How the Stock Market Works?

It is really hard to understand something when you cannot picture it in your mind. Since the stock market bears little resemblance from everyday super-markets, students can find it hard to picture the place in their minds. I think that is why it is so hard for people to grasp the concept of the “stock market”. So, I will try to clear things up for you guys.
First of all, the stock market is a market. It fits in with the economic definition of what a market is. People interact within this market and stocks are allocated somewhat like an auction. I will describe the two different types of stock exchanges: the physical location stock exchange, and the over-the-counter and the Nasdaq Stock Markets.

Physical Location Exchange
The physical location exchange describes the New York Stock Exchange, also known as the NYSE. It is an actual tangible physical entity. Members are said to have a “seat” on the exchange. These seats have to be bought. Major investment banks will generally have a couple of seats at the NYSE. Members are given telephones and other electronic equipment that enables each member to communicate with his or her firm’s offices throughout the country.
So let’s say, the San Francisco office of Goldman Sachs receives a call from a customer who wants to buy shares of GE (General Electric). At the same time, Morgan Stanley receives an order from a customer in its Los Angeles office to sell shares of GE. Then the bidding begins. Eventually the stocks will be sold to the highest bidder.
You might ask what if there is no buyer when the seller wants to sell. Or no seller is willing to sell when a buyer wants to purchase a stock. This can be explained by the fact that the NYSE only allows certain companies to be listed. Therefore, the companies within the NYSE usually have a whole bunch of stocks outstanding and have adequate trade volume. So that means, when there are millions or billions of a stock floating out there, most of the time, there will be a seller to match a buyer.

Over the Counter and the Nasdaq Stock Markets
These markets are also called “dealer markets”. In this market, investors are no longer exchanging stocks with one another. Now, investors are exchanging equities with dealers. These dealers hold inventories of equities (stocks). Dealers communicate with brokers, they quote the price at which they will pay for the stock (bid price) and the price at which they will sell shares (ask price). The bid price and the ask price are always different. The bid-ask spread determines the dealer’s profit.
These markets are not physical entities, but rather electronic networks. So the dealer are in facilities where there are a bunch of computers, terminals, and electronic networks that allows them to communicate with the brokers.

This post was much more tedious than I thought. I am tired.


Good luck and good night,
Charles


Sources: http://www.nyse.com/
Fundamentals of Financial Management by Brigham and Houston