You see the stock quotes streaming across your mobile phone. You hear everyone talking about it, but exactly how does the stock market work? The stock market works on one basic law of economics--supply and demand. How the market manages this supply and demand depends on its primary market activities and its secondary market activities. The primary and secondary markets serve different roles but investors buy and sell in both.
Think of the stock market as your local food market. Most people shop at the local food market because it has everything under one roof. Unless you’re a serious foodie, you don’t go to the orchard to buy apples and the cattle farm to buy meat and the wharf to buy seafood. You go to the local market. The market has the products you need; it makes it easy to buy and sell these products and provides a regulated environment for buyers and sellers to conduct business site unseen. The stock market works the same way.
Supply and Demand
Supply and demand makes up the driving force behind the stock market. Stocks rise in price when investors start buying. Buying decreases the availability of stock to the public. High demand plus short supply equals higher price. The opposite happens when investors start selling. Selling increases the availability of stock to the public. Low demand plus increased supply equals lower price.
Don’t assume that trading stock is the market’s primary function. In reality, that’s the stock market’s secondary function. The market’s primary function provides a place for companies to raise money for operating capital. Wall Street calls this the primary market. This gets done through issuing stock and other securities for sell to investors. The market’s other function provides a secondary market for buyers and sellers of those stocks and other securities after the initial offering. Wall Street calls this the secondary market. The first function resembles the high-end boutique store while the second function looks more like the thrift shop.
So you’re ready to buy stock and you call your stockbroker or discount brokerage firm. What happens next gets exaggerated a lot on television, but in essence, your broker sends the order to the trading floor of the stock exchange. Someone on the floor called a floor broker walks over to the section of the floor that sells stock in the company you wish to purchase. Unless you tell your broker you want to purchase the stock at a specific price, the floor broker typically buys the stock at the price offered. The floor broker then enters the trade in a computer that confirms your purchase and he confirms back to your brokerage company that you now own the stock. Selling stock works the same way. Also note that unless you tell your broker you want the physical stock certificates in your name, you will not get them. They stay in what’s called “street name” or the brokerage firm’s name. Don’t worry, they still belong to you, but keeping them in the firm’s name facilitates quicker buying and selling.
- stock market analysis screenshot image by .shock from Fotolia.com