People ask me how does the stock market work today? The answer to that question is fairly complicated but we'll try to break it down into some smaller chunks. By looking at who the participants are in the market and how they interact with each other we'll try to paint a picture of what the stock market is and how it functions.

Who Are the Major Participants in the Stock Market

First and most obvious are the companies you see listed in the business section every day. These are the companies whose shares are traded on a daily basis on week days. The companies you see listed are traded on exchanges - which have specific rules about the types (size and stock price mostly) of companies allowed to participate on those exchanges. Third we have the investment bankers, who raised money for the companies listed and created the listings that get placed on the exchanges. Fourth we have the brokers, who buy and sell shares on behalf of their investors. Lastly, we have investors, who put their money into an account and authorize their broker to buy and sell shares. While that doesn't cover in great detail the types and variety of all the participants, it should be enough to help me explain about just how does the stock market work.

How Does the Stock Market Work - Why Does the Stock Market Exist?

The stock market basically exists to connect people with money (investors) with companies that need money (listed companies). All of the participants' work results in the movement of money from people who have it to companies that need it to grow. That one sentence pretty much covers why we have the stock market in the first place. How does the stock market work to make this happen? That takes a little bit more explaining but we'll give it a go.

How Does Money Get from Investors to Companies?

It's important to understand that in 99% of cases the activity of bringing a company to the stock market in the first place is initiated by the company that wants to grow but needs more cash to either buy assets or hire more people or build new facilities. That company begins discussions with their bank to try to raise money to expand. Sometimes they simply can get a loan from the bank, other times they can not. It is these instances (when not enough loan money is available) that a company will call an investment bank and start the process of raising capital (money).

How Does the Stock Market Work to Get Shares Listed in the Paper?

Once the investment bank agrees to begin the process, they eventually give the company money in exchange for a percentage of ownership of the business. This percentage of ownership is then divided into equal parts (called shares). These shares are then priced based on the amount of money that was given the company plus a premium and fees and then re-sold to the general public (eventually) in an initial public offering. It is at this point the shares are actually listed on an exchange (a.k.a. they appear in the stock market). It's a little more complicated than that but the flow of funds basically goes like this: investment bank to company, brokers to investment bank, investors to brokers.

Investing on the stock market carries many risks, including losing some or all of your investment. Further, buying shares of a stock does not guarantee any return on investment either. Many people opt to use high leverage investing to maximize their buying power and increase their chances of larger profits.