“What is Stock Market?” This question may seem strange to those who are not familiar with investing or have never heard of it, but for investors it is a source of earning extra money. In simple terms it is a market where investors can buy and sell shares of publicly traded companies. It is a platform used by companies to raise capital for their business activities and they do so by issuing shares to the public.
What is Stock Market in Economics?
Some people may wonder what has stock market got to do with economics. To understand this, we need to understand the functions of the stock market in depth. A stock market performs several functions within the economy, which include:
- Raising capital for businesses: Companies can raise capital by issuing shares to investors. This process helps companies raise funds for business expansion.
- Providing liquidity to investors: The Stock Market provides an easy platform for investors to buy and sell shares.
- Price Discovery: The stock market facilitates easy discovery of a stock’s price through the interaction of buyers and sellers. The price of a stock is a collective assessment of a company’s value and its future prospects
- Facilitates price distribution: The Stock Market facilitates diversification of investment across different companies and sectors, thereby reducing risk and creating a balanced portfolio for investors.
- Serves as an economic indicator: The stock market acts as a barometer that measures the health of the economy. A steadily rising stock market usually indicates economic growth, but a decline may signal an economic crisis.
How does the Stock Market work to provide profits to investors?
Let us understand what is stock market and how it works with the help of a hypothetical example. In this, a company named ‘Wonder Chemicals‘ needs additional funds to start a new plant, and there is a girl named ‘Rita’ who wants to invest her savings in the stock market to get better returns.
Stage 1: Wonder Chemicals decides to raise money
The management of Wonder Chemicals, which owns 100% of the shares, organizes a meeting of all the major shareholders to solve the problem of additional fund requirements. After various discussions, they decide to raise funds from the public by selling ownership shares in the company. This process of selling shares to the public for the first time is called “IPO (Initial Public Offering)”, after which the shares get listed on the stock exchange.
Stage 2: Buying and selling Shares
Once the Wonder Chemicals IPO is executed and the shares are listed on the stock exchange, those who wish to invest in these shares can do so through a broker, who acts as a middleman. Some popular examples of stock brokers in the US include Charles Schwab, Vanguard, Fidelity, and JP Morgan. The Wonder Chemicals shares that are now available for investment, represent a small portion of ownership in the company. By buying these shares, one is essentially investing in the company’s growth story.
Rita, after doing thorough research on Wonder Chemicals, finally decides to invest in 100 shares of the company. She believes that its business is good and the company will be successful in the long run.
Stage 3: Setting the Share Price
The price of each share of Wonder Chemicals is determined by the supply and demand in the stock market. Those who wish to invest in these shares will submit a buy order (bid) at a certain price with the broker, while investors who wish to sell this share will submit a sell order at a different price. The trade is completed only when the buyer’s bid price matches the seller’s ask price, and then the shares are transferred to the buyer.
In the case of Rita, although she wishes to invest in Wonder Chemicals, she does not wish to buy its shares at a price higher than $5.00. However, when she attempts to buy shares of Wonder Chemicals with her broker, she finds out that the price of its shares has gone up to $6.00. Undeterred by this, Rita sticks to her target price of $5.00, considering it to be the best price. She places a buy order at $5.00 when the stock market opens in the morning. Eventually, her order is executed at $5.00 when the share price falls to her bid price.
Over time, Wonder Chemicals becomes very successful in its business ventures and its profits grow, attracting more investors’ interest in the company. This results in an increase in the share price, which is now $100.00, thus making Rita’s decision profitable.
Stage 4: Making Money
The two main ways in which investors can make money from the stock market include:
- Selling at a higher price: In the above example, if Rita decides to sell the shares of Wonder Chemicals at $100.00, she will make a good profit of $95.00 on each share. Now, it is up to her to decide whether she wants to sell all the 100 shares of Wonder Chemicals or just a few of them.
- Dividends: When a company makes profits, it may decide to share a part of its profits with its shareholders. This shared profit is called a “dividend.” However, it is not mandatory for the company to do so, and the amount of profit to be shared is always the company’s decision.
In conclusion, the question ‘what is stock market’ can be best understood when one invests in the stock market. Over time, the investor will automatically understand how the stock market works and how to profit from it. By actively participating in the market, investors gain valuable experience and insight into market dynamics, risk management, and investment strategies. This enables investors to make informed decisions and navigate the ups and downs with confidence.
Frequently Asked Questions
What is Stock Market in simple words?
In simple terms, the stock market is a place or platform where investors buy and sell shares of publicly traded companies with the intention of earning profits. Company shares represent units of ownership in the company.
What is the Importance of Stock Market?
Since the stock market is a platform where companies raise capital by issuing shares to investors, it plays a vital role in shaping the global economy. Positive sentiment in the stock market where it is rising steadily may be a sign of economic growth, while a persistent decline may be a sign of economic depression or an oncoming recession.
What is most important thing in stock market?
Apart from buying and selling stocks to earn profits, the most important thing for any investor is risk management. Diversification of stock portfolio is the key to minimize risk and maximize profits. Diversification of stock portfolio is nothing but investing in different stocks belonging to different growth sectors.