Personal Finance Friday - What is the Stock Market?

This might be an elementary topic to some people, and to others they may think it's kind of a mystery so they just leave it at that. Stock markets are super important to our financial lives, they are the biggest mechanism that people have to gain access to wealth created by businesses. Understanding how they work a little might help you get a fuller perspective on your finances.

The explanation of a stock market begins with the idea of a single stock. A stock, as many of you probably know, is a tiny individual piece of ownership of a business. Let's say, hypothetically, I want to start a business (though someday I hope to)... I would need to raise money to get it off the ground. An easy way to keep track of that money is to split it up into a certain number of units, say 100. So each one of those units represents 1 hundredth of an ownership of the business I'm starting. If you own all 100 you own the whole business. That is what a stock is, a tiny piece of owning a whole company. In the real world, big companies have BILLIONS of shares!

So businesses now have shares which is another word for stocks, like your "share" of the whole. From an investment perspective I may want to sell some of my stock so that I can buy something, like a house, or food, or another stock. I need to find someone looking to buy a piece of the company that I own. That can be hard. I only know so many people and they aren't always looking to buy a particular stock on a particular day. A long time ago, people would just gather in one spot to help solve that problem and literally trade pieces of paper with each other. Wall Street in New York was one of those places a couple hundred years ago. If you get a lot of people going to one place for a single purpose, you are more likely to find a person who is looking for what you have to offer! And so a stock market is born!

As time has gone on the process, like everything else in the world, has gotten faster and more sophisticated. No longer do we need to trade pieces of paper (though that sometimes still does happen in the background) and we don't need to go to one place in the physical world. But we still do need to go to a central "location", and that is what the modern stock markets are, the New York Stock Exchange, the NASDAQ, the London Stock Exchange, and so on. These are places where many, many people gather and trade electronic versions of those pieces of paper. When you log on to a brokerage account and enter an order to buy a stock, it eventually gets sent to one of these market places. It is then met by someone else looking to do the opposite of what you are trying to do... buy when you sell or sell when you buy.

Of course there are layers on top of all of this, but deep down that is what is at the core of the stock market. I think I'll plan on another post about why the stock market matters so much in our economy.