After the markets up and downs these days, the question of “How does the stock market work?” is an often asked by a lot of people. one, especially amongst those who have little to no background in finance and economics. Fortunately, the stock market is not as complicated as it seems with its bewildering array of numbers flashing on giant screens and brokers shouting quotations at the top of their lungs.
The Concept of Stocks
Simply put, one share of stock represents partial ownership of the company issuing it. There are two kinds of stocks issued – preferred stocks and common stocks – each with unique properties. Often, preferred stockholders are provided with more benefits than common stockholders in, say, the order and amount of dividends issued on one share.
Similarly, there are also two values attached to stocks – par value and market value. Par value is the price of the stock as set by the company while market value pertains to the price of the stock as determined by market forces. For example, a share of stock may be valued at par for $1 but its market value may reach as high as $100, thanks to market dynamics at work. This can also work in reverse since the same share of stock can be virtually worthless in the current market. Stocks are the foundation upon which the stock market works since it is the basic commodity being traded, bought and sold in the billions daily. Once you have understood the concept of stocks, you are better prepared for the answers to the question of “How does the stock market work?”
The Concept of Stock Trading
Stocks are sold and bought in venues known as stock exchanges, with said transactions conducted by licensed stockbrokers. Take note that the buildings housing the New York Stock Exchange and NASDAQ, two of the world’s most prominent exchanges, are heavily restricted from unauthorized personnel.
Fortunately, the power of the Internet has made it possible for ordinary citizens to dabble in the stock market without actually being inside the stock exchange buildings. Plus, you have the stockbrokers and the market makers to do the dirty work of finding sellers and buyers, as the case may be, for your stocks. Your stockbroker will only execute a transaction upon your orders or upon your predetermined criteria, which means that you still retain control over your shares of stocks. He/she earns commissions from each successful transaction while you earn profits from favorable spreads.
Of course, your profits will also come from the difference between your purchase price and your selling price of the same shares of stock, usually over a long period of time. For example, if you bought shares of Microsoft stock when it was just a startup company at $1 per share and you decided to hold on to it, you will recoup your initial investment hundreds of times over today when Microsoft is a powerhouse company. So, now that you have the basic answers to the basic question of how the stock market works, it is time to expand your investment portfolio from the usual savings accounts. With the right decisions borne of experience, you will earn thousands more in profits than you will probably have in interests.
A stock exchange is an organization, usually a corporation, that brings together stock brokers and traders by giving them facilities to carry out trading of stocks, other securities and other financial instruments. Does that sound so abstract? For a clearer picture of what is stock exchange, think of a market building and what you see inside. You see sections. Each section’s facilities define whom it caters to. The fresh meat and fresh fish sections have large freezers for storing raw meat; the produce section has coolers and display cases; the dry goods section has stock shelves for displaying items. People come to this place to buy and sell food items. A stock exchange is basically that. Although its sections, called markets, are not trading physically transferable goods and the markets per se are essentially not physically present within the building, a stock exchange is a virtual marketplace where sellers (issuing corporations or organizations) and buyers (traders) do their business.
But unlike ordinary marketplace, the prominent persons in a stock exchange are middlemen called stock brokers. They are regulated professionals who do the buying and selling of securities on behalf of investors. More often than not, stock brokers play the role of investment advisors to their clients. If you don’t understand what is stock exchange and how it works but would like to put your money where it gives you more than a regular savings account would, you’d want to go to a stock broker. But can you eliminate the stock broker from the picture? Find out more about stock exchanges and stock brokers with Forex Tracer, an automated investment advisor that works much like a real live one does.