If you’ve ever considered investing in the stock market (Stock market is important), you’ve probably asked yourself, What is the stock market and how does it work? It’s an important question to answer, because understanding how the stock market works will help you make smart investment decisions. For example, you’ll know that stocks are one of the few ways to earn money through dividend income and that reinvesting those dividends can help build your initial capital into a sizeable nest egg over time. So let’s take a look at what the stock market is and how it works!

The basics

A stock is a share of ownership in a publicly traded company. The stock market consists of all companies that have stocks that can be bought and sold by investors. Investors buy stocks with an eye toward selling them later at a higher price—when they go up, or increase in value—and thus making money on their initial investment. (There are other reasons people buy stocks, but we’ll leave those for another time.) If investors think a company will earn more money over time and make more profits, they’ll be willing to pay more for its shares now than what they’re currently worth.

Where do stocks come from?

Companies have to take a lot of things into account when planning for their future. For example, a new factory or expansion might cost hundreds of millions of dollars, and there’s no way they can pay for it all up front. So what do they do? They borrow money from someone who believes in them—in other words, from a bondholder or investor. The company gives them shares (the equity portion) in exchange for that loan, which grants those investors some part of ownership in that company (hence why it’s called an equity stake). When done well, it’s mutually beneficial: The company gets capital they need to grow and expand while keeping investors happy with growing returns on their investment.

Also Read A Beginner’s Guide to the Stock Market

A crash course in how it works

You’ve heard it a million times: The stock market is an incredibly efficient way for companies to raise money from investors and subsequently use that capital to create value. But how does it work? If we were explaining it in person, we’d talk about a whole host of factors that influence share prices, including interest rates (higher ones mean more attractive returns), sentiment toward different industries, inflation and more. But in written form, we have space constraints—so let’s stick with three major reasons: speculation, dividends and earnings growth. Why do people speculate on stocks? To put it simply: Because they think they can make a profit on them.

Also Read What is Cryptocurrency?

Being smart about your investments

Investing in stocks isn’t just a great way to make money; it’s also smart financial planning. If used properly, investments can help your savings grow into more money down the road. The risk, of course, is that you could lose some or all of your initial investment. But if you invest wisely, put in time and energy, and consider an array of options (like proper diversification), investing can offer a host of benefits—including tax advantages and increased wealth over time—that are hard to pass up. Here’s how it works: Imagine if I offered to pay you $100 today in exchange for $105 tomorrow. Would you do it? Of course!

Also Read 8 Questions to Help You Decide if an Initial Public offering is Right for You

What will happen when it crashes?

With unemployment and underemployment up, it’s a good time to ask what will happen when stocks start crashing? As we saw in 2008, economic downturns hit Main Street when banks stop lending. Americans rely on credit card debt, home equity loans and bank loans more than they realize. If these main sources of credit dry up due to fear of banks or an actual run on deposits like we saw in 2008, many people will be left with no way to pay their bills. It’s a situation that hurts both lenders and borrowers – at least temporarily. The result will be cash strapped consumers who have no money for spending—not exactly good news for retailers during Thanksgiving or Christmas season!

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Pritam Saha

Hi, I’m Pritam Saha. I have a passion for stocks and have spent my last 6+ years learning about the stock market. My Blog focuses on idea & concepts that improve the skills of the investor to manage their own money.