How Stocks, and the Stock Market Works
View “How the Stock Market Works” at http://www.youtube.com/watch?v=GnJCOof2HJk. Answer the questions below while viewing the short cartoon. Though this cartoon is considered a “classic” by today’s video standards, it is a perfect example of how businesses turn into corporations that produce dividends for their stockholders.
1. Why do businesses want to become a corporation?
2. Why would an investment banker want to see past documents and plans for expansion?
3. When buying a share in stock, do investors own part of the business?
4. What is a dividend?
5. Why would a business need to start selling stock at the NYSE?
6. At what point would a buyer of stock need a representative in the NYSE?
7. Why is industrial expansion important in the United States?
8. What do you think the potential risks of investing in the stock market are?
9. After watching the clip, do you feel that this old cartoon is still a close description of how the stock market works today?
10. Is the stock market still relevant in today’s economic situation? Why, or why not?
How Stock Markets Work
If you'd like to buy a share of stock in any publicly traded company you'll most likely need the services of a brokerage firm. Though it's possible to buy and sell shares of stock on your own, there are some practical and legal problems with this approach. The securities industry is highly regulated, so you can't just hang a shingle and start selling stocks to the general public, unless you're properly registered and licensed.
When you want to buy groceries, you go to the grocery store. When you want to buy a sofa, you go the furniture store. And when you want to buy stocks, you need to do business with a brokerage firm.
A brokerage firm is a dealer of stocks and other securities that acts as your agent when you want to buy or sell stocks.
Most trading of stocks happens on a stock exchange. These are special markets where buyers and sellers are brought together to buy and sell stocks. The best known stock exchanges are the New York Stock Exchange and the American Stock Exchange.
Besides these two national exchanges, there are many smaller regional stock exchanges, such as the Pacific in Los Angeles, the Philadelphia, the Boston, the Cincinnati, and the Chicago. Some small companies are listed only on a regional exchange, while some NYSE and AMEX companies are listed on these smaller exchanges, as well, to help trades happen faster and cheaper for investors.
When most people think of a stock exchange, they picture a scene of frantic activity, with traders in funny-looking jackets simultaneously jostling for position, shouting commands, making strange hand signals, and writing up orders. Behind this frenzied spectacle, however, is a methodical and organized system of trading, in which the price of any stock is set purely by rule of supply and demand in an auction setting. Specialists help match buyers and sellers, but shares are always sold to the highest bidder.
From the perspective of an investor, buying and selling stocks seems pretty simple. If you use a full-service broker, just call her up on the phone and place an order for 100 shares of Coca-Cola. Within a few minutes, you'll receive a confirmation that your order has been completed, and you'll be the proud new owner of Coca-Cola's stock.
Behind the scenes, however, there's a lot of action that takes place between your order and the confirmation. Here's what has to happen:
You place the order with your broker to buy 100 shares of the Coca-Cola Company.
The broker sends the order to the firm's order department.
The order department sends the order to the firm's clerk who works on the floor of the exchange where shares of Coca-Cola are traded (the New York Stock Exchange).
The clerk gives the order to the firm's floor trader, who also works on the exchange floor.
The floor trader goes to the specialist's post for Coca-Cola and finds another floor trader who is willing to sell shares of Coca-Cola.
The traders agree on a price.
The order is executed.
The floor trader reports the trade to the clerk and the order department.
The order department confirms the order with the broker.
The broker confirms the trade with you.
That's how a traditional stock exchange works, but much of the action that takes place when you buy or sell a stock is being handled with the assistance of computers. Even if you bought a stock that trades on a stock exchange, your order may be executed with little or no intervention by humans. You can log on to a brokerage firm's Website, enter an order, have the trade be executed, and receive a confirmation all within sixty seconds or less.