How Does the Stock Market Function?

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Some stock markets use people to match up individual trades.
Some stock markets use people to match up individual trades. (Image: Spencer Platt/Getty Images News/Getty Images)

Despite its inescapable influence on economic and financial news, the stock market is still a mystery to many people. Even avid investors aren't always sure how the market works or what happens when they place a trade. Stock market function is twofold: the actual process of trading stocks along with the supply and demand that drives prices and price trends.

Stocks

Stocks represent the ownership of a company. When a company is privately owned, the owner holds 100 percent of the stock -- whether she holds individual shares or not. When a company needs money to expand, it sells all or part of this ownership as stock or shares. Shareholders then have the right to a part of the company's earnings, in proportion to the amount of stock they hold. Most stock is held and traded electronically, meaning that share ownership is recorded and tracked via large computer databases.

Stock Markets

Companies that are "public" allow any person with money to buy, sell and hold their stock. These investors and traders meet -- either physically or virtually -- at stock markets or exchanges. Stock markets are a little like auction houses: representatives of buyers and sellers meet to agree on a price for a trade, and this price may influence prices for other investors and even other stocks. The two largest stock exchanges in the U.S. are the New York Stock Exchange and the Nasdaq. At the NYSE, humans still do much of the trading through physical interactions, while the Nasdaq is mostly computer-based.

Trades

When you decide to buy a stock, you call your broker or place a request through an online service. This request becomes a trade order, and is sent to the stock market trade floor or into the computer network to find a seller. Your market representative -- human or virtual -- wants to find you the lowest price possible. At the same time, the seller's representative is looking for the highest price possible. These two representatives will agree on a price based on other similar trades and with regard to any restrictions you have placed on the trade.

Supply and Demand

As with any commodity, stock prices are driven by supply and demand. If a large number of people want to buy a stock, prices will go up because there are not enough shares for everyone and some people will pay more to make sure they have shares. In stock market lingo, this is known as a "bull" market. The reverse is also true: if there are more sellers than buyers, prices will go down. This is known as a "bear" market. Demand for a stock is influenced by any number of things, including company fiscal health and potential as well as general economic trends and industry-specific issues.

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