How does the stock market work



How does the stock market work?

Answer

It's supposed to be a source for U.S. businesses to raise capital and grow the economy. In this function it is broken, it doesn't work.

Naked shorting and other abusive practices have made the stock market one big, rigged, ponzi scheme.

Currently banking stocks are being shorted by the big bucks guys so bigger banks can gobble them up with your tax money (the bailout funds).. Rep. Kucinich is investigating as this just happened to a major bank in Cleveland.

Answer

Let's do this by example. Let's say you are the owner of a company that is worth $10 million. You want to share the risk (and rewards) of doing business so you decide to 'go public'. You then decide to divide your business net worth ($1m) into 1 million pieces (shares). You then decide to sell 900,000 shares to the general public on the stock exchange. Simple math places the initial offering price of your shares at $10 each. You then have an 'Initial Public Offering' (IPO) where you sell the 900,000 shares with a starting price of $10. Your business is now $9 million richer in cash but you are no longer the boss but working for the share holders. Generally cash generated by IPO's are used to expand the business, cancel debt, etc. As time progress your business makes money and/or loses money. If you make a profit your business decides how much of that profit is retained to invest in the business and the remainder is divided up among the share holds. Let's say in the first quarter after your IPO, your company made $100,000 in profit that will be given to teh shareholders in the form of a dividend. Since there are 1million shares outstanding each share holder will get $.10 times the number of shares they have. You will receive $10,000 because you kept 100,000 shares. The value of a business can be determined by multiplying the number of outstanding shares (1m) times the current share market price. If the business made money and purchased assets and such, then the value of the indiviual shares will grow. If the company loses money the value of the shares fall. The buyers and sellers of the shares of your business are watching the value of your business to determine when to buy and when to sell which is all based on how they think your business will perform in the future. Buy a low priced share of a business that makes good money and the share value goes up, divindens are paid and you sell your stock at nice profit. Buy a high priced stare and the business falters and share values drop and no dividends are paid and you lose money.

There ya go... as short and simple and I can make it. Hope this answers the question.

Answer

It's a little more complex than that. That's not bad, though.

A corporation can get money for something like a plant expansion in three ways: it can go to the bank and borrow it; it can borrow it by selling bonds; or it can sell part of itself by issuing stock. Bonds and loans are a subject for another day.

There are two kinds of stock: initial issue, and secondary market. In an IPO, the company whose name is on the stock certificate says "for x number of dollars you can buy y percent of this company." It normally isn't a very high percentage per share--calculate the percentage if the company puts 50 percent of itself on the market as an issue of 100,000 shares.

Most investors don't get to buy into IPOs--these are largely for institutional and accredited investors. One of the big reasons is brokerages require investors to hold IPO shares for sixty to ninety days, to prevent short-term profit taking.

The secondary market is where the real action is--brokerages buy and sell "used" stocks, and the company whose name is on the certificate never sees any of this money. When you buy a used Ford, Ford doesn't get any of this money and shouldn't; the car doesn't belong to them anymore. Same deal here.

Let's buy some Dresser stock and see how this goes. They make Wayne-brand gas pumps, among other things. They compete with Veeder-Root, who makes Gilbarco gas pumps. At the opening bell today, both stocks cost $25 per share and are stable because a gas pump company really makes its money selling parts--the pumps themselves can last for decades. Today at 11am, Dresser announced a new line of drink cases and entry doors for convenience stores that they will build in a factory they just broke ground on. Veeder-Root does not announce this. Investors realize this means a person who builds a new convenience store can either call Gilbarco, plus a refrigerated-case company, plus a door company to get all her equipment...or she can call Wayne and get everything she needs from one firm. Investors in Veeder-Root may start selling their stock so they can buy Dresser instead. As they sell, the brokerage will start to get overloaded, so it does what any merchant does and cuts the price to encourage buying. At the same time, the brokerage that has the Dresser stock knows there's not enough of it to go around, so it starts raising the price. This has two effects. First, to a limited extent stock follows a demand curve--the higher the price, the fewer people want to buy it. This also encourages people who bought the stock already, but who don't necessarily invest long-term, to cash out and realize a profit. Eventually the stock reaches an equilibrium.

What about Veeder-Root? Gilbarco and Wayne both make good pumps, and it wouldn't take much for Gilbarco to beat Wayne--all they need do is have Gilbarco-brand doors and cases made for them--the lower-priced Veeder-Root stock will find buyers. When Veeder-Root comes in the next day and announces they've cut OEM deals with leading makers of doors and cases and that Gilbarco doors and cases will be available immediately, the tables are turned: Dresser has a piece of land on which convenience store cases will one day be made, but Veeder-Root has a complete line of equipment that people like already. Today Veeder-Root stock will get stupid expensive and Dresser will go down.

Fast forward two years. There are 600 new convenience stores with Gilbarco cases, doors and pumps. Wayne no longer has first-mover advantage, and they know it. They retaliate by introducing a case that holds twice as many sodas as Gilbarco's case does, in the same amount of floor space, and that tells the clerk when it's time to restock. Wayne receives 400 orders in the first three months it's on the market, so their stock rises and Gilbarco's falls (because Gilbarco is seen as "behind on technology").

There's also the stock split. A stock price that's too high is bad, m'kay? Fewer people can afford to buy $100 stock than to buy $50 stock, and a small percentage decline on a high priced stock looks worse than the same decline on a lower-priced one. (If you have two stocks--one priced at $100 and one at $20--a 5 percent decline on the expensive stock brings it down to $95 per share, but the same 5 percent decline on the less expensive share is only a dollar.) If a stock is outrageously expensive, the company has the option of doing a "stock split." These will be listed as "3 for 2" or "10 for 1" splits. If your company does a 5 for 1 split and the stock currently trades at $500, every $500 share will become five $100 shares--same market capitalization, but spread out over more shares.

How Does the Stock Market Work? A Guide For Beginners

If you are a beginner, you are probably wondering how does the stock market work? The answer is surprisingly simple: Companies go public and offer shares in their company to the public. The public buys the shares through what we know as the stock exchange. Investors can then use the stock exchange to buy and sell the stocks of the companies. Buying low and selling high can make people rich overnight. Of course you have to know what you are doing, and there are many factors involved. To gain a deeper understanding of how the stock market works, why don't we discuss a few of the most common terms.

Stock Prices: Stock prices are, to make it simple, the price that a specific stock sells for. This price is set by many market factors including the economy health, current trading trends, and technical and financial reports put out by the company (or independent third party).

Market Captialization: This is the actual value of the company or stock that is up for sale. Calculating the market capitalization of a stock is done by using the following formula -

Number of Outstanding Shares X Price of Stock = Market Capitalization of the Company

Once you have learned the basic premise of the stock exchange, you will want to learn how to buy and sell shares. To purchase stock you will need to create some type of investment account. Most times you can open up an account with a local stock broker. Thanks to the wonder of the internet, you can now make trades online on your own. It is as simple as setting up an account and funding it.

Hopefully now you have the answer to your question, how does the stock market work. The next step will be to learn how to successfully profit from trading. Good luck!

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What is stock?

Stock[pic] is a piece of ownership of a company. When a company needs to acquire extra money to help grow the business, they can sell some or all of the ownership of the company in the form of stocks. So if you were to buy 100% of a company's stock, you would own the whole company. If you own enough stock you also have some decision-making power within the company. Buying stock is a very popular form of investing.

What is a share?

A share is one individual piece of stock. It represents a very small percentage of ownership of a company.

What is the Dow Jones or the DJIA?

The Dow Jones Industrial Average (often referred to as the "Dow") is an averaged number representing the values of 30 U.S. "blue-chip" stocks. The DJIA is the most well-known market[pic] indicator in the world and was created in 1896 by Dow Jones & Company, which is actually a publicly-traded company (DJ) on the New York Stock Exchange (NYSE). They produce many important business publications including The Wall Street Journal, Barron's, and several stock indexes.

What is the Nasdaq?

The NASDAQ refers to two different things. First is the largest electronic stock market in the U.S. - the National Association of Securities Dealers Automated Quotation System. Second is the popular stock index called the NASDAQ Composite Index. It measures all domestic and international stocks listed on The NASDAQ, which number over 3,000. It was started in 1971 and is now one of the most important stock indexes.

What is the Big Board?

The Big Board is another name for the New York Stock Exchange.

What is the S&P 500?

The S&P 500 is a stock index published by Standard & Poor's. It measures 500 U.S. stocks that are supposed to be representative of the overall stock market. It was created in 1957.

What determines a stock's price?

There are many factors that play into a stock's price. Overall, though, the price is determined by investors' perceptions of what the stock is worth.

Some of the biggest factors include:

    How big and successful the company is (especially its earnings)

    Recent company news

    The state of the U.S. and world economies

    Whether there is a bull or bear market

    World events, whether good or bad

For more information, see our Stock Prices page.

What is a bull market?

A bull market occurs when stock prices are rising faster than their historical averages. It can last months or even years. It is the opposite of a bear market.

What is a bear market?

A bear market occurs when stock prices are falling faster than their historical averages. It can last months or even years. It is the opposite of a bull market.

What is a market crash?

The market has "crashed" when stock prices have dropped dramatically. One of the worst crashes was Black Tuesday, which occurred on October 29, 1929 and led to the Great Depression.

What is insider trading?

Insider trading occurs (1) when an insider to a company, such as an officer or someone who owns a large percentage of the company, trades the company's stock. This is legal and acceptable, as long as that person is not trading based upon non-public company information.

Insider trading also occurs (2) when anyone, including employees, trades using non-public company information. This is considered illegal.

How much money do I need to get started?

These days, you can open an online account with a brokerage with as little as $5. When you purchase stocks, your brokerage will generally charge you a commission fee of $5-25, depending on the type of brokerage and type of order you place.

What is the Bid price? What is the Ask price?

When you request a quote for a stock, you will receive the bid price and the ask price. The bid price is the best (highest) price you might receive if you sell your stock back to the market. The ask price is the best (lowest) price you might receive if you buy stock from the market.

You are not guaranteed to get these prices because the market fluctuates constantly and prices change quickly. Also, if you buy (or sell) shares of a low-volume stock, you run the risk of affecting the price due to excess demand (or supply).

Will somebody always buy my stocks when I sell them?

No. If you try to sell more shares than people are willing to buy or if your price is unreasonable, it may take a long time for them to sell, if at all. However, if you use market orders on medium or high volume stocks you should not have any problems selling them immediately.

What is day trading?

Day trading is the process of buying and selling the same stock during one day. Professional day traders commonly trade many times per day. More Details.

When is the market open?

U.S. markets are usually open 9:30am-4:00pm Eastern time, except on holidays.

How much return can I expect?

Historically, the market has advanced roughly 10% per year. Of course this rate fluctuates constantly. For instance, it may grow up 30% one year, then fall 20% the next year.

How do I know which stocks to buy?

That is a great question. With over 8,000 different stocks to choose from, it can be overwhelming to pick some possible winners.

Many people simply buy stocks that are recommended to them by their brokerages, their friends, or experts from TV, magazines, and newspapers.

Some people buy stocks from companies they think are big, stable, and successful. This may seem like a safe route, but there are no guarantees.

Other people buy stocks based on rumors that the price will rise/fall sharply soon.

Many experienced traders watch financial news on TV, read the relevant newspaper stories, and investigate companies that are in the news. They also use "technical indicators," which are numbers or graphs which may help indicate whether a stock will rise, fall, or stay the same.

A few people will randomly pick stock symbols by throwing a dart at a newspaper, for instance.

What is a mutual fund?

A mutual fund is a fund created by an investment company which combines money from many investors and invests it in a group of stocks, bonds, or other investment vehicles. The investment company actively manages the portfolio to meet a desired goal, such as long-term growth or steady dividends. One major benefit is diversification. Many mutual funds also charge a fee when someone buys or sells shares.

When someone buys shares of a mutual fund, they are not directly buying shares of the underlying companies. Instead, they are entitled to a proportional amount of the fund's profits, which are usually distributed two or three times per year.

What is a mutual fund's N.A.V.?

The Net Asset Value (NAV) is the current price of a mutual fund, which is calculated at the end of each business day. It is the total value of the fund's assets minus its liabilities and divided by the total number of shares outstanding. It is similar to a stock's closing price for the day.

What is a 401(k) plan?

A 401(k) is a type of personal pension plan that is offered by many employers. Employees contribute part of their salary (before taxes) and employers commonly match part of the contribution. The bulk of the plan is usually invested in mutual funds.

What are the main ways to make money with stocks?

Buy Low, Sell High (traditional long trading)

Sell High, Buy Low (short selling)

Dividends

Options trading

Futures

What is short selling?

Short selling is the act of selling stock that you don't own at a high price by borrowing it from a brokerage and then buying it back at a lower price in the future. The hope is that the stock price will drop in value and a profit can be made. This is an advanced technique that has strict requirements and higher risks. More Details.

What is a dividend?

A dividend is money that a company gives to its shareholders when it has extra profit. Since the shareholders own the company, they deserve its profits. However, sometimes companies want to use these profits to help grow their business and decide not to distribute dividends, at least for a while.

What is the P.E. ratio?

The Price to Earnings ratio is simply the price of a company's stock divided by its Earnings Per Share. It is often used as an indicator of whether a stock is overpriced, underpriced, or on par. The PE ratio by itself is not always enough to make a good determination but it can be helpful to compare it with other companies in the same industry. The NASDAQ's average P/E is about 35.

What is a stock split and a reverse stock split?

A stock split is an increase in the number of outstanding shares of a stock. The price of the stock is immediately adjusted so that the total equity remains the same. For instance, if a $100/share stock splits 2 for 1, there will be twice as many shares but they only be worth $50 each now. This is usually done to make the stock more affordable to the public.

A reverse stock split is a decrease in the number of shares. This is usually done to raise the price per share to meet stock exchange requirements or simply to look more "healthy."

What is an IPO?

When a company issues stock to the general public for the first time, it is called an Initial Public Offering. The SEC has strict guidelines on how this is carried out. The company can issue more stock in the future, which is called a Secondary IPO.

What is Dollar Cost Averaging?

DCA is the act of buying the same dollar amount of a stock each month. This allows you to buy more shares when the stock's price is low and fewer shares when it is high. It can often be more successful than buying the same number of shares each month.

What is a penny stock?

Less than $1 (or $5 in some cases) per share. More Details.

What is a small-cap stock? Mid-cap? Large-cap?

These terms refer to a company's market capitalization, which is the number of outstanding shares times the stock's price.

|Small cap: |$250 Million to $2 Billion, approximately |

|Mid cap: |$2 Billion to $10 Billion, approximately |

|Large cap: |$10 Billion and up, approximately |

What is a Blue Chip stock?

It is the stock of a large company that has a long history of stable operation and solid stock performance. A great example is General Electric.

What is the SEC?

The Securities and Exchange Commission (SEC) is the government agency responsible for protecting investors by monitoring and regulating brokers, dealers, and the stock and bond markets in the U.S. They also make sure publicly-traded companies disclose the required business details to the public.

What is a Margin Account?

A margin account allows you to quickly and easily borrow money from your brokerage to purchase additional shares. In other words, it provides leverage for your account. It also allows you to do short selling. Of course interest is charged interest on any borrowed money and the SEC has very strict regulations on these accounts.

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