How the Stock Market Works? For Dummies, Basics, Understanding and Learning for Beginners

nyse biggest stock exchange in the world

This is the New York Stock Exchange (NYSE) – Largest Stock Market in the world

How the stock market works? What is a stock exchange?  Do you want stock market for dummies? Or you are looking for understanding stocks. Well! It may be troubling. And here I am going to explain working with stock markets aka stock exchanges, Initial Public Offering, Shares and Share Price. This article is really simple and it will explain you everything about stocks. It will help you in understanding stock exchanges and also equip you with the basics. It is a must learn for beginners.

how the stock market works

How the Stock Market Works?

As a newbie, you may wonder what sort of a thing is this stock market also knows as a stock exchange. You must have stumbled across this while surfing the web and landing on financial websites. You may have landed in a money section of a website by chance and may have wondered what are these shares. You may have seen channels on TV which continually show the prices of stocks in stock exchanges  At times, you may have even seen breaking news of ‘Stock Market Crash’. All these sorts of things may appear a riddle to you until you learn how those stocks works. For me, it appeared Greek when I saw stock prices.

nasdaq how the stock market works

This article is going to answer all your questions in mind. One thing I would like to make clear is that I am not at all going to use the technical terms of stock markets. The English which I am going to use will be the one which a layman speaks.  Also, in this finance article, I am going to explain stock exchange only and not off things which are off-topic.

Why do we need a stock market?

Need for a stock market can be easily understood if we take an example. This example will represent a practical situation which happens with almost all of the entrepreneurs.  Let us say that you wish to open a car manufacturing company and have no money with you. The company will produce cars to be sold in the market. And your prediction is that you will make $500,000 in profits each year.

As a matter of fact, a car needs to be manufactured and for this you need different types of machines. Also, you need to purchase a piece of land and hire people who will work for your company.

You went to purchase land and machines. You found that the total cost involved is $1 million. Now, the question arises. From where will you gather $1 million? For the sake of simplicity, let us assume in this example that you have no money  How will you purchase land and machines for manufacturing cars?

What are Shares in a Stock Market?

bombay stock exchange working of stocks

In this case (above example), you will try to divide your company into several parts and sell each part to an investor. This division of company into parts is called as Shares. An investor is a person who wishes to give money and purchase parts of the company for the sake of profits. Hence, in our case, the investor purchases some part of the company only for the sake of profits each year. Remember that, the company is to make $500,000 in profits according to predictions.

What is Share Price?

As the logic demands, we have to raise $1,000,000. We divide the company into 200,000 parts and then sell half of those parts to investors. Since we need $1 million, we place the price of 1 part i.e. 1 share for $10. This is known as Share price. According to its definition, Share Price is the cost of one share of any company. Different companies have different share prices. In our example, we sold all the shares to investors and finally raised $1,000,000.

Do I keep all the profits in a joint-stock company?

how the tokyo stock exchange works

You started the company and after one year, you made $500,000 in profits. Now, you will not get all the profits because there are other owners as well who have purchased shares of the company. Total number of shares in case of our company is 200,000. Hence, dividing  profit $500,000 by number of shares 200000, we get $2.5 profit per share.

Profit per share is $2.5! Hence, if a friend invested and purchased 10 shares. Then, he will get profit of 10 x 2.5 = $25. Isn’t this a profitable business?

In our example, who are investors? These are real people. Who can be these people? They can be our friends and family members. What if our family and friends are poor? Hence, we need to look for unknown people who are ready to invest money. This kind of folks are there everywhere who want profits for their money. We will get this kind of people at stock market or stock exchange. Stock Market is a place where a company sells shares and investors purchase those shares.

Because of share market things get easier. We don’ have to wander here and there for investors. We can get them through stock markets!