Everyone’s heard of the stock market — but few know why it works. Were you aware that each stock has two prices? That you can’t buy and sell for the same amount? That a “stock market” works better and is more open than a “stock store”?

If you’re like most of us, probably not. Here’s why stock markets rock:

• They match buyers and sellers efficiently
• All prices are completely transparent and you see what other people have paid/sold for
• You pick your own price and will get that amount if there’s a willing partner

Most explanations jump into the minor details — not here. Today we’ll see why the stock market works as it does.

iPhones Ahoy!

I’m told iPhones are popular with the 18-35 demographic. A market research firm asked me to find a good selling price, so I’ll pass the question onto you:

Me: You, the coveted 18-35 year old demographic, want an iPhone. What’s it worth?

You: Dude, just get the price. Duh.

Ok hotshot, riddle me this: what is the price, exactly?

• What you can buy it for? (Your best bid)
• What you can sell it for? (What you’d ask for it)

So which price is the “real one”? Both.

You see, buyers and sellers each have prices in mind. When prices match, whablamo, there’s a transaction (no match, no whablamo).

The idea of two prices for every item is key to understanding any market, not just stocks. Everything has a bid and an ask, and each shopping model has a different way of handling them. This leads to different advantages for buyers and sellers.

Shopping Time

Suppose we want to buy an iPhone from Amazon. You see the selling price of $200 (Amazon’s ask), and personally decide if it’s “worth it” (i.e. less than or equal to your bid):

In the store model, Amazon shows a public asking price ($200). Each buyer has a secret bidding price, some more than others. Buyers willing to bid $200 or more purchase the iPhone; the rest hold off ($199 and below).

Amazon picks a price that attracts the most bidders yet still keeps a profit. In the store model:

• Buyer pro: Buyers know the price and can pay less than their internal value
• Buyer con: Buyers have to visit multiple stores to find the best price
• Seller con: Sellers don’t know what each buyer is willing to pay; it’s difficult to set the pricing. Do low sales mean a bad price or a bad product?

Even though buyers are “in control”, they may have to search around to find a store that meets their bid (if any). That’s inefficient.

Onto eBay

Now suppose we want to sell our new, unopened gadget (you, the 18-35 demographic, are fickle like that; the survey said so). Sure, we could try to sell it on Amazon — now we’re our own store and need a price we think people will pay. We’re in the same boat as Amazon, and could set the price too low. That’s no fun.

Instead, we auction off the new iPhone on eBay to maximize profits:

In the eBay model, buyers have public bids and compete for the product. The seller keeps their minimum price secret and hopes to make a profit by having someone “overpay”. In the auction model:

• Seller pro: Sellers have a secret ask (reserve or minimum price) and can get paid above this.
• Seller pro: Buyers’ demand is transparent. They can easily see if they are pricing too high.
• Buyer con: Difficult to buy a product.

eBay is great for sellers — you have the chance of making extra profit. For buyers, it’s not so great: you can lose auctions by $1 (paying 201 when 202 was the highest bid), even though the seller would have been happy with 201. You could enter multiple auctions with $201 but risk getting two iPhones.

Want Ads and Hagglers

There’s other trading approaches also:

• Want ad: Publicly announce your desire for an iPhone and let sellers fight it out.
• Haggle: Find someone with an iPhone, and without knowing a selling price, make an offer. You both haggle back and forth, try