Learn How the Stock Market Works
The stock market is driven solely by supply and demand. The number of shares of
stock available for sale dictates the supply and the number of shares that
investors want to buy dictates the demand. It's important to understand that for
every share that is purchased, there is someone on the other end selling that
share (or vice versa). When people's views of the stock market or
individual stocks change (which can be driven by economic fundamentals, consumer
confidence, fear of terrorism, or company earnings), the demand for stock
changes. This also causes the prices to change. For example, if
people in general believe that the economy is growing, they become more
optimistic and want to own more stock. This increases the demand for
stock. At the same time, since people are selling less stock, it also
decreases the supply of stock for sale. Both of these factors cause the
average stock price to rise.
In essence, 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.
To give you a better idea of what happens behind the scenes, here's an
example of one of the many ways that the stock market works:
You open an account with E*Trade. You send E*Trade a check for $1,000.
E*Trade deposits the check into a trading account that is listed under your
name. You log onto E*Trade and place an order to buy 100 shares of a stock in
Company A, which is currently trading at $5. E*Trade uses it's network to tell
the NASDAQ and all of it's related networks that there is demand for 100 shares
of Company A's stock. The NASDAQ finds someone who is willing to sell 100 shares
of Company A and, instantaneously, they execute the trading of stock between you
and the person selling the shares. The trade information is sent to a
clearinghouse where the information is processed and the shares will now be
registered to you. Basically, the clearinghouse will designate 100 shares of
Company A to E*Trade and E*Trade will designate those 100 shares as yours. The
actual stock certificates are typically held "in street name" at the brokerage
and never really need to exchange hands (although you could request that the
stock certificates be transferred to your name and held by you).
In a nutshell, that's how the stock market works. It's really just like any
other marketplace - it facilitates the exchange of goods between interested
parties and works to reduce distribution costs and set prices.
