The Stock Market

You may have heard that the stock market is a place where participants buy and sell company stock, also known as shares as each stock represents a share of ownership in the company. This is true, but is a simplified view.

For instance, the stock market is really very many stock markets. Most countries have at least one stock market, such as the London Stock Exchange in the UK, and some countries like the US have several markets, including the New York Stock Exchange, NASDAQ, Chicago Stock Exchange, etc. Generally, the stocks traded in any particular exchange are those of companies with head offices in the country, but there are ways that major companies can have their stocks traded in other countries too.

 

The Stock Market

Increasingly, the buying and selling is done online, and the stock market does not have to be a physical place of assembly. NASDAQ was the first market which was fully electronic, starting in the 1980s as a bulletin board for dealers of stock prices, and going on to allow remote trading.

The price of shares depends on the supply and demand for them, and this is related to the expectation of a company’s performance, in other words what people expect it will be worth in the future. If the majority of shares are gaining in value, then it is called a “bull market”, whereas when prices are falling you are in a “bear market”. You can also be “bullish” or “bearish” about individual stocks, depending if you think the price is going up or down.

The stock market and other marketplaces will also trade “derivatives”. This is a general term applied to any financial instrument that derives its value from something else, with the something else being called the “underlying”. Commonly, the underlying may be a company’s stock or a commodity. When you trade derivatives, you never own the stock or commodity, but simply profit or lose according to how the price varies. This allows you to profit from a fall in price, known as “shorting”, which if you simply buy stocks you cannot do. One of the features of derivatives is that you can gain or lose much more than you trade, so it is even more important that you know what you are doing if you choose to trade them.

The typical participants in the stock market can be classified as “retail” or “institutional”. Retail participants include people like you and me. Institutional investors include pension funds, banks, finance houses, etc. You cannot buy shares directly from a stock market, you need to use a broker or dealer who is authorized to trade in the market. However, buying and selling is virtually instantaneous for most of the financial transactions that you will place.

The price of stocks and the other financial securities varies continuously while the market is open, and is based on supply and demand. If the demand goes up, which means that many people want to buy the stocks, then you can expect the price to rise. Conversely, if the supply goes up because many people want to sell, then the price will fall.

The price varies to try and achieve a balance between buyers and sellers. If the demand goes up, forcing the price up, it will reach a level where some participants no longer want to buy, so the demand will stabilize. When the supply is great enough to push the price down, then some sellers may think twice about whether they want to let their shares go so cheaply, and withdraw them from the market, reducing the available supply.

While the stock market provides a huge marketplace for speculators, its purpose is to make available a place for companies to raise money. Companies need money at various stages of their growth, and typically may want to fund expansion of premises, research, and other things. The process by which companies can ask for money on the market is called the Initial Public Offering (IPO), and this involves a lot of paperwork, which culminates with the company selling new shares to anyone who wants to buy.

The offer price of the company shares is carefully considered by financial advisers, but sometimes goes wrong, for example when Facebook recently went public and the newly issued shares soon lost value. Stocks are only worth what the market participants are prepared to pay for them. You will find out more about this aspect when you study market psychology.


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