Credit for this article goes to some random guy I met on Reddit:
Imagine you had a business selling lollipops at school. Since you can buy a bag of 100 for $10, you can sell them for 25¢ a piece for a profit.
But you don't have $10. But there is profit to be made for all if people give you the money. So you ask your friends to **invest**. They each give you $1 and you give them (and yourself) some **stock** in the **venture** - a promise to split the profit. You guys buy a bag, and in one week, you sell all your lollipops for 25¢ each.
So now you have 0 lollipops and 25¢ x 100 = $25
Awesome!
Maybe you pay yourself a market rate for your job in the venture as salesman (you're also an employee since you sold the pops) - say $5
So you have $20 to split 10 ways. Everybody makes $2 from their $1 investment - everybody wins. you could pay them back their $1 investment and another $1 profit - this extra is called a **dividend**.
Now, would your investors go in again next week? Sure! You're doubling their money. And you ran out of lollipops right? So maybe get everyone together to vote and we all agree at a **shareholder meeting** to skip the dividend and turn the venture into a **business** that reinvests the profit into 2 bags of lollipops and make money even faster.
Next week you sell out again. Since you're just one sales guy, you still only cost $5 and your **profit margin** has risen. You can now buy 4.5 bags of lollipops each week. Your business is growing!
Now the new kid in school has noticed your business and he wants to buy a share. You **sold** a share to your friends for $1. But now each week, that share grew in the potential value of its dividend. So how much should a share cost today?
Even though the investors haven't actually gotten money back on the business, the share they own has grown in value as the business has grown.
Well one of your old friends wants to buy a comic book that costs $5 and he has no allowance because he spent all his money buying his share the first week. He's ready to start making money back but the stockholders want to keep reinvesting the dividends. So some of the shareholders and the new kid, Martin get together on the playground and start talking. Comic book kid says is willing to sell his share. So he **asks** for $5 from Martin. But Martin doesn't want to pay that. So Martin **bids** $4.50. There is now a **bid-ask spread of .50¢** - meaning it's less likely for a sale to happen then if that spread was $0 and more likely than if the spread was $1.
Some more kids gather around. They're hip. They want to grow their lunch money. So they **bid** $4.75.,$4.85, $4.95 - **sold** comic book kid thinks this is close enough and a transaction happens.
But now Martin's got FOMO. He offers $5.10 to buy it from the new owner. Seeing the **stock price** rise, other owners consider selling. They consider **holding**. They consider buying more. All start negotiating. Some kids call their parents and ask for an advance on their allowance. Some parent hear about this crazy business that doubles each week and they tell the kid to act as a **broker** on the trading floor and do the deal on the parent's behalf. Baby, you've got yourself a stock pit.
Waaaaaaahhhh!!! Okay, okay Part II
**Market, Limit, Stop orders; Futures contracts; Options; Shorting; Insider trading, and market manipulation**
None of this stuff affects the **profit** of the company. The stock was sold in the **initial public (school) offering** (IPO). And since then, the company itself has just sold lollipops and reinvested in growth. But if they want to grow more they can get all the shareholders together and vote to sell more shares. This **dilutes** the existing shareholders, but if it helps grow the company, the stock price will go up and it means a smaller slice of a bigger pie - so they decide to do it. They **issue more shares**.
So Lollipop Co. (ticker: LOLI) is booming. I mean, it basically doubles every week so people want more stock. And neighborhood adults and local business owners want to grow their money. So they head over to the playground and ask the teachers if they can get in to buy some stock. The teacher are like, "Um... no you can't go on the playground, you don't go to this school and you're an adult, perv. So the local adults pass notes to the kids to buy stock on their behalf and have the kids **broker** a deal. But the price difference people will sell for keeps moving so the kid asks, "what price are you willing to buy it at?" And the parent (client) can say: - place a **limit order** - I'll only pay up to $6.50 and if it moves past that before you can find a seller, cancel it - place a **market order** - I'll buy it at any price you can get it for over the next hour or so. - place a **stop order** - for some reason I only want to buy above a certain price. Probably because if it is moving down
in price I think it will keep moving down.
These purchases are getting complicated and kids don't want to work for free. Adults (institutional investors) have *a lot* of money compared to kids. Each aggressive purchase makes the stock price move up.
The broker kids get paid a fee - maybe 25¢. But the adults are buying like $1000 in stock at a time. So a really clever kid, Max, decides to start buying LOLI when his adult does. Since the stock price was like $7, if an adult wants to buy 1000 shares, the price has to move up as he asks kid after kid after kid to sell all his shares. He knows this means the stock price will get higher and higher - so he personally buys as much as he can before he starts trading for his adult. He has invented **frontrunning**.
Teachers see this and get upset because frontrunning drives the price of the stock up for neighborhood adults unfairly and those adults are the tax payers that pay the teacher's salary. So they declare frontrunning against the rules.
Meanwhile, as the CEO and sole employee (I guess) of Lollico. you know the weekly sales figures before anyone else. You could **manipulate** the market price by leaking information about it. You can say the sales are low, then buy up stock and say - "psych" (do kids still say psych?) and watch the price rise. Teachers hate this too because again it makes the taxpaying adults mad. So they say its against the rules and call it **market manipulation** - specifically it is **misreporting financials** and **insider trading**. The opposite is **pump and dump**. So now you need to file a record of your sales and expenses with the Special Educational Council or **SEC** (securities and exchange commission - a stock is also called a security for some reason) that ensures everybody is following the rules.
Max - recently released from timeout - has another brilliant idea. LOLI is now at $4,555 because of all the adults who have bought in. This time, he thinks that this whole LOLI thing is way oversold. He thinks the stock isn't worth what the market says because Max actually read my ELI5 and understands that fundamentally, the stock is worth what **dividends** it can pay you and there aren't enough kids at this school to buy millions of dollars of lollipops. Max wants to bet against the price of the stock going up. He can do this a few ways. One way is to "borrow" a stock from some adults. So Max, while he doesn't own the stock, has borrowed it and sold it for less (**short**) of what it is worth. He now has a bunch of borrowed cash. If the price moves up, he will owe a lot of money to those adults. Potentially infinite money. Shorting is dangerous - but Max likes to live dangerously. He shorts the stock and then goes around asking kids if they've ever gotten a dividend. No one seems to understand what a dividend is - it has been like a whole month since LOLI went public (school) and everyone forgot. Max explains why stocks have value and all of a sudden everyone freaks out and starts selling before their stock is worthless. The stock tumbles down to $15 and Max pockets the $4,540 difference. He's basically the only one who made mad lunch money at this point.
But the company is fine - they're still selling lollipops