Can someone explain how selling stock works?
March 1, 2010 12:38 AM   Subscribe

I'm interested in exploring the world of investing. After doing some reading on how the markets work, some key terminologies to know etc. there are a couple of questions that elude me regarding the selling of stock, namely, when I sell my stock, who's buying it, and how exactly do I lose money on the market?

Regarding part one of my question, let's say I invest x amount of shares into say, Amtrak that equals $500. Obviously, the goal is for Amtrak to make a profit so I may see money in the for of dividends, or in the case of a growth stock, a more valuable stock to sell down the road. Let's say Amtrak throws the safety book out the window and as a result, has a major train wreck once a month for a whole year, causing the value of stock to plummet. Does this affect my personal finances as well as my investment? Or is my mindset "That $500 bucks is money I may or may not ever see again, so it's part of the risk" mindset a bad one to have? (thus Amtrak's poor record hurts only my investment)

Continuing the analogy, let's say the value of my stock plummets and I want to sell. Who in their right mind would buy my stock? If someone else doesn't buy it, is the company obligated to buy back their stock, or is there a case where you're plain stuck with stock no one wants to buy?

Thanks much for your help!
posted by FireStyle to Work & Money (14 answers total) 9 users marked this as a favorite
When investing, you want to seek a return on that investment, either through dividends or by selling whatever that investment bought. Your level of risk determines what investments you should purchase. If you are "playing" the market with $500 of capital that you can afford to lose and you want to double your money more than you want to not lose your money, your risk tolerance is very high. If you are trying to keep your retirement fund intact at the age of 70, your risk tolerance is very low. That is how you lose money on the market: if whatever your investment (of $500) bought loses value and never recovers that value, and the chances of that happening are the risks involved in purchasing that security. This, among other reasons, is why penny stocks or so-called "pink sheets" are so risky; they are usually marginalized by the larger exchanges for a reason and are subject to very little transparency and potential manipulation (due to their very low share prices), both of which decrease the amount of information available to an investor and the possibility that the investor is buying something outside his or her risk tolerance.

No, a company is not (generally) obligated to buy back its own stock, and yes, it is entirely possible you can wind up with a share of stock that no one else wants. This happens quite often in bankrupt companies, where their stock is now worth approximately the recycle value of the paper on which those shares are printed (assuming a physical share certificate exists), or the novelty factor of owning a now-defunct company's shares.
posted by fireoyster at 1:07 AM on March 1, 2010

It really depends on the time frame for which you're investing. If you are saving for retirement in 40 years, then you can withstand substantial risk because there's time for the ups and downs to even themselves out. If you're retiring in 3 years though, you can't be quite so stoic and you have to limit your risk.

In your hypothetical the stock would drop to below a dollar and would be delisted from the exchange. At that point it's still theoretically possible to buy or sell the stock but in reality most of the time it's just a lost investment.
posted by Rhomboid at 1:29 AM on March 1, 2010

Your question's a bit of a mess. If you have the time, I highly recommend Shiller's podcast lectures on Financial Markets. I found the lectures to be pretty straightforward and uncomplicated; it's a popular course for a reason. Just don't take too pointers from the guest speakers as I don't think they were telling 'the whole truth'.

On with the question at hand; you've identified a few major problems, and I'll try to address them. Firstly, your risk in a stock is limited to the value of the company's assets, not your own. This is not the same as the $500 you put into a stock, that money went to the person who sold you the stock. You own a percentage of the company now, which means owning a percentage of what the company owns, and a percentage of any dividend paid. By law, limited liability corporations shield investors from losing anything more than their share of the company. The most that's at risk to you is the value of your shares.

Theory suggests that investors should value a stock based on the dividends it will pay, discounted over time (a dollar today is worth more than a dollar tomorrow). If a company's expected profits fall, the stock price shall fall. The problem you face is that many people confuse trading for investing. Investors seek returns over time greater than their time discount, while traders buy low and sell high, and don't generally care about receiving the dividends since investors will change the price they pay right now. If too many people get involved in this, it kind of devolves into a perverse beauty contest.

The important point to note here is that if stocks never pay a dividend they're extremely hard to value. If we assume a company runs for 30 years and goes bankrupt at that time, holding that stock was roughly worthless. Growth stocks don't pay a dividend because they claim they can invest money for larger dividends later. I have yet to figure out what this means for Berkshire Hathaway, despite my owning a tiny stake in them.

The last point is that the entire value of your shares is at risk. If your company goes bankrupt that could mean all the company assets are transferred to the people it owes money to. For example, GM shareholders could see the company transferred to GM bond holders without compensation. It is absolutely the right idea to hold that you could lose all the money you put in the market. Stocks are a high risk category, with an average high return. For this reason many people advise investing in a mix of stocks with safer bonds. Of course, bonds pay less, but feature less risk (but not none).

Who would buy shares of a company in distress? Mainly speculators who would like to pay a few cents to see if something unexpected happens in the courts, I guess.

TL;DR version: Different kinds of investors with different time horizons may buy what you sell, but all money you invest in stocks and bonds is at risk.
posted by pwnguin at 2:15 AM on March 1, 2010

Response by poster: Not to insinuate that I would do this, I'm still in the realm of the hypothetical. Do some people put money in stocks for the intent on making a certain amount of money, and then pulling out once they achieved their goal?

For example, I want to pay a personal loan worth $10,000. I decide to invest $1000 into a stock, and after 5 years, that stock is worth $10,000, so I sell to effectively use that money to pay off a personal debt. Do people do this, is there a name for it, and I guess it is safe to assume that it is bad practice?

Thanks again, for the responses... the buying part of the process is easy enough to understand, but what people do with their stock once they have it is the question that seems to go unanswered in the literature I'm reading so far. Like, is Warren Buffet only worth so much because if he cashed in every single stock he owns, he'd have a billion + $ in liquid assets, or is he getting crazy checks at the end of the year?
posted by FireStyle at 2:28 AM on March 1, 2010

If you want an income from your investments, you can invest with that in mind, in stocks that pay out high dividends or in funds that are designed to produce an income.

If (like me) you are young and your stocks are intended as a retirement fund, you invest for growth, and any dividends are invested right back in the retirement fund.
posted by emilyw at 3:09 AM on March 1, 2010

Re: your second set of questions:

- Yeah, investing borrowed money in the stock market is generally considered a recipe for disaster. There are cases where it's a good idea, but it's pretty unlikely that you have one on your hands if you need to ask on AskMe.

- Selling stock for retail investors generally works through the power of market making.

- Warren buffet does not hold his billions in cash. He still gets crazy checks because a USD 37 bn fortune produces a lot of cash flow.
posted by themel at 3:20 AM on March 1, 2010

You have a lot of questions here, so let me take them one by one.

(1) If you sell a block of shares, another party buys the shares. You don't know who this party is. It could be a market maker, an exchange specialist, an institutional investor. It doesn't really matter. The stock exchange acts as a clearinghouse to process all the trades and match buyers with sellers.

(2) If a stock declines in value the only part of your personal finances that decline will affect is your investment, or, if you took a loan out to purchase the shares, the amount of margin that you would have to pay in order to make the lender whole. Given the nature of your questions I strongly suggest that you do not buy on margin. Contrary to others' opinions here, buying on margin is a profitable activity, but it requires a lot more experience and capital than you seem to have.

(3) If a stock declines in value and you want to sell it, there may be many other people out there who want to buy it, either because they're covering a short position, or they see value where others don't, or they're making a market in the stock and so providing the market with liquidity by trading in it, etc.

Now, for a general comment. It seems that your understanding of investing is, at this point, rather muddled. A better question for you to ask would be: how can I educate myself about investing. You say you've been reading some stuff, but it's not clear to me what stuff you have been reading. At this point, I would start with a very basic primer on the markets. The blog Get Rich Slowly would work for this purpose.
posted by dfriedman at 4:54 AM on March 1, 2010

Warren buffet does not hold his billions in cash.

Please don't comment on finance if you don't know anything about it.

Buffett finances his operations via his insurance companies' float. Insurance companies' float is in the form of cash and other short-term, highly liquid securities, such as CDs and Treasuries. These are all functionally equivalent to cash.
posted by dfriedman at 4:56 AM on March 1, 2010

Like, is Warren Buffet only worth so much because if he cashed in every single stock he owns, he'd have a billion + $ in liquid assets, or is he getting crazy checks at the end of the year?

It's worth noting that the "net worth" figures you hear tossed around about Bill Gates and Warren Buffet and the like are really more related to their holdings. Yes, as noted above, Warren Buffet (and Berkshire Hathaway) certainly have some "crazy checks" (IE cashflow), but Warren Buffet's net worth is measured in his holdings of BRK, etc.

In the same vein, Bill Gates' $50bn (or whatever) is measured in his reported holdings of MSFT. So no, he could not really write a $50bn check tomorrow if he wanted to. (This is simplified, but essentially correct).
posted by jckll at 6:19 AM on March 1, 2010

Not to insinuate that I would do this, I'm still in the realm of the hypothetical. Do some people put money in stocks for the intent on making a certain amount of money, and then pulling out once they achieved their goal?

Yes. investors often have an exit strategy. That is, when a stock rises to X value, I will sell to maximize my profits. Or, should a stock fall to Y value, I will sell to minimize my loss. This isn't bad. You should know why you're investing and what you hope to achieve. However, in your example of the personal loan, you have short term needs for that money, and you can't count on the stocks to perform as you hope. Given that, you shouldn't rely on this strategy to meet your short-term commitments, and you shouldn't invest money you can't afford to lose.
posted by willnot at 8:01 AM on March 1, 2010

Response by poster: This is very enlightening, thanks much for the responses. As I stated earlier in the question, I am exploring the idea of getting into investing, and sometimes it's more effective to ask questions than to guess the meaning of literature I don't understand, which is precisely why I like this site =)

But I have a better idea what literature to read, and things to look for.

I think to start, I will save up $500 to begin investing (which is why I've been using that figure in all my examples, and because it is money saved with the intent on learning how to invest, could effectively afford to lose - though I certainly hope that's not the case!) While I'm saving, I will be doing a lot more reading on the topic... the links provided are a nice starting point.
posted by FireStyle at 9:43 AM on March 1, 2010

If you're interested in play markets with real money, the Iowa Electronic Markets are a good resource. They're not quite stock markets, but 500 is the most a person can invest with them, and you can buy in for as little as 10 dollars. I'd compare their prediction markets mostly to options or futures. They also publish a lot of academic studies of investor behavior on these markets that can make for good advanced reading.

The problem you will have with investing 500 dollars in retail investing is broker's fees. If it costs you 5 dollars to place a market buy order and 5 dollars to place a market sell order, your investment has to grow by 2 percent just to break even. If those fees are 20 dollars, as is true of my IRA, that number becomes 8 percent.
posted by pwnguin at 11:00 AM on March 1, 2010

If you're only planning to invest a few hundred dollars, I'd suggest choosing a low-fee broker (I like Vanguard, but there are others), and investing in an index fund. What that means is that you're putting a tiny bit of your money into each of a bunch of different stocks that represent the whole market. That way, if one stock goes down and another goes up, you don't lose money, or at least not as much. Historically, index funds have netted substantially more profits than managed funds, in which an expert tries to pick for you specific stocks that s/he thinks will all go up. With such small amounts of money, and just starting out, you're better off diversifying and tracking the market, which is what an index fund is designed to do.
posted by decathecting at 12:43 PM on March 1, 2010

Doesn't sound like OP is really trying to make money though. It sounds like he just wants to play around with stocks. If he's got $500 to lose and wants to think of it as a learning experience--or gambling--then he should probably just find an ultra-low cost brokerage.

Perhaps just google around for "discount brokerage" to find reviews. Off the top of my head, Zecco, Sharebuilder, Tradeking, etc. You should be able to find trades for about $5/ea with one of these, or about $10/ea if you want to go a little more high-brow (eTrade, Scottrade, etc).

Granted with $500 it's still going to add up, but if you're just making a few trades it should be OK.

Note that this is exactly the OPPOSITE advice I would give to someone who is serious about building wealth, creating a nest egg, etc. But if you're just interested in the mechanics of the stock market and have no problem losing much or all of your money there's nothing wrong with it.
posted by jckll at 1:18 PM on March 1, 2010

« Older Whats a Dad to do?   |   Get to Rovinj in comfort and style Newer »
This thread is closed to new comments.