How would you explain the stock market to a ten year old?

Author
Anmol Gupta

Ever wondered what those constantly changing numbers on black screen of traders indicate? Well, stock market is something that fascinates many, but understood by very little. Through this story, I have tried to break it down for you. (Originally published on Quora as answer to this question), following is the story of Jack and Jill. Tip: Grab your popcorn.

Chapter 1 – When Jill had an idea!

Few years back, there was a 10 year old boy called as Jack. Jack was totally into comic books. So much so that he had close to 50 comic books in his collection. At that time, comic books used to cost INR 10. Typically, other 10 year old kids like Jack used to purchase only 1 or 2 comic books in a month because their pocket money didn’t allow more than that. Jack was able to build his collection as he used to spend all his pocket money on getting comic books. One day, Jack’s friend Jill visited jack. Jill was another comic book fanatic except that she could only afford to buy comic books once in a while. Jill really wanted to read all the comic books in Jack’s collection Jill wasn’t very comfortable in borrowing those comic books from jack. She came up with an idea, she asked Jack to “rent” his comic books to him. Jill offered to pay INR 1 to Jack to borrow his comic books for 2 days. Jack got excited, he liked the idea as anyway he was not reading all the comic books at once. Instead of keeping his books idle, now he could get INR 1 per 2 days and within 20 days, he will be able to buy an extra comic book. For Jill, she didn’t have to pay INR 10 to own the comic book. Now with the same pocket money, Jill could read 10 times more comic books. A perfect win-win situation.

Chapter 2 – When Jack saw the opportunity!

The word got spread out quickly in Jack and Jill’s school. Many other kids from school started approaching Jack to rent the comic books. Jack was elated. After all, he had built that collection over 2 long years putting all his money on comic books, and not using it to buy ice creams or chocolates. In no time, Jack was making INR 200 per month with just renting his comic books. It was getting difficult for Jack to keep track of comic books, collecting money from kids and finding time to read on his own. Jack got Jill on board to share the workload and agreed to pay her 50% of the monthly earnings. Within 2 months, Jack and Jill were running a full-fledged business soaring at INR 500 per month. They even named the business as JJ’s Collection.

Chapter 3 – When Jack and Jill went to public!

JJ’s started experiencing a huge demand for their comic books from kids across the town. Neither had they had sufficient collection to serve them all, nor the time to manage that many orders. They clearly saw how much money they could make if they could serve all the people who wanted their service. JJ’s needed to have at least 10 times the books they had in their collection, and hire 10 more people to manage their business. To keep the stock of those books, they also needed a warehouse and an office to seat those 10 new people they wanted to hire. They needed a big chunk of money upfront to up their stock of books and set up the office at different locations in town so that kids from different parts could pick up and drop the comic books easily. JJ’s were making good profits but not enough to fund their expansion plans. They needed more money. What could they do?

Jill’s business mind came up with another idea. So far Jack and Jill owned 50% of the business each and enjoyed all their profits by themselves. They clearly knew that if they bring in more partners, their ownership in business will decrease, but they stand a chance to make even more money just like Jack started making more money by giving up 50% ownership to Jill. Jill went to parent of kids who were renting out the books from them with her brilliant business plan. JJ’s needed INR 100K for their expansion plan. If someone funded them with INR 100K, JJ’s were ready to give them 25% of JJ’s ownership’s. Getting INR 100K from one person was difficult but getting INR 10 from 1000’s of people was easy. JJ’s went to common people like their parents, parent of other kids, their teachers, and neighbourhood and offered them a piece of their company for INR 10. They called this piece a ‘Share’ of their company. Quite natural, right? If someone invested INR 1000 in JJ’s, they got 100 shares of JJ’s. This way, JJ’s sold shares for INR 100K – a total of 10K shares were sold which constituted 25% of the ownership of the company. Rest of the 75% still belonged to Jack and Jill. Going ahead, whatever profit JJ’s would be earning was supposed to be distributed to all the shareholders i.e. 75% would go to Jack and Jill and 25% will get distributed to people who bought shares of JJ’s.

Chapter 4 – When some shareholders were becoming restless!

JJ’s had really come a long way in last two years starting from Jack’s room with 50 comic books to raising INR 100K from public and expanding their business to 10 other locations in the town. All went well and INR 100K were used to fund the expansion. Now, some shareholders were in dire need of money and they wanted to give back their shares to JJ’s and get the money back. But, JJ’s didn’t have money to give back as all of that was used to fund the expansion. On the other hand, there were more people who were willing to buy JJ’s shares as they knew it was a promising business due to the way Jack and Jill were managing it. Problem was, people who wanted to sell the JJ’s shares didn’t know the people who were willing to buy those shares.

To solve this problem, Jill talked to few big businessmen in town as she thought they would have faced the same problem. Not so surprisingly, Jill found out that this was a known issue and it had already been solved decades ago. Guess what was the solution? No? Share Market or Stock Market! The place where people willing to sell their shares could find people willing to buy the shares. So, JJ’s was not the only business which came up with the idea of taking money from public and offer them shares, there were tons of them who had already done that. All those businesses after raising the initial money from people, got registered in the stock market so that people willing to buy and sell their shares can do it. Now, JJ’s were listed on stock market with all the other biggies in town. JJ’s shareholders could now easily sell off their shares and buyer who missed the bus earlier, could catch it now! The stock market enjoyed making money by charging 0.001% of each transaction that happened on its platform.

Chapter 5 – When Uncle Sam was being (un)reasonable?!

But there was a problem. Uncle Sam who had bought JJ’s shares worth INR 1000 was not very comfortable in selling them at INR 1000 to someone else as he was not gaining anything out of it. He helped JJ’s 2 months back when they needed money the most. So, he wanted some reward for that. In those 2 months, JJ’s hadn’t distributed any profits as all money was getting used up to fund the expansion. Only option for Uncle Sam was to sell the shares for more than INR 1000. Was it even possible as JJ’s had initially decided the per share price to be INR 10. Could Uncle Sam change the price to make gains? Well, it turned out that stock market allowed Uncle Sam to sell his shares at a price more than INR 10. BUT, but, but! There must be someone else who should have be willing to purchase the share at the price desired by Uncle Sam. If Uncle Sam could to find such buyer, he could sell off his shares. Stock market didn’t have any problem with that and naturally and JJ’s didn’t any problem as they were not even involved in this transaction. They got their money from Uncle Sam. Now, when Uncle Sam was selling his shares to someone else, Uncle Sam would get to keep all the money. JJ’s wouldn’t get a penny. Now, Uncle Sam wanted to sell his shares at INR 12 price thereby making INR 2 profit on each of his share. The only problem was how does he convince the buyers to buy shares at INR 12 when he recently purchased them at INR 10?

Well, Uncle Sam was smart. He was observing the business of JJ’s very carefully. He knew it was going to become even bigger. That’s why he invested in JJ’s at the first place. He convinced the buyers that in those 2 months, JJ’s had got even more potential to grow than expected earlier. With all the loyal customer base they had, they could start selling even more products and services and make even more money. Hence, the value of JJ’s business had grown significantly in last 2 months. So, his selling price of INR 12 per share was quite reasonable. Some buyers bought the Uncle Sam’s analysis, some didn’t. Uncle Sam sold his shares to people who were convinced with his analysis. Uncle Sam made a decent profit in 2 months. He was quite happy and spent all that money on a short vacation.

Chapter 6 – When Uncle Tom and Aunt Patricia got into the game!

Other buyers were also expecting that they would also make profits just as Uncle Sam did by selling their shares at a higher price than he bought them at. Now, Uncle Sam was not the only smart chap in the town. There were quite a few people who were keenly analysing the business of JJ’s. Btw, some intellectuals from this pool were recognized as analysts as they were really good at analysing a business. Based on the analysis of analysts and their own analysis, different sellers were willing to sell at the price they found to be right, and different buyers were wanting to buy the JJ’s shares at the price they thought to be reasonable.

There was a person who wanted to sell the JJ’s shares at INR 100 per share, while on the other hand there was Uncle Tom who was willing to sell them at INR 14. On the buyer’s side, there was an eternal pessimist who wanted to get the shares at INR 1 and there was Aunt Patricia who was willing to buy it for INR 13. Finally, Uncle Tom and Aunt Patricia settled for INR 13.5 and Uncle Tom sold his shares to Aunt Patricia at INR 13.5 per share. Now, this became the daily routine at stock market. As the JJ’s business was growing, more and more people were interested in buying their shares.

Due to flourishing business, the shareholders of JJ’s were able to sell the shares at even higher price to the buyers. After a year, JJ’s shares were getting sold at INR 25 per share in the stock market! All credits to Jack and Jill who were running the business so efficiently.

Chapter 7 – When Jack and Jill went down the hill!

Suddenly, JJ’s hit a roadblock. Their business suffered some loss due to couple of their warehouses catching fire. The intellectual analysts started cutting down their performance expectations of JJ’s business and their as a result, JJ’s share prices started to decline. JJ’s became less valuable than before as it had to cover for the loss that occurred. But, why do JJ’s had to worry about share prices going down? After all, they didn’t get any money when a shareholder sold their shares to another person, right? True, but JJ’s did need to worry about their share price. JJ’s were planning another expansion throughout the country and they needed even more money. This time when if they went to people to sell shares and get the money, people won’t be paying INR 10 per share. People would be paying what the share price in the market was as that price had been arrived after thousands of minds had done their analysis on JJ’s business.

So, if JJ’s wanted to raise INR 1 million, and if their share price in the market was INR 20, they would need to sell 50K shares. While if their share price was INR 40, they needed to sell only 25K shares. Selling less shares meant Jack and Jill gets to keep more ownership of their company. By selling more shares, Jack and Jill needed to give away more ownership of their company. Hence, they would be entitled for lesser profits of their company. So, Jack and Jill’s interest lied in performing better so that their share prices became higher and higher, and they were able to raise more money by giving away less ownership.

There was another incentive for Jack and Jill for striving to keep the share prices high. Guess what? Value of their own shares! Jack and Jill also had got the shares of JJs right, they could sell some of their shares in the stock market themselves and get money in return if they needed. Higher the share price, more was the amount they would have got!

So, that my friend is what happens in stock market! Just like Jack and Jill’s JJ’s Collection, there are tons of other businesses whose shares are traded on stock markets. There happens to be millions of buyers and sellers willing to buy and sell shares of different companies. The price at which they buy and sell, gets derived from the expected future performance of the company, and it keeps on fluctuating every now and then as negotiations between buyers and sellers goes on continuously.

When Jack and Jill are going up the hill!

All that is fine, don’t you want to know what the current status of JJ’s Collection is? Well, JJ’s Collection have launched their own series of comic books. They have named it as Marvellous which revolves around stories of 12 different super heroes. If rumors are believed to be true, JJ’s Collection would soon start producing movies based on their comic book super heroes. Due to their follower base of about a billion kids and adults, analysts are already predicting the JJ’s movies to be super hit. And guess what? Yes, just like a tUber ride, share prices of JJ’s Collection are showing an abnormal surge after this rumor got ‘leaked’ :-)

Disclaimer: All the characters and entities in this story are fictitious. Any resemblance to real persons or entity, living or dead, is purely coincidental.


About the Author
Anmol Gupta
Anmol is CEO at 7Prosper. He is SEBI Registered Investment Adviser, with expertise in Finance and Technology domains. Anmol is committed to help people achieve their financial freedom.

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