The How the Stock Market works.


How does the stock market work?

If you’re thinking about investing your money somewhere but don’t know where to turn, the chances are that you will ask at least one person their opinion on what you should do. They will in turn, immediately reply with either one of two responses. They will either tell you to put it all in the stock market and they may even suggest some good stocks, or they will tell you to stay as far away from the stock market as you can. Add into that an economy that has seen much, much better times and it gets even more confusing. The truth is, there is no right or wrong answer. Or rather, there is, it will just depend on your situation. But it’s because the world of investing, and particularly the world of the stock market, is so confusing that it’s vital to understand how it works before you can even begin considering placing your life savings into its hands.


To understand how the stock market works, you must first understand the concept of shares. What are they, who sells them and who buys them, and why? To first understand what the value of a share is, you must be able to envision a company as a whole and what it’s worth. What it’s worth can get tricky because there can be different values placed on it. Say for instance, that the owner of a company decides to sell it. If he only sells the initial pieces of his investment, such as the building that he purchased to run his business from and the equipment he bought, he would probably end up about even or possibly, even a little bit more in debt or better off than he was when he first opened the business. However, if the owner chose to go over the books during the time that the business was open and determine an interest value for the business, he could also factor this value into his asking price.

Say for instance that the business on average, made a profit of $75,000 a year. At a 10% return rate, he could sell the business for $750,000 and if he could find a buyer who was interested in paying a 5% return rate, he could sell the business for $1,500,000. But, even after this the owner may have even more options. If a group of people heard about this potential sale, they could get together and offer to pay the owner $150,000 each (if there are 10 people) for part ownership in the company. This way, each of the 10 owners would own a piece of the company and would receive a fair portion of the income as well as be partly responsible for the running of the business as well as future expenses after the initial purchase. The owner of the company could also keep 5 shares for himself and sell the others so that he would still have the majority of the control within the company but would have other people helping to pay and run the business.

When put simply, stock works just like this company that was sold. A company’s stock is a measuring stick of their assets and profits. If you are considering investing in stock and wondering which stock is ‘good stock,’ you will need to know what the dividend on the stock is. Dividends are generally distributed yearly and they represent how much the stock will make them. Say for example, with the company owner selling his business, that after 1 year of operation under 10 owners, or shareholders, that each owner made $7,500. This number would be the dividend on a share of stock. The amount that is being divided amongst the shareholders as their dividends is referred to as stocks outstanding. So in the case of the company that’s been sold, the stocks outstanding would be $75,000. If you are considering investing in stocks, one of the first things you will most likely look at is the value of the outstanding shares and multiply this by the share price. The higher the number, the more valuable the share is and therefore, the more valuable the company is as well. The number you get after the multiplication is called the capitalization of a company.

Stock Exchanges

The New York Stock Exchange (NYSE) is one of the most well-known stock exchanges in the entire world and while what happens here is very exciting, and can be quite intimidating, it’s no different than what happens at any other stock market. A stock market is simply a place for companies to sell the shares in their company. This way, they don’t need to rely on other forms of advertising. But stock exchanges are also good for the investor because they act as a collector of all the companies that have stocks for sale. This way, someone who wants to buy shares doesn’t need to talk to each company individually because they are all right there under the same roof and it can all be done in one place.

When you imagine what the NYSE looks like, picture one big room and if you’ve seen it portrayed in movies it usually isn’t that much different. This room is where investors and companies can go to exchange stock. This makes the entire process much simpler. However, just because you don’t live close to New York doesn’t mean that you can’t be a part of this buying and selling process. If you want to invest but can’t, or don’t want to, actually go yourself, you can hire a stock broker who will do all of this for you and buy on your behalf. Stock exchanges allow the investor to buy stock immediately. Without one, the investor would need to advertise on their own that they were looking to buy stock, wait for people to call them, and then bargain to get the best price. A stock exchange eliminates the need for all of this.

At the stock exchange, buyers know the exact value of a company’s stock every second of every day. You can literally stand and watch the value of a company rise and fall within a matter of minutes. Things such as current company news and the economic situation will affect all of this. Those who are interested in buying stock should take all of this into account before buying and this is another reason why many people choose to hire a professional stock broker. If the company starts to get negative media attention for example, or if they announce that they are experiencing a record debt, investors will automatically begin to see the value of the company’s stock go down. This is generally when investors start to try selling their stock in the company but this will always depend on the investment plan and personal discretion of the investor or the stock broker. Other factors such as the amount the share was purchased for (the dividend) and the projected future profits of the company, will also affect the value of a share.


When a company decides that they would like to break their company down into pieces and sell shares, it needs to first become a corporation. It does this by incorporating itself. Consider a company that only has a single owner, which is a sole proprietorship, or that has two or three people who own it equally, which is a partnership. In both of these scenarios, the owners all collect the profits of the company and distribute them equally and are all responsible for decision-making and paying for business expenses.

A corporation works very different from these two types of ownership. A corporation is viewed as being able to do just about anything that a person can do, in terms of legal and financial matters. Corporations have a federal tax ID number, which the corporation will use for all proceedings such as purchasing property, being sued or suing someone, and creating contracts between it and someone else, or another corporation. A corporation is also officially recognized as a company that has shares that investors can buy and have a hand in the ownership of the company. It cannot be predetermined, in any scenario, the lifespan of a corporation or if it will ever dissolve at all.

Just as there are laws that people have to abide by, there are also laws that corporations must abide by. These laws have been set in place to protect the shareholders as well as the companies. Many of these laws concern the structure of the corporation and its process of procedure. For example, it is law that every corporation have in place a Board of Directors. If only one person holds all of the shares for that company, they can sit on the Board and declare that the Board will only consist of one person but there must still be a formal Board of Directors. The Board of Directors controls what the company does and makes and executes all of the company’s decisions. The officers of the company, including the President and other major officers) are also hired by the Board of Directors. Every year the shareholders of the company meet to elect the Board of Directors.

But this doesn’t mean that every corporation that has stock will be part of the ‘big room’ at the New York Stock Exchange. That will depend on whether they are a publicly-held or privately-held company. For example, if there’s a family restaurant in your neighborhood that is going out of business but the community hates to see it close, 10 people in the neighborhood might choose to buy a piece of the business from the owners. The owners could also keep a piece to stay in the business. These 10 people, including the owners, live their lives and from time to time, want to have a bigger hand in the operations of the business and want to buy another neighbor out, or those who have purchased a piece of it may want to move and so, sell their share of the business. This is definitely on a very small scale, how stocks work and in this case, because there are so few investors and they are making private deals amongst themselves, this is a privately-held corporation. On the other hand, publicly-held corporations have thousands of investors and thousands and thousands of shares. When a company is ‘going public’ this is what they mean and it’s usually a huge celebration. It’s a sign that the company is very well-established and has become quite successful.

Although it may seem as though corporations only exist to make a lot of money, there are many benefits to having corporations around. They provide us with the opportunity to have access to huge and expensive things such as airports. No single person would ever be able to own and operate their own airport and so, if someone or a group of people want to open an airport they will form a corporation and sell stocks to raise enough money to buy equipment, airplanes, a building, and all the other millions and billions of dollars it would cost to open an airport. When a company goes public, it does so with an Initial Public Offering, which has the sole general purpose of making money for the company and making it quickly. Those who think that the company has great potential, will make a lot of money, and pay them a great dividend, will decide to invest in that company and will buy shares in that company.

Another benefit that corporations have is that it places the owners of the company at far less of risk. If a corporation is sued or gets into serious financial trouble, only the corporation will feel the negative effects of this. This is because a corporation basically can do whatever a person can do. In a very worst case scenario, the corporation may need to close its doors but even in this situation, the real owners of the business aren’t in a position to lose everything they have and once leaving the company, will be free to do whatever else they want. However, in a smaller company that only has one owner, if the company gets sued, the owner gets sued. This means that any damages that have to be paid will come right out of the owner’s pocket and it really could end up with them losing everything they have.

Income Stock vs. Growth Stock

When you are considering different corporations to invest in and when you are looking at prices of stock, you will probably hear the words ‘income’ and ‘growth’ a lot. What this is referring to is the type of stock that you will be purchasing and this will tell you what you can expect to gain from it.

Income stock is the type of stock that has a price that remains fairly consistent, as long as the company’s profits and expenses stay fairly consistent. Every year once the company has determined the amount of profit they made for that year, the company will divide that profit up equally amongst all of its shareholders. While you are going to be getting something every year, the price of the stock will never really fluctuate, meaning that it will never go up and you will never be able to sell it for more than you got it.

The company can however, decide not to share its profits with the shareholders and instead, decide to invest it in things such as equipment and startup expenses for a second branch of the company at a different location. While you won’t be getting anything on a yearly basis, you will be part of a company that is growing and continuing to make more profit (because now there is profit being generated from two locations and not just one!) This is what stock brokers and others in the business call ‘getting in on the ground floor’ because it’s becoming a part of something that is going to get much, much bigger. These stock prices will generally increase vastly over time and will soon be worth much more than what you paid for them.

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 The How the Stock Market works of the Stock Market.

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