We can quickly summarize the way the stock market works by comparing it to just any other kind of market: a place where people buy and sell products and services. It obeys to the same basic law, demand and offer. When demand soars, prices usually jump and vice-versa. The stock market however sells something very unique: shares of companies.
Companies usually get listed on the stock exchange as a way to raise capital (see our next tutorial about what are stocks). If the company’s ideas and prospects sound good, investors may see an opportunity in owning part of that company. Buying stocks means buying part of a corporation. That company may strive, or it may sink.
Investors trade shares using brokers: professional entities accredited to perform trades on various markets. When buying or selling a stock, an investor traditionally fills an order and sends it to the broker, who then submits it to the relevant market. If you wish to buy common stock from Apple, for instance, the broker will relay the order to the Nasdaq, which is the market where Apple is traded.
Stocks are traded on various markets around the world, such as the New York Stock Exchange (NYSE), Toronto Stock Exchange (TSX) etc… Some stocks are sold on more than one market, and markets are not necessarily geographically distributed (the Nasdaq, for instance, lists both US and non-US companies). Markets can also be specialized in particular segments. The Nasdaq, for instance, is a trading market specialized in technology and growth companies.
When hearing of a drop of X% for the TSX, or Y% for the Nasdaq, people refer to the change in the indices of such markets. The indices represent the overall performance of the companies listed on the markets. In the case of the Nasdaq, the main index looked at in the news is the Nasdaq Composite – an index of all common stocks listed on the Nasdaq. It is value-weighted based on the capitalization of the more than 3,800 companies listed there. Various indices exist, for the Nasdaq and other markets, and are used to analyze the performance of various sectors and sub-sectors by compiling value-weighted data from relevant companies.
Owning stocks can obviously be lucrative for investors because if the circumstances are favorable, the confidence from investors towards that company can increase and push the stock price to rise. If it does, the investors can sell the stocks for a profit. Some companies also distribute periodic dividends to investors, a way to share the profits that have been made.
The stock market is a key instrument of wealth manipulation worldwide. The stock prices on various markets mainly represent the confidence that investors have in the companies. It is therefore not a perfect entity, but careful and well-informed decisions can yield great returns for investors.