Are you an amateur investor? Do you know how the price of the stock is decided? Do you know how the stock market works? Let’s understand the stock market in a Lehman’s language.
You must have visited vegetable market nearby your home. Imagine the vegetable market which sales different vegetables at one place. You will find all types of vegetables there at multiple shops.
How does the stock market work?
Now imagine yourself as a wholesaler or reseller of vegetable. You visit this market one day. Where you find that No. other dealer or reseller is buying an onion. And the shopkeeper is ready to sell you onion at the cheapest price available in the market since there is no one to buy it other than you. Price of the onion is low as there is no demand for that. Low demand – low price, high demand – high price. Simple economic rule of demand and supply applies here.
You see some dealers or resellers are buying a banana at the double the price of yesterday as there is a festival coming up tomorrow. Here the price of banana is high as it’s demand is high and there is a shortage of banana on the market. So shopkeepers are selling banana at the premium price.
The stock market is similar to how this vegetable market works. In place of the vegetable market there is the stock exchange, like a National stock exchange or Bombay stock exchange, and in place of vegetable shops there are various companies, and the vegetables are nothing but shares. As far as the price of the stock is concerned, it is you who decides the price of the stock. Just like you evaluate whether the price of the vegetable is reasonable, you need to evaluate whether the price of the shares is reasonable. If you think that share is overpriced you can bid for a lower amount and if you think that the price of the vegetable is reasonable you can buy it at the best price available. The price of the stock you see on the internet is the price at which that particular stock was last bought.
Coming to how the stock is valued, there are various methods to value a stock. I can write about each method of valuation of the stock. However, not a single method of valuation of stock would be equal to the price at which the stock is traded at the price of the stock is decided by us and it’s based on the supply-demand rule.