Last Updated on January 15, 2019 by Lucien Dale
For our newbie readers, the stock market may seem like a complex and challenging concept to understand and leverage, however in all actuality, it’s quite simple. In this article we will be using a basic analogy to breakdown exactly how the stock market works.
Imagine you have a lemonade stand. To get that lemonade stand-off the ground, you need to buy lemons, a lemon squeezer, sugar, a pitcher, cups, a table, and materials to make a sign. You currently do not have enough money to purchase all these things, and you do not want to borrow money from anyone, so you decide to sell equity in your lemonade stand. Equity refers to a portion of the company in which you sell to someone thus entitling them to a certain percentage of your company. To raise $80 dollars for your lemonade stand, you offer 8 of your friends the chance to buy 10% of your lemonade stand. After charging $10 dollars a piece to 8 people, equating to 80% of your company’s total equity, which effectively values your company at $100, you buy all the supplies from the money you’ve just received. When you start going into business, you make much more money than you had previously expected. After this sudden increase of money, you decide to expand your lemonade stand into something more broad, like selling homemade brownies. Once you’ve spent the revenue you have generated, and purchased the materials for the brownies, you pay your shareholders, the people who bought equity thus enabling you to start your lemonade stand, dividends. The brownies sell like crazy and your first investors are satisfied with their returns, so they decide to sell a portion of their original equity for a higher price then they paid for it. This causes a raise in the price of the stock. If the brownie endeavor does not go well and the company loses money, then your shareholders will likely sell a portion of their equity, or stock, for a lower price than they paid for it. This ends up cause a dip in stock.
We hope this explains how the stock market works in relative terms. Although this example is slighted dumbed down and illogical, this is essentially how the stock market works. Now get out there and buy some equity from a company you wish to support!
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