Beginners: What is the Stock Market?

Posted By Robert On Wednesday, June 25th, 2014 With 0 Comments

The financial world is a scary place, and the stock market is the financial capital. People are yelling familiar words in strange ways, like “securities” and “shares”, but nobody is talking about keeping things safe or sharing anything. First they say it’s a “stock market” and then all of a sudden it’s a “stock exchange”. It makes no sense. Nobody in their right mind would want to be involved with such a place.

Yet you’ve heard the rumors. And now you’re curious. Strange things have been said to happen in this “stock market”. Average Joes come and then go as millionaires. That sounds lovely until you remember the others who leave, tears streaming, as they’ve lost everything. No. It’s not Las Vegas.

Of course, we’re just kidding when we talk about the stock market as if it had a physical location. In reality, the stock market is the place where stocks are purchased, sold, and traded. That’s why it is also sometimes called a stock exchange. And thanks to wireless Internet technologies, the stock market can exist almost anywhere.

So, what is a stock? Is it anything like a sock? Well, stocks are a bit less tangible than your socks. Stock, quite simply, represents ownership of a company. A stock represents one piece, or share, of that collective ownership.

Just as there are different kinds of socks – like cashmere or cotton – there are different kinds of companies that you can purchase stock from. Success in the stock market is all about finding the right companies to invest in and determining the right time to purchase their stocks.

See? That wasn’t too confusing, right? You now know what the stock market is and how it basically works. Next, we will will share how to determine what stock is your best fit.

Price Discovery: How Prices are Made

This is how price discovery for all markets, stocks, commodities, futures, options, etc works:

Say you have a generic commodity X, to find its price you need to have buyers and sellers. This is where the theoretical concept of supply demand results in real world prices.

Now we get into the bid offer spread, the bid is the highest price anyone willing to buy at, the offer (often called the ask by some) is the lowest anyone is willing to sell.

When someone buys up all that is offered at a given price, the next price you can buy at is the next lowest offer, i.e. the offer increases and the spread between the bid and offer widens until someone is willing to bid at a higher price, the spread narrows but the price itself increases.

The opposite happens in selling, where sellers clear out the bids driving the price to the next highest (but lower) price someone is willing to buy at. This is the market and the essence of price discovery, wherever you have an efficient market the action of buying and selling in large numbers will affect prices.

As an example take oil, 250 bid at 101.25, 101.30 offered for 400. that means at that time you can buy 400 contracts in oil for 101.30, if you want to buy at any cheaper price, you will have to “join the bid”, say you want them at 101.26, that means you are bidding the highest, so you bid is now the top most, the oil quote would now be 400 bid at 101.26 (your order) 101.30 offered for 400, but you will have to wait for someone to sell to you at the cheaper price, you might get all you want, you might get none.

If you want to buy for 101.25 the new order will be 650 bid at 101.25 (the initial 250 followed by your 400 orders), 101.30 offered for 400.

The depth of market is all the amount people are willing to sell or buy not at the best available prices, so say the offer depth is 101.30 for 400, 101.35 for 1100 (more people want to sell expensive, obviously), 101.40 for 2500, if someone buys 4000 contracts it will clear all the offers moving the price from a theoretical 101.27 (mid of the spread) to 101.37 if the bid follows the offers are more people are willing to buy at a higher price to sell into the new demand to buy.

Hope that helps illustrate how buying selling changes prices in the market.

edit –
this applies to real market trading where you get the best prices, if you are trading on a spread bet platform or something where your orders won’t change the market since they don’t go to an exchange, i.e. your betting against a bookie, your order will have no market influence. however the prices they offer you will always be worse than those at the exchange, using the aobve example, they would spread oil 101.20, 101. 35, so as soon as you bet against them they can hedge it for a profit in the market, i.e. you buy 101.35 they take the other side of the trade, i.e (sell for 101.35) and immediately buy back for 101.30 in the market, so they have a 0.05 booked profit.

p.s. the numbers aren’t accurate, they are for illustrative purposes only

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