The Purpose of the Stock Market

The stock market is one of the most important, yet most misunderstood, aspects of a capitalist economy. It allows companies to raise funds, while giving investors a chance to make money. The stock market is an important indicator of the state of a country’s economy as well. It is crucial for any investor to have a proper understanding of how the stock market works in order to take advantage of opportunities and make money.

The Basics

The stock market is the loose network of economic transactions that involves companies selling shares of their stock to investors. Each share of stock in a company grants the investor partial ownership in a company. An investor goes into the market to buy or sell shares of stock from a company for a set price. Investors in the market determine this price.  When investors feel that a company will be more profitable in the future, the price of a share in that company increases; accordingly, when the outlook is not as bright, the price decreases.   Therefore, indirectly, the profitability of a company sets the price of its stock.

Raising Funds

The prime function of the stock market from a corporate perspective is to raise funds. When a corporation needs money, it issues shares of stock, which investors buy. Ultimately a share in stock is a measure of the value of a company.  If a company is valued highly, then it is worth more money and can issue more stock. Thus, companies are limited in how much money they can raise. If a company attempts to put too much stock onto the market, the price of the stock will drop.

Economic Indicator

The overall stock market is a very good economic indicator.  When an economy is flourishing, the prices of most companies’ stocks are rising. Often, countries have formal indices, like the Dow Jones Industrial Average and NASDAQ in the United States that attempt to show general market trends. These indices are composed of companies from various sectors of the economy that give a balanced view of the country’s general economic health.

Investing and Making Money

The most basic rule of investing in the stock market is “buy low and sell high.”  To make money, investors want to buy shares of stock when their price is low, and sell them when their price is high.  Thus, investors try to find stocks that may currently be underperforming, but have potentially lucrative outlooks.  When a company beats estimated revenue or profit, its stock price will increase, and owners of stock can sell shares at higher prices, making money. Investors can make money through dividends as well. A dividend payment occurs when a company divides its profits among its investors and pays them money.

The stock market has three main purposes. It allows companies to raise funds; it is an economic indicator; and it provides a way for investors to make money. On every transaction in the stock market there is a winner and a loser; however, by investing intelligently and balancing short-term and long-term investments, most investors are able to earn money in the stock market.