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.