How the Stock Market Works

The stock market is one of the most important sources for companies to raise money. This allows businesses to go public, or raise additional capital for expansion. The exchange provides investor liquidity and allows investors to move in and out of their equity positions easily. As compared to the real estate market the security exchange allows positions to be opened and closed in a matter of seconds, as opposed to days and months in a real estate investment.

History has shown that the price of shares and other assets is an important part of the dynamics of economic activity, and can influence or be an indicator of social mood. Rising share prices, for instance, tend to be associated with increased business investment. Share prices also affect the wealth of households and their consumption. For this reason, the Federal Reserve tends to keep its eye on the stock market as an indicator of the overall financial health of our economy.

Exchanges also act as the clearinghouse for each transaction, meaning that they collect and deliver the shares, and guarantee payment to the seller of a security. This eliminates the risk to an individual buyer or seller that the counterparty could default on the transaction. If this happend then the ease with which private investors take equity positions would diminish, thereby affecting the overall financial liquidity of the stock market itself, since liquidity does not come from institutions alone.

The smooth functioning of all these activities facilitates economic growth in that lower costs and enterprise risks promote the production of goods and services as well as employment. In this way the financial system contributes to increased prosperity for the United States as a whole and provides a vehicle for global investor participation.

Kim Hummert