What is the Stock Exchange and How to Invest Successfully

Discover the world of stock exchanges, their role in the financial market, and how to start your investment journey.

Comprehending the stock exchange is no easy feat, although it's certainly not impossible. As Warren Buffet often states, investing is straightforward but far from simple. His reference is particularly aimed at the stock market, where he constructed and still preserves his wealth.

Many investors really have no idea how the stock exchange works. That's why we're here to explain and with this knowledge you will become a better investor. After all, this understanding is essential for anyone seeking financial independence.

The stock exchange is nothing more than an organized marketplace where shares of publicly traded companies and other securities are traded. Now, I want to demystify one of the biggest misconceptions people have.

Many people imagine the stock exchange as a place full of people shouting, using phones and pointing at large screens. This view is outdated, as currently, transactions occur electronically.

How does the stock exchange work?

First, we need to understand that companies start appearing on the stock exchange with the goal of raising funds and financing projects. These companies decide to offer shares of ownership in exchange for capital, as if the owners of the company were inviting new partners to participate in the business.

This is a named as IPO. When this happens, the company is conducting an IPO (Initial Public Offering). From that moment on, the company starts to appear on the stock market, and on the other side, investors express their interest in this company through buy or sell offers of its shares.

When an IPO takes place, this action is referred to as the primary market. This is the moment when the stock price is determined through a calculation that takes into account the supply and demand relationship from investors for these securities.

After this initial phase, investors who wish to acquire shares in this company will use the secondary market. In the secondary market, transactions are only completed when there's an agreement between a buy order and a sell order from two investors. For example, when someone wants to sell a stock at a certain price and finds another person who wants to buy the same amount of shares at the same price. All of this is conducted through a platform called a (home broker), which is the interface typically provided by brokerage firms through which investors operate in the stock market

The investor who purchases a stock can profit through the appreciation of that share or through the distribution of company earnings, which we refer to as dividends. Appreciation and depreciation can occur based on various factors, as in the short term, it's news, rumors, and other noises that drive stock prices. In the long term, it's the company's underlying performance that determines the appreciation or depreciation of these shares.

Investing in the stock exchange might seem quite challenging at first, but it's a relatively straightforward task, in reality. What often deters and confuses investors are the countless stories of people who lost fortunes while investing in the stock market. From these bad examples, many even end up associating the stock market with lotteries and games of chance. It is true that the stock market can indeed lead to significant financial losses for investors, especially for those without knowledge or those taking excessively large and unnecessary risks. However, at its core, investing in the stock market involves identifying good companies and supporting them with financial contributions.

What are the risks of investing in the stock exchange?

There are different types of risks involved when trading on the stock exchange, but for today, let's focus on two that I consider to be the most significant.

The first one is called liquidity risk, which occurs when an investor is unable to sell their shares. This typically happens with companies that are less actively traded on the stock market. In such a case, the investor finds themselves holding shares they no longer want and can't get rid of because there are few buyers willing to pay the price they are offering to sell those shares.

The second risk is market risk, which is closely tied to the depreciation of the stock. If an investor buys a share and sees its value decrease due to various factors, and then decides to sell it, they may not be able to recover their investment, resulting in a loss.

Certainly, the topic of the risks of investing in stocks has much more to it. For instance, the same stock that depreciated in value could, in the future, return to its original price or even appreciate further. However, it's important to emphasize that this possibility can be associated with factors that may be beyond the control of both the company and the investor.

This is where the importance of having knowledge about the market and practicing effective diversification comes into play, as it's one of the crucial aspects for those aiming to achieve success in the stock exchange.