How Does the Stock Market Work?

In order to properly answer the question how does the the stock market work, first I have to explain what is the stock market. The stock market is a place where stocks are traded. And as for every market, there must be buyers and sellers. Buyers represent demand and sellers represent supply.

The price of any stock is determined by relationship between supply and demand, by market participants willing to buy or sell at a certain price. If demand exceeds supply, price should rise. If supply exceeds demand, price should fall. This economic principle applies to every market.

From this results that for a deeper understanding of what makes the price of a stock change, it is necessary to know what influences supply and demand. There is a lot of factors that determine price movement and their effect is relative because only buyers and sellers know why they bought or sold any given stock. Between these factors belongs news about company, industry or the whole economy. If good news comes out on a company, the price and demand for the stock mostly go up. When bad news occurs, the price and demand mostly go down. Next factor is information about company's performance like sales growth, earnings, production and so on, next element is the market psychology, what is topic itself, and generally there is countless amount of other factors that influence opinions of market participants.

Nowadays these stock trades are very organized and performed electronically by computers in stock exchanges like New York Stock Exchange (NYSE). Stock trading is very popular and everybody with little capital and phone or computer with internet connection can be part of the stock market.

Paper trading - ground school for traders

What is paper trading? It's trading without real money - trading only on the paper. And without money means without real risk of losing real money. As pilots are learning to fly first on the simulator so should do traders (to simulate trade). On simulators pilots don't risk loss of their life or destroying plane (and traders losing money). But they are improving their skills. I hope that this analogy can help you better understand reasons and benefits of paper trading.


I think and recommend that before putting real money into real trades beginners should first test their skills on the paper. With paper trading you can test your strategy without risking losing money. The factor that you are not using real money can have big impact on trading psychology - you are not under preasure of losing money and you can make more rational decisions without being influenced by emotions. By the time your trading skills are getting better and you gain confidence in your trading actions. When your skills will be on desired level you can then start real trading with real money.


As a good example of trading or investing simulator in my opinion I would like to recommend Investopedia Simulator that I personally use. It offers a lot of features, real data and a lot of informations mainly about stocks.


As I said before with paper trading you can trade without risk of losing money and still you can gain skills and experience. That's the main point of paper trading as I see it.

Options trading for beginners

When you buy a stock you purchase partial ownership in the company. An option is a contract that gives the owner the right but not the obligation to either buy or sell the underlying financial instrument on wich it is based. Value of the stock option is in part based on, or derived from, the value of it’s underlying stock. I will try to explain this later in this post on one example.

There are two types of options on stocks: call options and put options.

Call option gives the owner the right, not an obligation, to purchase 100 shares of the underlying stock at a specific price per share (strike price) on or before the date of expiration. Call options are in common used when expecting the price of underlying stock to go up.

Put option gives the owner the right, not an obligation, to sell 100 shares of the underlying stock at a specific price per share on or before expiration date. Put options are in common used when expecting the price of the underlying stock to go down.

Example:

Let’s say that the value of XYZ company is $10. Trader thinks that the value of company will go up. He buys 10 call option contracts(controls 1000 shares) for $0.50 per share(that’s $500 for this trade) at strike price $11. Supposing that 1 month later the value of company is $12. Trader can use his options and purchase 100 XYZ shares for $11.000 and sell them for $12.000 or he can sell his option contracts for let’s say $1000. His gain would be $500 because he purchased options for $500 and sold for $1000. That’s 100% profit!