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Economics & Personal Finance
How the Stock Market Works, Exchanges, Orders, Indices
Buyers, sellers, market makers, and benchmarks
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The stock market is a network where people and institutions buy and sell ownership shares of companies. It matters because stock prices help signal how investors value businesses, risks, and future profits. Companies can raise money by issuing shares, while investors can gain or lose money as prices change. A stock exchange organizes this trading so buyers and sellers can meet under clear rules.
Key Facts
- A stock is a share of ownership in a company, and its price is set by supply and demand in the market.
- Market value of a company is market capitalization: market cap = share price x number of shares outstanding.
- A market order trades immediately at the best available price, while a limit order trades only at a chosen price or better.
- Bid price is the highest price a buyer is offering, and ask price is the lowest price a seller is accepting.
- Bid-ask spread = ask price - bid price.
- Index return = (ending index value - starting index value) / starting index value x 100%.
Vocabulary
- Stock exchange
- A stock exchange is an organized marketplace where listed stocks and other securities are bought and sold under formal rules.
- Broker
- A broker is a firm or platform that places buy and sell orders for investors in the market.
- Limit order
- A limit order is an instruction to buy or sell only at a specified price or a better price.
- Index
- An index is a number that tracks the combined performance of a selected group of stocks.
- Liquidity
- Liquidity is how easily an asset can be bought or sold without causing a large change in its price.
Common Mistakes to Avoid
- Confusing a stock exchange with the whole stock market is wrong because an exchange is one organized venue within a larger network of brokers, investors, regulators, and trading systems.
- Assuming a market order guarantees a specific price is wrong because it guarantees execution speed, not the final trade price.
- Treating an index as a stock is wrong because an index is a measurement, while index funds or exchange-traded funds are the tradable products that track it.
- Ignoring the bid-ask spread is wrong because the spread is a real trading cost that can reduce gains, especially for low-liquidity stocks.
Practice Questions
- 1 A company has 50 million shares outstanding and each share trades at $24. What is the company’s market capitalization?
- 2 An index rises from 4,000 to 4,260 in one month. What is the index return as a percentage?
- 3 An investor wants to buy a stock but refuses to pay more than $38 per share. Should the investor use a market order or a limit order, and why?