How The Stock Market Works?

Discussion in 'Trading' started by thingyamabob, Feb 16, 2006.

  1. This sounds kind of rediculous, but I have been trading stocks through my Scottrade account now for about 8 months, but I have know idea how stocks work.

    I understand corporations, dividends, calcualting stock prices off of shareprice divided by earnings per share, etc....

    But I have never really looked into where the money comes from. All I know is that I bought AIG for example at 55 and sold it at 69 and I recieved my money and everything is great.

    Now Im looking into buying some microcap stocks that are worth less then $2 a share.

    My question is this:

    If I buy a microcap stock for 50 cents and it goes up to $2 and I sell the stock, where does the money come from that I get back? These are tiny companies with limited assets and limited profits. If I invest $15000 and the stock shares climb and my total share values become $40000l, where does that $25000 in profit come from and how does it make its way into my bank account when I sell the stock?

    Does that come out of the microcap companies bank account? What if they spent all the money on R&D and there is nothing left? I just don't understand how I can make $25000 off a company that potentially has very little money and be guaranteed they are going to give me back my proceeds from the sale of their stock...

    Maybe someone can clarify this for me. Thank you in advance!
  2. saxman


    the $ doesn't come from the company, but from the trader/s who buy ur shares when u sell them.
  3. Well then.... That seems really obvious now. Thanks.

    Okey doke, let me ask another question then.

    If I buy these microcap stocks, is it true that I might not be able to sell them?

    I heard that unless there is someone willing to buy them, you are stuck with the stocks, thus I could potentially lose a fortune as the stock drops and I can't dump it.

    And on the opposite end of the spectrum, if I find a hot microcap stock I want to buy, I have heard that unless there are shares available, I can't buy any. Is this a common problem with microcap stocks, where you find a hot 50 cent stock and you can't get any shares?
  4. saxman


    yes, u can get stuck. unless someone wants to buy/sell their shares.

    my advice is to not waste ur time on those cheap stocks.
  5. jsmooth


    you can also get money/income from dividends though...which comes from the companies it's not totally a "zero sum game"

    "money isnt made or lost, its simply transfered from one perception to another....theres a winner and a loser, its a zero sum game" ~ Gekko - Wall Street
  6. When you buy a stock you are buying a piece of paper that says you own 1 share of the company. These pieces of paper are released to the public by a company during an intial public offering.

    Company A wants to raise money so they sell 10,000 shares (pieces of paper) to the public. The public now has these 10,000 shares. The public trades these shares amongst themsylves determining the price of these shares. These shares go up depending on how much someone is willing to pay. You can have a company that is a piece of crap and if some rich guy wants the shares he can bid them up as high as he wants. The point is these shares dont have to do anything unless someone else wants them, if company B is the greatest company in the world and nobody wants to own it, its shares will go down in price.
  7. Baron

    Baron ET Founder

    The stock market is sort of like the car market. When Ford produces an SUV, they get money for that car when it is purchased by a dealer. The dealer then sells the car to you for a markup, or perhaps even for a loss if the dealer just wants to get rid of it to make room for new year models. Once you've bought the car, you will drive it and likely sell it to someone else or trade it in to a dealer for a new vehicle. Ford got their money when they originally sold it to the dealership. Any profit or loss that you incur by selling the car to someone else is your business, so Ford is out of the loop on that entire transaction. Any money you pocket will be coming from the buyer of your used car, not Ford.

    Likewise, when a company does an initial public offering, they get money for those initial shares they sell. That's the money they run their company operations with. If you decide to sell your shares to someone else the next day for a 5% gain or sell them in 50 years for 5000% gain is totally up to you. But no matter when you decide to sell, you will likely be selling your shares to someone else out there in the marketplace who feels like your shares are still a good value and therefore worth owning. So once a company's IPO has occurred, you are trading those shares with other market partipicants, not the actual company.

    An exception to this would be a stock buyback, but that's another discussion.
  8. Wow, these have all been some pretty good answers.

    I tried a couple other forums and got nothing, but this forum is pretty amazing.

    So basically to sum it up:

    --Microcap stocks are risky because once you buy you may not be able to sell the stock, thus costing you a forture.

    --Since you buy stocks through a broker you never actually deal directly with the company and the money comes from the brokerage when you sell, not the company.

    --And microcap stocks have a limited number of available shares, so you can't always get in on a hot IPO being no shares are available.

    I think I got it now.
  9. Baron

    Baron ET Founder

    Thanks, we dazzle people on a regular basis :D
  10. bronks


    Holy moly! Three posts and you've already got THE MAN replying to you. Love to see management gett'in their hands dirty. :D
    #10     Feb 16, 2006