How Does The Stock Market Work?

How Does The Stock Market Work?

A stock can be thought of as fractional ownership of a company, one that entitles its holder to specific rights and claims. Therefore, the stock market exchange can be considered a marketplace where people meet to buy and sell these fractional ownerships. 

 

The price at which people are willing to buy and sell varies for each person, these various orders can be added together, which is what creates an exchange order book. The stock market operates similarly to an auction house, where buyers place bids and sellers try to reach a consensus. Stocks are commonly traded on exchanges, and a prominent example is the New York stock exchange.

 

As mentioned previously, companies interested in selling shares are listed on the stock exchange for potential investors. Companies often do this to expand their businesses by raising new capital. The prices of shares of a stock is based on the underlying demand for the stock. As the demand varies, so does the price. Overall, price is a function of two things, supply and demand. The more demand there is for a stock, the more people will buy it, driving down the supply. In contrast, when there is low demand for a stock, sell supply builds up, and investors may decrease the price they are willing to sell at, thus decreasing overall price. Therefore, it’s important to try to identify stocks that will have increased demand over time. 

 

There are criteria to be met before a company can be approved for listing on a stock exchange, and the criteria for listing varies based on the exchange. Various requirements can be needed, such as listing fees, liquidity/market makers availability, a certain amount of earnings, and other criteria based on the exchange. Different exchanges cater to different types of assets, and some exchanges may cater to small cap stocks, while others will not. The requirements for each would thus be different.

There are overall two types of markets. Primary and Secondary. 

 

The secondary market is what most people are used to. This is the market where already issued stocks and assets trade, such as on an exchange. Buyers readily buy and sell here.

 

The primary market, instead, is where newly issued stocks and assets originate from. When a company offers a new set of stock for sale directly from its treasury or new stock, then this is a primary sale. 

 

Another type of market is the over-the-counter (OTC) stock exchange. This is a decentralized market where two participants can trade different assets with each other. OTC stocks are not listed on any formal stock exchange like the NYSE (New York Stock Exchange). Instead, they are listed on specialized over-the-counter bulletin boards (OTCBB) or pink sheets. They provide other options to companies that cannot meet the formal exchange listed criteria.