How the Stock Market Works
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- Category: Stock Market
The stock market is driven by supply and demand. The number of shares of stock dictates the supply and the number of shares that investors want to buy dictates the demand. It's important to understand for every share that is purchased, there is someone on the other end selling that share (or vice versa). The stock market is really just a big, automated superstore where everyone goes to buy and sell their stock. The main players in the stock market are the exchanges. Exchanges are where the sellers are matched with buyers to both facilitate trading and to help set the price of the shares.
The primary exchanges are the NASDAQ, the New York Stock Exchange (NYSE), all of the ECNs (electronic communication networks) and a few other regional exchanges like the American Stock Exchange and the Pacific Stock Exchange. Years ago, all of the trading was done through the traditional exchanges (like the NYSE, American and Pacific Exchanges) but now almost all of the trading is done through the Nasdaq, which uses ECNs and thousands of other firms with access to the Nasdaq to facilitate trading.
Stocks have two types of valuations. One is a value created using some type of cash flow, sales or fundamental earnings analysis. The other value is dictated by how much an investor is willing to pay for a particular share of stock and by how much other investors are willing to sell a stock for (in other words, by supply and demand). Both of these values change over time as investors change the way they analyze stocks and as they become more or less confident in the future of stocks. Let me discuss both types of valuations.
Many¬ factors affect prices in the stock market, including inflation, interest rates, energy prices, oil prices and international issues, such as war, crime, fraud and political unrest. Sudden rises or drops in stock prices are often called spikes. Spikes are extremely difficult, if not impossible, to predict. Stock market trends are like the behavior of a person. After you study how a person reacts to different situations, you can make predictions about how that person will react to an event. Similarly, recognizing a trend in the stock market or in an individual stock will enable you to choose the best times to buy and sell.
If you'd like to buy a share of stock in any publicly traded company you'll most likely need the services of a brokerage firm. Though it's possible to buy and sell shares of stock on your own, there are some practical and legal problems with this approach. The securities industry is highly regulated, so you can't just hang a shingle and start selling stocks to the general public, unless you're properly registered and licensed. When you want to buy groceries, you go to the grocery store. When you want to buy a sofa, you go the furniture store. And when you want to buy stocks, you need to do business with a brokerage firm. A brokerage firm is a dealer of stocks and other securities that acts as your agent when you want to buy or sell stocks.
