How the Stock Market Works


How the Stock Market Works


At first glance, the concept of the “stock market” may seem a little intimidating to those who have no background in business or finance. But never fret, we’re here to show you what you need to know to get you started on the broad and fun world that is the stock market.

To begin, let us first decode the meaning of the two words that comprise the term – “stock” and “market”.

What Is a Stock?

When companies need to expand, the first thing that they need to do is raise capital. In order to obtain capital, one option that companies consider is to offer their stocks to the public.

Stocks are intangible items that represent a share of the company’s assets and earnings. So when a company offers their stocks to the public for sale, the individuals or businesses who bought those stocks are then called stockholders. Stockholders are basically the owners of a corporation. However, your say in the company’s decisions as a stockholder is based on how many stocks you own vis-à-vis the total stocks issued by the company.

Stockholders may either retain the ownership of the stocks and participate in the company’s earnings through earning dividends or sell these stocks to other investors, usually for a profit.

We already discussed most of this and if you need a refresher, you can refer back to Stocks – The What, Who, When, Where, Why and How

What Is a Market?

This term is rather less complex than what we previously discussed. A market, as we all know, is an actual or nominal place where buyers and sellers of goods, services, and contracts meet for sale or exchange. For example, a supermarket is a type of market (Pardon us for stating the obvious). In a supermarket, buyers and the seller (supermarket owner) meet to trade the seller’s goods for the buyers’ money.

What Is the Stock Market?

If we combine the two terms together, the result would basically be that a stock market is a nominal place where buyers and sellers of stocks meet to trade stocks for consideration. This consideration is usually in the form of cash.

How the stock market works

Note: Some of the elements used in the illustration were obtained from

As mentioned earlier, stockholders may opt to retain or sell the stocks they hold. Should the stockholders opt to sell their stocks, they gotta sell them somewhere, right? And you’re right! These stocks are traded in the stock market.

Stock Exchanges vs. Over-The-Counter Markets

The stock market is a broad concept representing the vast network of buyers and sellers of stocks all over the world. However, there must be a specific place where these people meet, right? True, there’s the internet and all that jazz now, but there should be something like an organized place where these trades happen, correct?

Yep! Stocks can be traded either in organized stock exchanges or over-the-counter markets (OTC).

Okay, before we go any further, it is important to note the difference between the primary and secondary markets of stocks. When a company wants to expand and decides to obtain capital by selling its stocks, it offers its stocks to the public for the first time through an initial public offering (IPO). This first-time sale occurs in the primary market. It is important to note that in the primary market, the stocks are purchased directly from the issuing corporation.

Meanwhile, in the secondary market, the corporation is no longer involved in the trade of its stocks. Now, investors trade among themselves. The stock market is primarily the secondary market.

For more details, refer to my article on primary vs. secondary markets.

Okay, let’s go back to trading. So we know that the stock market primarily consists of the secondary market and the investors trade among themselves in stock exchanges or OTC markets.

What Is a Stock Exchange?

A stock exchange is an organized place where brokers and investors trade stocks. It provides a centralized place to conduct the trade of stocks and other securities. Usually, one country will have at least one stock exchange. The most popular stock exchanges in the world are New York Stock Exchange (NYSE), NASDAQ, London Stock Exchange Group and Japan Exchange Group.

One key characteristic of a stock exchange is that a stock is priced uniformly, no matter who the seller or the buyer is. For instance, your friends Bill and Bob are both stockholders of Company X and they both decide to sell their stocks on the NYSE. Buyers of Company X stocks will always pay the same amount at any given point in time regardless of whether they bought them from Bill or Bob. This is because it’s the market price.

What Is an Over-the-Counter (OTC) Market?

On the other hand, OTC markets are kind of informal gatherings of a network of dealers of stocks and other securities. Unlike stock exchanges, dealers in OTC markets “make the market” by quoting the price for which they will sell their stocks to the customers and the price for which they would bid for the stocks that other dealers hold. This does not mean that these quoted prices are quoted uniformly throughout the network.