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Like the appeal of the Kardashian family, the stock market is a mystery to many. In this article we’re gonna demystify how the stock market works.
To do that, we’ll start with an imaginary company, the Iowa Lobster Company. Iowa Lobster makes artificial lobster meat in its labs that tastes just like the real thing. And they’re growing like crazy (the company and the fake lobsters).
Seeing an opportunity, Iowa Lobster wants to expand into fake crab and shrimp. Problem is they need a lot of cash to do that.
They go to the bank to see about getting a loan. But the banker is more of a meat and potatoes type guy. He doesn’t want to lend Iowa Lobster the money.
Which is fine with Iowa Lobster cuz they’d really prefer not to take on any debt to fund their growth.
Another option they have is to have an IPO and “go public”. This means they’ll sell stock in their company to investors. By selling shares of their company’s stock, Iowa Lobster will raise the moolah they need to grow their biz.
If companies like Iowa Lobster had to sell the shares directly to investors, it would be a messy process. They’d have to find the investors, keep track of the money, the shares, etc.
Plus when you have investors and the company dealing with each other directly, there’s a lot of room for funny business on either side. People can easily end up getting screwed.
Enter the stock market. Or, more specifically, the stock exchanges.
A Stock Exchange provides a marketplace where buyers and sellers come together to exchanges shares of company stock. These exchanges provide much needed regulation and standards to protect companies and investors.
The biggest stock exchanges in the US are the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX) and the Nasdaq.
You, as an investor, buy and sell shares of companies like Iowa Lobster through these exchanges. When you do, you are not buying your shares directly from the company. You are buying them from other investors.
Using an exchange also makes the buying and selling more efficient. If you had to go out to find someone to buy your shares of a stock on your own, it could take awhile. But a stock exchange and the technology supporting it, sales happen almost immediately (assuming the market is open when you place your trade).
The price of a stock basically comes down to supply and demand. Buyers and sellers in the market have different ideas of what the value of a stock is and what price they’re willing to buy or sell it for. All these transactions get compiled second by second (for larger, heavily traded stocks anyway) to send the stock price up or down.
If there are more buyers than sellers, prices will go up. If there are more sellers than buyers, prices will go down.
In order to trade in the market you need a stockbroker, a middleman between you and the market. This could be an actual person you call. Or more likely these days, you open a brokerage account and you use their website or app to place the trades you want and computers take care of the rest.
The computers will match the buyers with the sellers to complete a trade. It’s more efficient than having people do it. It also lowers costs for investors and faster trades.
This is how the stock market works in a nutshell. Yes, a totally oversimplified nutshell. But a nutshell nonetheless.
If you wanna know more, go get an MBA. Or, save some money and just read a more in depth and more boring article elsewhere on the Interwebs.
But for most investors, you really don’t need to know much more than this. Just know the stock market works to provide an efficient, relatively safe marketplace to trade shares of public companies.