I’ve never understood the stock market, or futures trading in general. I know the idea is to buy stocks cheaply and sell them when they increase in value, but I don’t get the economics of it. If you make money from stocks, where does that money come from? Someone must lose that money, right? Likewise, if you lose money (eg: you held a Nasdaq stock yesterday), who gets the money you lost?
“I had a feeling that in Hell there would be mushrooms.” -The Secret of Monkey Island
Okay, let’s give this a go.
You and I are speculators. You see that Acme stock is selling at $20, but you believe that the price will go up. Your reasons for believing this include: you know something about the company’s future performance, you’ve studied that company’s financial reports and believe they will continue to do well, you’re a cock-eyed optimist, etc. You buy 10 shares of Acme stock for $200 (plus commision).
Time passes (anywhere from 5 minutes to 5 years). Because other speculators have bid up the price, Acme stock is now worth $30/share. I become interested in buying Acme stock, for the same reasons you originally bought it. You sell your stock to me for $30/share. You’re profit: $100 (less commission).
Where’d the money come from? Me (or someone like me).
Reality is a little more complicated, since the actual sale of stock takes place between licensed brokers. The price of the stock is driven up or down by bidding; said prices quoted during budding are determined by people’s perception of a company’s performance, both past and present.
Hope this helps.
Not really, diceman. The prime thing to remember is that, in the modern economy, money and wealth are completely decoupled in the short term.
An extreme example: Consolidated Fuzz (symbol: CFUZ) has 100,000,000 shares outstanding, and last traded at $100; thus a market capitalization of $10 billion (by any conventional estimate). Now, one round lot (100 shares) are traded at $50 (perhaps because Deborah Norville announces that belly-button lint causes cancer). The presumed value of every share drops to $50, and the presumed market cap drops to $5 billion. If all of my money is in CFUZ stock, I have “lost” half of money. Where did it go? Well, nowhere. Vice versa when CFUZ jumps from $50 to $100 (when Deborah Norville tells us that she meant to say that lack of belly-button lint causes cancer).
Now, as I said, this is an extreme example. Divide by a few million, though, and you’ve got the markets.
“Kings die, and leave their crowns to their sons. Shmuel HaKatan took all the treasures in the world, and went away.”
I buy two paintings by, let us say, Atticus Finch (extra credit for the first person to peg who he really is, by the way) for $15 at a yard sale.
Years go by. Atticus paints more, becomes well-known, has a few exhibitions, and then - I hit the jackpot. He dies.
The next year, I sell my first original Atticus for $100,000. Five years later, the market having gotten even more intense, I sell my second Atticus for $200,000.
Who “lost” the money that constitutes the difference between what I paid for the paintings and what I sold them for?
No one. The paintings simply became more valuable.
So, too, with stocks. Their rise in price simply indicates that they are more valuable; their fall that they are less so. No one is necessarily losing or gaining any money other than the owner of the stock.
It’s not a zero-sum situation. There is not x amount of money in the world. If I hand dough, blueberries, and spices to three different people, the first, untrained as a cook, may create nothing but an inedible mush. Value? Zero. The second may create a tasty blueberry pie, value $5 or so. The third, a chef of great talent, may create a blueberry tart of exquisite taste, value $30.
Where did the extra wealth come from? It was created, pure and simple.
Bricker –
Too easy. To Kill a Mockingbird
My Child Is An Honour Student At Hogwarts
Thanks, guys. The painting example was very helpfull. I was under the impression that stock trading was more like buying something at the store. It’s still not crystal clear, but I think I’ve got the general idea.
BTW: how do you like my new sig?
–It was recently discovered that research causes cancer in rats.
Pluto - yes, it was pretty easy… but with game shows awarding vast sums of money for knowing what two colors make up an Oreo cookie, I figured it would be at least a little challenging. 
Futures and options in general are different stories, sure enough, because you have what amounts to people taking different sides of a bet. One will lose.
Thanks. You made me spill my coffee laughing.
Let’s go back to the OP:
No. The money comes from the guy buying the stock from you (we’ll ignore commissions for simplicity). You made money because you bought the stock at $10 and sold it at $25. However, the person buying at $25 hasn’t lost anything unless the stock goes down. It’s quite possible that no one in the transaction loses money – if the stock price continues to rise.
The money you “lost” went to the guy you bought the stock from initially. When you buy a stock at $25, the seller gets it (it’s actually a bit more complicated, but this is all theoretical anyway). If the stock drops to $10 and you sell it there, it means you get paid $10 a share from the new buyer after paying $25 a share to the old buyer.
Now I’m talking about actual losses here. There are also paper gains and losses – money you make or lose but don’t cash in on. The stock may drop to $10, but if you hang on, it may rise again. No money actually changes hands until the stock is sold (not counting dividends, etc.).
The stock price is determined by the market: people decide what they think the stock is worth. It’s driven by demand (supply is usually constant), which is driven by what people think the company is worth. This is a completely subjective value (see the various Internet IPOs that still haven’t earned a profit – in theory they should have a low value, but they are perceived as “hot” so that drives the price up), filled with absurdities (e.g., if a company fails to make the analysts’ earnings estimates, it’s the company that’s at fault, not the analysts’ for making lousy estimates).
“East is east and west is west and if you take cranberries and stew them like applesauce they taste much more like prunes than rhubarb does.” – Marx
Read “Sundials” in the new issue of Aboriginal Science Fiction. www.sff.net/people/rothman
I had a slight epiphany while reading the answers; maybe it’ll put a different perspective on this whole issue.
Diceman had a problem figuring out who makes money and who loses money in a stock trade. The phrase “zero-sum game” came up a lot, as if trading stock back and forth could only happen a limited number of times.
What makes stock trading work is that stock can be traded an infinite (well, very large) number of times. As long as someone is selling and someone is buying, profit can be made.
When people stop buying and bid the price down, then you have a crash. Game over, man!
I beg your pardon, Guy, but your statement seems to overlook the fact that stocks have an intrinsic value, and generally pay dividends to the holders thereof.
It is possible to buy a stock, never sell it, and make money.
Hmmm, good topic. So how do options work? I never really understood them. You buy a reservation to buy the stock? What about margin calls? Why do you have to pay money if a stock goes dow? Is that like reverse dividends?
“Teaching without words and work without doing are understood by very few.”
-Tao Te Ching
Wow, Dem, you’re covering a lot of action here. An Option is an agreement that allows you to buy or sell shares of stock within a stipulated time and for a certain price. Put options give you the right to sell a block and Call options give you the right to buy 'em. If you’re a CEO for a large company you might get some of these options for free as a part of your bonus.
A Margin Call happens if you’ve been buying stocks on margin and those stocks went down. In other words you put up some of the money for the stock and took out a loan from your broker for the rest of the cost (you bought on margin). If your stocks go down the broker will want you to cough up some more money. If you don’t come up with the dough, the broker will produce the cash by selling your shares (and you just sold low).
Unless you focus a formal education in this area you’re in an exotic place that most people should stay away from. 9 out of 10 people who speculate in commodities lose their shirts. 8 out of 10 day traders lose their shirts. This area is not “investing.”
It is gambling.
And if I wanna gamble–Vegas provides a lot more exciting way to lose dough…and naked women, too!