Sunday, September 23, 2007

How the Stock Market Works

There are many people who are invested in the stock market. Many of us who have money in any type of retirement account can count ourselves as a participant in the market as a whole. But have you ever stopped and wondered how the stock market actually works? Have you ever attended an auction? If you have then you might be able to relate with the daily operation of the stock market because it's basically just that, an auction for shares of ownership of publicly traded companies.

As in an auction, there is an auctioneer. But in the New York Stock Exchange (the largest stock market in the world) and the American Stock Exchange he is called a market maker. The market maker tries to match buyers with sellers just as an auctioneer would. There is no set price for a share of stock. Institutions and traders bid to buy and offer to sell and the price is set by the market maker. The price will fluctuate throughout the day depending on supply and demand. There is no fixed price for a share of stock. Bidders buy on the expectation that the price will go higher and sellers sell because they think the price will go lower. It's a huge psychological game that repeats itself daily.

Many of you have seen the floor of the NYSE on the news or on CNN during news reports about the trading day. Maybe you have seen the ringing of the bell to announce the beginning or the end of the trading day. It really is a sight to watch floor traders buy and sell their shares with the emotions of fear of loss and the greed of potential profit. The actual participants look at the stock market as something completely different as most investors.

The NAZDAQ operates completely different from the New York and American Stock exchanges. The NAZDAQ operates completely electronically. The trades placed on the NAZDAQ are placed through a huge computerized network. It's still an auction but buyers and sellers place their bids and offer shares through the network. If you can imagine a sheet of paper split down the middle into columns with bidders on one side and sellers listing their ask prices on the other. On each side both are put into different levels depending on their bid or ask price. The highest bid price gets the honor of the top slot in the buyer's column and the lowest sell price receives the same on the sell side. This is basically a description of the quote system called Level II which active traders pay close attention to as they make their daily trades.

To many of us all this goes on behind the scenes. For a growing number of people this has become an area of study as the internet has given them access to the daily auction called the stock market. The number of online traders has steadily grown since the nineteen-nineties and some have profited handsomely and continue to do so. Others consider themselves fortunate that all this goes on behind the scenes and are content with their mutual fund. Whichever camp you find yourself in, the objective is the make a profit in the greatest auction in the world.

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