How Does the Stock Market Work?

One of the daily topics that you hear about in the news is the stock market. You'll hear random things like "the Dow hit an all-time high" or something to that effect quite frequently. However, do you really have any idea what they're talking about? How does the stock market work? The truth is...many people haven't the slightest idea.

The stock market is an important part of our economy and has a great deal to do with our economic power in the world. While it may not affect you individually, it does have a cumulative effect on you in some way. So exactly, how does the stock market work? Let's look at the basics.

Imagine that you wanted to start your own business. We're not talking about the neighborhood lemonade stand. Imagine that it's a legitimate, big business. This business is going to require a lot of capital to get started and you don't have the money. Instead of going into your local bank and asking for a loan, you want an alternative form of funding. Therefore you come up with the idea to sell pieces of the ownership in your business. You divide shares of your business up and sell them for a certain price. Now, each person that buys a part of the business is a partial owner. You can still be in charge of the daily operations of the business, but your business owners now require a share of the profit. You pay the investors a share of the profit (also called a dividend) every so often and they receive a return on their investment. This is the basic idea behind the stock market.

It is a way to raise money when big businesses need to expand or get started. In return for the money, they give out a small portion of their ownership in the company. Therefore the investors are now a business owner, but don't have to take on the tasks of everyday business ownership. This represents a win-win situation for the investors and the companies.

This explains what stocks are, but how does the stock market work? The stocks are then traded on what is called a stock exchange. When someone wants to sell their portion of ownership in the company, they go to where stocks are being sold. A stock exchange is basically a place where buyers and sellers of stocks can meet up to conduct business. This makes it easier to move stocks than a traditional means of selling something. The great thing about the stock exchange is that you don't physically have to go to New York to get something done. You can call in to your broker or put in an order over the internet.

The stock prices are affected by many factors including supply and demand. If there is a low supply of a certain stock and many people want it, the price goes up. If there are many people trying to unload a stock, the price goes down.

Hopefully this has helped you to understand the basics on how does the stock market work and you'll feel comfortable getting started on your own.