What is the point of the stock market? What is it for, and why might someone want to trade or invest?

Question

Sometimes you have to explain this to young people or people unfamiliar with the stock market.

• Why would a company want to be a stock company?
• Why would a person want to trade stocks?
• How does a stock market help society?

Answer 1

The stock market is just like any other market, but stocks are bought and sold here. Just like you buy and sell your electronics at the electronics market, this is a place where buyers and sellers come together to buy and sell shares or stocks or equity, no matter what you call it.

What are these shares? A share is nothing but a portion of ownership of a company. Suppose a company has 100 shares issued to it, and you were sold 10 out of those, it literally means you are a 10% owner of the company.

Why do companies sell shares? Companies sell shares to grow or expand. Suppose a business is manufacturing or producing and selling goods or services that are high in demand, the owners would want to take advantage of it and increase the production of his goods or services. And in order to increase production he would need money to buy land or equipment or labor, etc. Now either he could go get a loan by pledging something, or he could partner with someone who could give him money in exchange for some portion of the ownership of the company. This way, the owner gets the money to expand his business and make more profit, and the lender gets a portion of profit every time the company makes some. Now if the owner decides to sell shares rather than getting a loan, that's when the stock market comes into the picture.

Why would a person want to trade stocks? First of all, please remember that stocks were never meant to be traded. You always invest in stocks. What's the difference? Trading is short term and investing is long term, in very simple language. It's the greed of humans which led to this concept of trading stocks. A person should only buy stocks if he believes in the business the company is doing and sees the potential of growth.

Back to the question: a person would want to buy stocks of the company because:

• He believes that the company's products are amazing
• He believes the company has potential for growth
• He wants to own a company like this one
• With the growth of the company his personal investment will grow, therefore for financial returns.
• For tax advantages
• To beat inflation

How does a stock market help society? Look around you for the answer to this question. Let me give you a start and I wish everyone reading this post to add at least one point to the answer.

• Employment: Companies raise money through stock markets to expand and grow. Expanding businesses need more manpower to support the business, hence create employment for you, your family and friends.
• Allocation of risk to those who want it

Corporations in general allow many people come together and invest in a business without fear that their investment will cause them undue liability - because shareholders are ultimately not liable for the actions of a corporation. The cornerstone North American case of how corporations add value is by allowing many investors to have put money towards the railroads that were built across America and Canada.

For The stock market in particular, by making it easier to trade shares of a company once the company sells them, the number of people able to conveniently invest grows exponentially. This means that someone can buy shares in a company without needing to knock door to door in 5 years trying to find someone to sell to. Participating in the stock market creates 'liquidity', which is essentially the ease with which stocks are converted into cash. High liquidity reduces risk overall, and it means that those who want risk [because high risk often creates high reward] can buy shares, and those who want low risk [because say they are retiring and don't have a risk appetite anymore] can sell shares.

Answer 2

I rather like The Ascent of Money, by Niall Ferguson. This comes in several formats. There's a video version, a written version (ISBN-13: 978-1594201929), and an audio version.

This book covers the history of financial instruments. It covers the rise of money, the history of bonds and stocks, insurance and hedge funds, real-estate, and the spread of finance across the world. It is a great introduction to finance, though its focus is very definitely on the history. It does not cover more advanced topics, and will not leave you with any sort of financial plan, but it's a great way to get a broad overview and historical understanding of money and markets. I strongly recommend both the video and the written or audio version.

Answer 3

In finance, form is function, and while a reason for a trade could be anything, but since the result of a trade is a change in value, it could be presumed that one seeks to receive a change in value.

Stock company

There may have been more esoteric examples, but currently, possession of a company (total ownership of its' assets actually) is delineated by percentage or a glorified "banknote" frequently called a "share". Percentage companies are usually sole proprietorship and partnerships, but partnerships can now trade in "units". Share companies are usually corporations.

With shares, a company can be divided into almost totally indistinguishable units. This allows for more flexible ownership, so individuals can trade them without having to change the company contract.

Considering the ease of trade, it could be assumed that common stock contract provisions were formulated to provide for such an ease.

Motivation to trade

This could be anything, but it seems those with the largest ownership of common stock have lots of wealth, so it could be assumed that people at least want to own stocks to own wealth.

Shorting might be a little harder to reason, but I personally assume that the motivation to trade is still to increase wealth.

Social benefit of the stock market

Assuming that ownership in a company is socially valuable and that the total value of ownership is proportional to the social value provided, the social benefit of a stock market is that it provided the means to scale ownership through convenience, speed, and reliability.