How Does the Stock Market Work?

This is the burning question that anyone who is interested in making money will ask at some point in their life.

So i will attempt to answer this question and give you a bird’s eye view to one of the only mechanisms that can create money out of thin air.

Before I can explain to you how the stock market works, yo must first understand a few simple concepts. So first thing first, what is stock?

What is a Stock?

 

Stock is a certificate documenting ownership in a corporation. An entity or person that owns stock in a corporation is called a shareholder. For every share of a corporation’s stock a shareholder owns, they are typically given one vote. If a shareholder owns over 50% of the total shares of that stock then the shareholder is said to own the controlling share of the corporation (in other words they have the ability to make all the major decisions).

Based upon this, it is clear to see that if a business wants to issue shares of stock they first have to be a corporation and follow the laws of incorporating. But why would a business want to issue stock?

Simple, businesses want to issue stock because each share of stock is worth a set amount of money and they can sell each share to raise capital in order to grow its business.

You can become an owner of a corporation by acquiring shares of stock in the corporation. Naturally, when the founder(s) of a business incorporate, they issue stock in a manner that allows them to be the majority shareholder of the corporation in order to maintain control. In addition, during the incorporation process, the owners elect a board of directors to make the company’s major decisions.

The board of directors then decides how many total shares there will be. For example, the board may decide to issue 10 million shares of stock. If the stock sells for $5.00 a share, then the company has the potential to raise a total of 50 million dollars worth of capital. The shareholders who buy this 50 million dollars worth of stock is betting that the company will then use this money in a manner that will increase the value of their shares so they can resell their shares for a profit or receive dividends from the company.

Public and Private Corporations

Now that we understand those basics we can get to the crust of the matter, public and private corporations.

Private corporations usually only issue a small amount of shares to people that are known by the owners. Because of this, shares are usually bought and sold between a finite number of people, and the decision to allow someone to become a shareholder is closely monitored by all of the owners.

A public corporation issues many more shares than a private corporation. This allows it to raise exponentially more capital than a private corporation. In order to sell such a large amount of shares, the shares are issued to millions upon millions of people in an IPO.

What is an IPO?

 

An IPO stands for initial public offering and is a very complicated process which requires an investment bank or brokerage house to handle the enormous amount of paperwork required. On top of this, because of the massive number of people involved, most shareholders are total strangers and a mechanism is needed to buy and sell shares.

This mechanism is called a public stock exchange or stock market and this is where we finally start to answer our initial question of how the stock market works.

What is a Stock Market?

A stock market is just like any other market such as a Wal-Mart for example, except stocks are bought and sold in a more dynamic fashion. Although, just like when items in Wal-Mart go on sale when there is a high supply and low demand as well as prices are increased in the opposite scenario, the stock market generally follows the same supply and demand theory.

When a lot of people are selling a particular stock and only a few people are looking to buy that stock, the stocks price on the stock market falls. On the other hand, when few people are willing to sell their stock, and many people want to buy it, the stock price on the market rises.

The decision to want to buy or sell a stock depends on various factors, but usually it comes down to how much revenue and profit a corporation generates, and forecasted growth rate, the management of the company, and external market factors such as the state of the economy.

So in reality a stock market is much more simple than one would have you think, it is just a place for corporations to raise money from investors, and investors to make money through buying and selling to other investors.

Clearly there is more detail in this process than I’ve discussed in this article, I’m fairly confident that I’ve covered the basics needed for you to have a clear understanding of how the stock market works.

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