for both the company and the investor. The company can usually get a lower interest rate than what a bank would charge, while the investor gets a higher one than they would in a savings account.
The key here is to gauge the risk the company might not pay the money back. The higher the interest, the higher the chance the company might not pay the back. There are also ratings, decided by independent credit rating agencies, who classify how reliable a company’s bond is: the higher the rating, the more likely you’ll get your money back, and usually the lower the interest rate.
“Bonds can be issued by companies, states, regions or even supranational entities like the European Union. Government bonds are the safest normally, but in return for that safety their yield does not differ much from the interest rate you might get on a savings account. Right now, some even offer negative interest rates, which is a tricky subject we won’t get into right now.
A share is a portion of the company, an interest in its business. If you bought a share, you are a co-owner of the company and entitled to a portion of its profits.
The owner of a share has two earning options: on the difference in the value of shares (bought cheaper, sold more expensively) or on dividends - this is when the company shares a part of the profit with the shareholders. Let’s look at an example.
Imagine that you have a friend, a farmer, who suggests you both go in halfway on buying a goat. Your part of the goat is your share. The goat will give milk, the milk will be sold — you will receive your half of the profit from the sale of milk, after other expenses are accounted for. This milk profit is your dividend.
And if the value of the goat on the market suddenly doubles, and you decide to sell your share to another investor, you will earn on the increase in value — you will profit once from the difference between the sale and the purchase price, but you will no longer receive your regular dividends.
At Vivid, our product focuses on fractional shares. This is a derivative product that allows you to buy half a share, or a tenth of a share, or whatever fraction you want. More on that in later lessons.
The risks in the stocks are obvious: like a goat, the company's business may get sick, so to speak, or demand for milk may fall for some external reasons. Then your share will bring less profit, and it will be difficult to sell it on the market for the same amount you bought it at — nobody wants to buy an unprofitable goat.
Let's say you want a piece of cake. Just a tiny slice. You have only two options. You can find a recipe, go to the store for ingredients, bake a large cake, and then cut out a slice and eat it. You end up spending a lot of energy, time and money. The better option would be to go to a bakery and buy a slice individually.
Funds, or ETFs, work just like that. They collect a portfolio (cake) of securities (ingredients), and then sell to investors a share (piece) in that portfolio.
The ETF portfolio may consist of shares or bonds of different companies or may track the price of a particular commodity or index. Each ETF decides on its own how to form its portfolio.
The funds also receive dividends from the shares held. What do the funds do with the dividends? Each fund decides for itself. Some pay dividends to investors, while others keep and buy additional shares with the money, raising the price of the fund and increasing the potential profit should an investor decide to sell their share.
The advantage of a fund is first of all a lower risk: if one of the assets loses value, the loss will be covered by the income from other assets. Also, ETF stocks require considerably less money to buy into than buying every stock or asset they have in their portfolio on your own. It’s cheaper to buy a slice than every ingredient.
You now understand the basics. Let’s test your knowledge, and then go a bit deeper.