How Does A Stock Market Work?

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Being able to take part in a company’s growth is just one of the perks of investing in the stock market.

I always hear the term “stock market” but I never bothered to learn more about it until recent years. ?‍♀️ And it’s one of my regrets that I didn’t care to learn about it much earlier..

And it seems like people still don’t invest in the stock market because some of them don’t know how it works. 

I think when it comes to stock market, a lot of beginners (me included) first thought that stock market is complicated. Well, not really. You just need to take some time understanding on it works.

And you don’t need to constantly see how the stock market is performing every day – that’s for traders. Investing on the stock market doesn’t make you a day trader 🙂 You can definitely choose to just invest in a stock in a company and let it sit there for as long as you want.

In this post, I’ll try to answer how does a stock market work and some of the most common questions about it!

If you’re ready to learn more about the stock market and why it’s almost always recommended by any financial books, then read to the very end! 🙂

How Does A Stock Market Work?

how does a stock market work

In general, a stock market is where investors and traders buy and sell stocks of a publicly listed company. The stock market should not be confused with the stock exchange.

Stock market = refers to all stock trading and its transactions while,
S
tock exchange = facilitates all of those things.

What Are Stocks?

Stocks or shares are pieces of a company. If you buy a stock of Facebook, then you’re now considered as a shareholder. You own a piece of the company. You’re now part of both the decline and growth of Facebook.

Why Would Companies Give Out Shares?

Companies give out a piece of the company for them to expand and grow their business. Plus, they can also use the investor’s money to fund their researches.

Think of it this way, let’s say I have a coffee business. And I want to expand my business and open up in different parts of the city. 

But in order to this, I need money. When I went to the bank and applied for a loan, unfortunately, they wouldn’t approve it.

Why Did Your Loan Got Rejected & What You Can Do About It?

So another option that I can do is sell a piece of my company to my friends, family, or loyal customers. They then give me money and I give them a piece/share/stock of my company.

They are now part of my growing business. When my stores earn money, I can give out a piece of my profit to the investors in which they call it as a dividend. 

And if my company gets big enough and I need more investors to grow, I would enter the stock market so that there will be millions of people who will get access to buying my shares.

How Does A Company Enter A Stock Market?

Lana Del Ipo GIF - Find & Share on GIPHY

It enters the market by what they call an Initial Public Offering or IPO. This is where a private company transitions to a public company.

The company will issue more shares so that they can raise more capital from public investors. Public investors would be the people in the stock market – the average joes like you and me.

The money that they will raise will be used to fund their growth and expansion. 

If you want a more detailed explanation on the process of IPO, you can check out Plain Bagel’s video below:

Visa, Facebook, Microsoft, Alibaba, and Amazon are some of the companies that are waaay above their IPO price. This means if you’ve invested during their date of listing, you would have more than tripled your investment today.????

What Makes A Stock Price Move Up And Down?

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Supply and demand are what makes the stock price move. The supply represents the sellers and the demand represents the buyers.

If there are more buyers than sellers, then the stock price goes up.

While on the flip side, if more people are selling the stock than people buying it, the stock price goes down.

For example, you and your friend have shares in Company X. And Company X is currently at a price of $100. And just recently, Company X released a statement that they will incur some losses this year because of the current pandemic. 

So now you want to sell your shares because of this news. But no one is willing to buy shares of Company X at $100 because of their current statement.

Instead, people are willing to buy it at $97. Since you want to sell your share immediately, you settle for the $97. And the next person who’s willing to buy a share of the company is only going to buy it for $95, so your friend sells his share for that price. And this continues until the last transaction is made for the day. And in this case, the last transaction happened at $90.

So Company X went from $100 per share to $90 per share in just one day, a -10% decrease in price.

But in the actual stock market, there are thousands of transactions done every second. That’s the reason why you see stock prices go up and down at a fast pace. ? 

How Many Stock Markets Are There?

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There are a lot of stock markets out there. From America to Europe to Asia. Some of the famous stock markets that you’ve probably heard of are:

  • New York Stock Exchange (NYSE)
  • NASDAQ
  • London Stock Exchange
  • Japan Stock Exchange
  • Shanghai Stock Exchange

If investors would like to look at how their stock market is doing, they won’t look at each stock listed in the exchange but rather they would just check out a stock market index.

What’s A Stock Market Index?

A stock market index is a measurement of a stock market’s performance. Since there are a lot of stock markets out there, it just means that there’s a lot of stock market indexes as well.

To name a few popular stock index and what they measure:

  • S&P 500 – Tracks the top 500 companies publicly listed in the US
  • DJIA – Measures the performance of the top 30 companies publicly listed in the US.
  • Nikkei – The index that measures the performance of stocks in the Tokyo Stock Exchange
  • HangSeng Index – This records and monitors the largest companies listed in the Hong Kong stock market.
  • FTSE 100 – Tracks the top companies listed in the London Stock Exchange

How do investors make money in the stock market?

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There are two ways to earn money in the market and that’s through capital appreciation and dividends.

Capital Appreciation.

This is where an investor sees an increase in their investment’s market price or how much the share price increased. 

For example, basing in real data, if you invested $20,000 in Visa in January of 2010. During that time of the month, Visa’s price was only around $22, and looking at its price today, it’s already $190 at this time of writing. That’s around a 763% increase in price. Making your investment to a total of $152,600. ?

That’s basically how investors and traders make money in the market.

Dividends.

A dividend is a company’s payback to the investors for investing and trusting their money with the company.

That dividend comes from the company’s profit. But they won’t be giving all their profits to the investors,  because some of it would be reinvested back in the company.

How Do People Lose Money In The Stock Market?

Losing Money GIFs | Tenor

Sadly, it’s not always rainbows and sunshine in the market. If there are people who are making money, there are investors who lose money as well….

If investors make money by capital appreciation, they lose money by capital depreciation.

For example in the case of buying an IPO. Let’s say you bought Uber’s IPO price at $45/share with your $10,000. And at the time of this writing, Uber’s current price is $30/share. That’s a 33% decrease in price. If you sell your shares now, your initial investment of $10,000 is now worth $6,700. Giving you a total loss of $3,300.

Another example would be the scenario mentioned earlier. If you bought shares of Company X at $100/share, and that news came out, and no one is willing to buy at a $100, then you’re forced to sell on a loss as well.

What Are The Different Ways To Make Money In The Market?

Just as the saying goes, there are many paths to the top of the mountain. The same goes for the stock market. There are many people who have succeeded in building their wealth in the stock market with different styles.

Some have built their wealth by trading. Trading stocks involves looking at the stock’s price chart.

They use different market timing techniques to enter and get out of a company. But it’s easier said than done. And also, these guys have a shorter time frame when holding their shares.

Others have built their wealth by investing in the long term. These people are willing to hold on to a stock for 5 to 10 years or even longer. The most popular investor and one of the richest men in the world also uses investing to build his wealth.

Which One Is The Best Way?

Top 30 Warren Buffett GIFs | Find the best GIF on Gfycat

It really depends on you. I know that’s not the answer you wanna hear, but it’s true. ?‍♀️

To me personally, I would rather go for investing because I don’t have the time to look at price charts all day because of work. 

Plus, I would be more comfortable in just investing my money in the long term. According to the book The Intelligent Investor, it’s better not to think about the different market swings that happen from time to time in the stock market.

In an article posted by Business Insider, Warren Buffet said that he knows that individual stock picking isn’t for everyone. Everyone doesn’t have the time to study about different companies, to look at their balance sheets and interview the executives.

So instead, Buffett recommended going for a low-cost index fund. He even mentioned that an investor who has little knowledge of investing can put money in an index fund and outperform most investment professionals.

If you’re planning to invest in a low-cost index fund, US News released a recent article displaying the lowest cost index fund in the market.

Learn And Apply

If you reached this part of the post, congratulations! And I thank you for reading until the end. Now that you have this information, don’t let it get stuck in your head but apply them as well!

Since you already know how the stock market works, it’s time to learn about the different things you need to consider before you invest in stocks online!

If you have some investing tips of your own, share them below! 🙂

If you find the post helpful, please share it around!

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