Things you might not have learned in school but should know about: How the stock market works
The stock market is a vast, interconnected marketplace where people buy and sell ownership stakes in publicly traded companies. It serves as a vital part of the global economy, fulfilling two primary functions:
- For Companies: It provides a way for businesses to raise capital to fund their growth, expansion, or new projects. This is typically done through an Initial Public Offering (IPO), where a private company sells its shares to the public for the first time.
2. For Investors: It gives individuals and institutions the opportunity to become part-owners of these companies. By purchasing a stock (or share), an investor might profit from the company's success, either through an increase in the stock's value or through dividends (a portion of the company's profits paid to shareholders). When an individual buys a stock (which is divided into individual shares), you become a part-owner of that company.
How It Works
The stock market operates on the fundamental principle of supply and demand. The price of a stock is determined by how many people want to buy it versus how many want to sell it. Positive news about a company's earnings or a strong economic outlook can drive up demand and, consequently, the stock price. Conversely, negative news can lead to a drop in price.
This trading primarily occurs on regulated platforms called stock exchanges, such as the New York Stock Exchange (NYSE) and the Nasdaq. These exchanges provide the infrastructure to match buyers and sellers and ensure fair, transparent, and orderly trading.
Typically, you can't buy and sell stocks on an exchange yourself. You would use a broker who acts as an intermediary, facilitating the transactions on your behalf through a brokerage account. There are exceptions, though:
- Direct Stock Purchase Plan: This is a program offered by some companies allowing investors to buy shares directly from the company without a broker. Benefits can include lower fees and the ability to purchase fractional shares. DSPPs are often paired with Dividend Reinvestment Plans (DRIPs). DRIPs reinvest any earned interest back into the company, often at a discounted rate, rather than you earning direct cash.
- Employee Stock Purchase Plan (ESPP): This program allows employees to purchase company stock, usually at a discounted price, through payroll deductions. It's a benefit offered by many companies, enabling employees to invest in the company and potentially profit from stock appreciation.
Primary vs. Secondary Markets
- Primary Market: This is where a company first sells its shares to the public during an IPO. The money raised from these sales goes directly to the company.
- Secondary Market: After the initial offering, most daily trading takes place here. This is where investors buy and sell existing shares from one another, and the money from these transactions goes to the selling investor, not the company. When you hear about the stock market being "up" or "down," it's generally referring to activity in the secondary market.
Key Terms to Know
- Stock (or Share): A unit of ownership in a company.
- Shareholder: An individual or institution that owns shares of a company's stock.
- Dividends: A portion of a company's profits that is paid out to its shareholders.
- Stock Market Index: A measure of the performance of a group of stocks, often used as an indicator for the overall health of the market (e.g., the S&P 500, Dow Jones Industrial Average).
- Capital Gains: The profit you make when you sell a stock for a higher price than you bought it for.
