How the Stock Market Works

Have you ever wondered how the stock market works or why we have a stock exchange to begin with? It is simple, because it makes sense to have one.

Imagine you are an entrepreneur, you open up a restaurant and it cost you $400,000 to do so. It cost you $200,000 to run the store every year. The first year you make $300,000 for a total profit of $100,000 when you subtract the expenses. The second year your store pulls out even more money, you make $350,000 for a total profit of $150,000.

You’re happy but decide to sell the store you figure you can sell it for 2,000,000 because that would give the investor a profit of 7.5%, well above inflation. You find a few people who would be interested but cannot come up with the $2,000,000 to buy the company. You decide to break the company down into 1,000 shares and sell each share for $2,000.

Now each person who buys a share of the company owns 1/1000 of the company and gets 1/1000 of the profit. This profit is given to the shareholders in dividends. These payments may be distributed annually, monthly, quarterly or in any time frame.

With this new strategy you can decide to only sell 49% of the company which still allows you to hold the majority of the company and raise cash to build 2 new restaurants therefore increasing the size of your company.

This is how the stock market works to help you the store owner as well as the investors who buy shares in your company. But what if the investors want to sell? They need a place where they can sell their shares relatively quickly if necessary.

This is why the stock exchange was created. This is a place where investors can come in to buy and sell shares of companies and business owners can put shares of their company up for sell. It also gives birth to the brokers because someone needs to find a buyer for ever seller and a seller for every buyer.