Explaining the Stock Market to Kids

Between Internet trading services and 401k retirement plans, many Americans are now involved in the stock market in some way, as opposed to 25 years ago, when fewer people were involved. The result is that many parents are now directly affected by what happens at the NYSE and NASDAQ, which means they might want to have a simple means of explaining what the stock market is to their children.

In order to explain what a stock market is, you need to start by explaining what a stock is. In simple terms, a stock is a share of ownership in a company. If you imagine the ownership of a company divided into 100 pieces, then each of those pieces is a stock in that company.

A stock market is a place where stocks are traded, or bought and sold. In the United States, there are two major ways to accomplish stock trading: through the New York Stock Exchange, which is a physical, brick-and-mortar place where this trading is done, and through the Internet. The other is the NASDAQ, which is entirely on the Internet. Other countries around the world also have stock markets.

Unlike going to the store, where there is a fixed price for everything, the price of stocks varies according to how in demand it is at any giving time. A stock that looks like a good investment--one from a prosperous, money-making company--is more in demand than one that isn't. If, for example, the G.W. Boomerang Company is making money and it looks like they will keep on making money in the future, that stock becomes popular and people want to buy it. To continue the example, let's say the G.W. Boomerang Company has 100 shares of stock on the market, and 35 of them are owned by Mr. Kirby Smith. There will be many people trying to buy Smith's stock in the G.W. Boomerang Company, so the price will go up. Meanwhile, the Wonderful Widgit Corporation has reported big losses. This makes people wonder if the company is such a good investment, and some owners of Wonderful Widgit Corporation stock will want to sell their stock. The problem is that because Wonderful Widgit is losing money, there are not many buyers. That means the price of Wonderful Widgit will go down.

There are two ways of making money through owning stock. First, because a stock represents ownership of a piece of a company, when the company makes a profit, that means stockholders get part of that profit. If G.W. Boomerang Co. made a profit of $1 million, then Kirby Smith's 35 shares of stock mean that he will receive $350,000. This is called a dividend, and it is one of the main reasons ownership of a money-making company is valuable. The other way of making money on the stock market is to sell stocks for more than you bought them for. Kirby Smith bought his stocks at $100 per share. However, now that the G.W. Boomerang Co. is doing so well, and so many people want to buy the stock, those shares are worth $200. He paid $3,500 for his 35 shares, but if he sells them, he will make $7,000.

The stock market is not a sure way of making money. There is no guarantee that when you buy stock in a company that it will do well. No one who bought stock in the Wonderful Widgit Corp. anticipated them losing money, for example.

There are services, called indexes, that report how the stock market is doing. They take the stocks from a group of important companies and combine them into a number. If that number is going up, then while individual companies might be doing poorly, overall things are going well. On the other hand, if that number is going down, individual companies may be doing well, but most are doing poorly. The Dow Jones Industrial Average, S&P 500 and NASDAQ Composite are all examples of American stock indexes.