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  • Dylan Lewis: You may have heard that investing in stocks can be a great way to create wealth

  • over time. And that's certainly true, but how does the stock market work?

  • I'm Dylan Lewis from the Motley Fool, and in this FAQ, we're going to answer that question and talk

  • about how you can get into the market.

  • Stocks, otherwise known as equities or equity

  • securities, represent ownership interests in companies. The stocks that are publicly

  • traded are available because those companies decided to list their shares and make them

  • available to public investors. Now, stock markets facilitate the sale and purchase of

  • these stocks between individual investors, institutional investors, and companies.

  • There are two components of stock markets: the primary market and the secondary market.

  • First, the primary market. Stocks first become publicly traded through a process known as

  • an initial public offering, or IPO. This involves a company selling shares or pieces of itself

  • to investors in order to raise capital and listing their shares on a stock exchange.

  • This initial sale comprises the primary market. After that, you have the secondary market.

  • That's after the IPO takes place, virtually all subsequent stock trades take place between investors.

  • That is, the company is not involved. Stock exchanges such as the New York Stock Exchange

  • or the NASDAQ facilitate buying and selling of stocks between investors.

  • The vast majority of stock trades take place on the secondary markets between investors.

  • That means that, for example, if you wanted to buy shares of Microsoft and hit the buy button

  • through your broker's website, you are buying shares that another investor has decided to

  • sell, not shares from Microsoft itself. Just to take a second to piece it altogether,

  • let's break down these symbols. NASDAQ is the exchange that shares of Microsoft are

  • listed on. MSFT is the ticker symbol for the company Microsoft. These abbreviations are

  • identifiers that help avoid confusion and uniquely identify a specific exchange and stock.

  • OK, so, if investors are constantly buying

  • and selling shares on the secondary market, how are stock prices determined?

  • Well, the price of a stock is largely governed by the basic economic principles of supply and demand,

  • plain and simple. At any given time, there's a maximum price someone's willing to pay for

  • a certain stock and a minimum price someone is willing to sell shares of that stock for.

  • Think of the stock market as an auction, with some investors bidding for the stocks and

  • other investors that are willing to sell. If there's a lot of demand for a stock,

  • investors will buy shares quicker than sellers want to get rid of them, and the price will move

  • higher to reflect that. On the other hand, if more investors are selling a stock than

  • buying, the market price will drop. Now, you might be thinking yourself,

  • "What if people don't want to sell their shares? How can you buy them?" In order to ensure

  • that there's always a liquid marketplace for stocks on an exchange, individuals known as

  • market makers act as intermediaries between buyers and sellers. Market makers buy and

  • hold shares and continually list quotes to buy and sell those shares. The highest offer

  • to buy shares listed from the market maker at any given time is known as the bid,

  • and the lowest offered selling price is known as the ask. The difference between those two

  • is called the spread. The main reason for using market makers as a system, as opposed

  • to simply letting investors buy and sell shares directly between one another, is to ensure

  • that there's always a buyer to match with every seller and vice versa. If you want to

  • sell a stock, you don't need to wait until a buyer wants your exact number of shares;

  • a market maker will buy them right away. Now, if you want to buy a stock, you'll have

  • to do it through a broker -- basically, someone that is licensed to trade stocks on an exchange.

  • A broker may be an actual person who will tell you what to buy and sell, but in today's

  • day and age, it's probably an online broker that processes each transaction electronically.

  • When you buy a stock, here's a simplified version of how it works. You tell your broker

  • what stock you want to buy and how many shares you want. Your broker relays that order to

  • the exchange. A market maker sells you the shares at the current market price.

  • Then, those shares are delivered to your account. You've probably heard statements such as

  • "the market is up" or "the stock beat the market." Often, when discussing the stock market, people

  • generalize "the stock market" to a stock index. Stock indices such as the S&P 500 or the

  • Dow Jones Industrial Average are a representation of the performance of a large group of stocks,

  • but not the entire exchange, and are often used as a benchmark to compare the performance

  • of individual stocks to an entire portfolio. For example, the S&P 500 index tracks the

  • performance of 500 of the largest publicly traded companies in the United States.

  • Indexes are a convenient way to discuss an approximation of what is happening in the stock market,

  • but they do not fully represent the entire stock market.

  • The beauty of a stock market index like the S&P 500 is that they aren't just a measure

  • of how stocks are doing; they can also be a way for folks that are new to investing

  • to easily put their money to work. Thanks to Jack Bogle and Vanguard, the average investor

  • can buy a fund that tracks an index like the S&P 500 and pay a tiny fee to do so, making

  • it easy and cheap to start investing. For folks that are looking to get into the market

  • for the first time, we recommend doing exactly that. Look for an ETF or a mutual fund that

  • tracks the S&P 500, and boom, you are immediately a part owner in 500 of the largest publicly

  • traded companies in the United States. If you're looking for some more guidance,

  • we have a free investing starter kit over at fool.com/start. It walks you through all

  • things money and investing and it has a five-stock sampler to get you started.

  • Again, that's fool.com/start. If you enjoyed the video, let me know by liking it and hitting the thumbs

  • up button below. It sounds dumb, but it tells YouTube that we're doing good stuff over here

  • and it helps us reach more people. And if you haven't already, subscribe to the channel

  • to get more awesome investing content like this. Thanks for tuning in, and until next time, Fool on!

Dylan Lewis: You may have heard that investing in stocks can be a great way to create wealth

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How Does the Stock Market Work?

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    林宜悉 posted on 2020/03/04
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