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How does the stock market work?

stock marketAnyone who’s ever seen the news will have heard about the stock market, but what is it and how does it work? Read on to find out more.

What is the stock market?

The stock market is like a big supermarket where traders buy and sell shares – or ‘stock’ – in companies. Investors give their money to traders and tell them which shares to buy. Investors can be either individuals or other companies, and when they own shares in a company they become its ‘shareholders’.

What are shares?

Shares are exactly what the name suggests – parts of a company’s value shared amongst different owners. The value of a company is decided by things like how many assets it has and the profit it makes. A company that owns lots of expensive assets like buildings and makes big profits will have a greater share value than a struggling small business.

The company then divides this value into shares and sells them on the stock market to shareholders who receive a proportion of the company’s profits – often called a ‘dividend’ – according to how many shares they own. For example, say a company has 1,000 shares. One shareholder owns 500 of these, another shareholder has 250, and then 25 other shareholders have 10 shares each. If the company pays out £100,000 in dividends, the majority shareholder takes £50,000, followed by £25,000 for the next shareholder, with the other shareholders all getting £1,000 each.

How do you make money on the stock market?

stock market trading floorSince the price of shares change, the trick to making money on the stock market is knowing when to buy and sell them. If someone buys shares at a very low price and then sells them when they rise, they can make a lot of money. Many investors don’t have time to watch their share prices all day, so they employ analysts and traders at a stockbroking firm to advise them. Stockbrokers take a percentage of the profits from every sale, which could be millions if they make a big sale at just the right time.

Why do share prices change?

Share prices go up and down depending on supply and demand. If a lot of people want shares in one particular company the share price goes up, but goes down when people want to sell their shares quickly. How popular a company’s shares are is determined by lots of factors, such as how much profit it has made, whether it is being taken over by another company, and events in the news. For example, shares in BP fell during the Gulf of Mexico oil spill in 2010, but rose again following a deal with Russian oil company Rosneft.

What is a stock market crash?

Sometimes large numbers of different shares all fall in value at once. This can happen for a number of reasons, like certain companies defaulting on loans, which then affects other companies or banks that have lent them money. Shareholders might then panic and all try and sell their shares at once, driving prices down even further. In extreme cases this causes a stock market crash, which has bad effects for the whole economy. This happened in 2008, when some banks like Lehman Brothers and Royal Bank of Scotland either collapsed or had to be bailed out with taxpayer’s money, leading to a recession.

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