How the Stock Market Works

by | May 27, 2020

“The stock market is just for rich people”.

“Isn’t it risky?”

“It’s pretty much gambling”.

This is what I used to think, but it couldn’t be further from the truth.

The Stock Market is a place where buyers and sellers meet to exchange stocks or shares of public companies.

If you’ve seen movies such as Wall Street or The Big Short, then you have probably heard of the stock market.

When people say the stock market, they usually mean a stock index. The biggest stock index in the world is the New York Stock Exchange (NYSE).

Many countries have their own Stock Exchanges such as the ASX in Australia, the Financial Times Stock Exchange (FTSE) in the United Kingdom, and the Nikkei in Japan.

What is a Stock

When you buy the stock of a company, it means you are buying a piece of ownership in that business.

Each piece of the company is called a share.

Companies will sell shares to the public to raise money for growth, develop new products, and many other business expenses.

What is a public company

A company is said to be public when they offer their shares to the general public.

When a company ‘goes public,’ it means you can buy shares in it openly on the stock market.

If a company is not public, it is private. This means it is owned by its founders or private investors.

What happens on the Stock Market

The Stock Market is like an auction house.

On one side you, have your buyers and on the other side, you have your sellers.

When someone wants to buy shares, they will place a ‘bid’ because that is the price they are bidding.

When someone wants to sell a stock, they will place an ‘offer or ask’ because that is the price they are offering or asking for the shares.

If a buyer and a seller can agree on a price, then the share will be exchanged for money.

Remember when you buy and sell, you are trading with another person, not the company itself.

How to Buy Shares

To buy shares on the stock market, you will need a Broker.

Long gone are the days where you need a broker who works on a trading floor like the image above.

Today you can find a broker by simply searching online.

Once you sign up with a broker, you have to pick a stock to buy.

Say you want to buy some shares in the stock of Microsoft.

Through your broker, you will place buy order. There are two main types of orders:

  1. Limit Orders
  2. Market Orders

Limit Orders

When you place a limit order, you specify the exact price you’re willing to pay.

Say Microsoft last traded at $150 per share. You may place a limit order to say that you are willing to pay $149 per share. Your order will show up on the buyer’s side as a ‘bid.’

If someone who wants to sell their Microsoft shares places an order to sell at $149, then the two orders will be met and the exchange will take place.

When this occurs, your order is said to be ‘filled’.

Limit orders are useful when the price you pay is more important than just buying the shares.

Market orders

Sometimes you don’t mind what price you pay, you just want to buy the shares.

This is when a Market Order comes in.

Market orders work a little differently.

You want to buy some shares of Microsoft.

This time you place a Market Order through your Broker.

This means you buy the shares at whatever price a seller if offering them.

If someone is selling their shares for $151, that is how much you will pay.

If they are selling for $160 per share, that is how much you will pay.

Market orders are useful when time is more important than the exact price you pay.

Stock prices can move up and down quickly.

Sometimes when you place a limit order, the price will have moved by the time your order goes through, and you will miss out.

A market order ensures you buy the shares at the exact time you want to.

How to Make Money from Stocks

There are two main ways to make money from stocks:

  1. The stock price can go up. Say you bought 10 shares in a company for $100 each. Your investment would be $1000. If the price goes up to $110 per share, you could sell your shares for $1100, making a $100 profit.
  2. Dividends. When a company makes a profit, it may pay some out to shareholders. Not all companies pay dividends.

Whether you are hoping to sell your stocks for a profit or earn a consistent dividend, the stock market will open many doors to build wealth, it is most certainly not just for rich people.

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