Understanding the Stock Market

The stock market is arguably the core of investing. The stock market is where the majority of investors are, and something you can get involved within. So, what is the stock market, how does it work and what do you need to know when understanding the stock market.

What is the Stock Market?

The stock market is an exchange for stocks and shares. The stock market allows companies to go public and sell shares within their business. Additionally, the stock market is an exchange for investors to trade stocks and shares.

How does the stock market work?

Understanding the stock market means knowing how it works. Initially companies will get listed in the primary market through an IPO (Initial Price Offering). This allows investors to directly buy shares from the company. Once the initial shares have been sold by the company, investors in these stocks can trade them in the secondary market. The stock market becomes a place for investors to buy and sell shares from each other. These shares are bought and sold through a broker on a stock exchange, which acts as a medium for the stock market.

Stock Exchanges

The stock market is a generic term to describe the combined number of investors who buy and sell stocks. It essentially refers to all the companies which are publicly listed which can be traded by these investors.

The stock exchange refers to an organisation which allows companies to list their shares to allow investors to buy them. They are the formal platform for which stocks and shares can be traded.

Stocks are listed on stock exchanges which are the market which connects buyers and sellers. There are a number of stock exchanges which companies may list their company upon, in which they must choose one to trade upon. Each stock exchange has different requirements so companies will choose one most suited to themselves.

Who is involved?

The stock market requires a set of financial institutions to make it easy to buy and sell stocks and shares. In its simplest form, the stock market requires the investors, the companies, the stock exchange and a broker. Of course, it can get slightly more complicated for larger amounts of money, but for the regular investor, it is a fairly simple exchange.

When the company lists on the stock exchange, they will list their company on the stock exchange. Investors will require a broker in order to access the shares from the company. The investor will then use the broker to buy the shares.

Companies > Broker > Investor

When the investors begin trading shares and buying from each other then once again the broker acts as the platform to buy and sell these shares. They make it simple for investors to complete transactions on the stock market.

Investor > Broker > Investor

Stocks brokers and brokerage firms (including online platforms) are registered with the stock exchanges to act as intermediaries between buyers and sellers. They simply allow the trading of stocks and shares to take place.

Obligations in the stock market

Stock markets are highly regulated in order to protect investors. Businesses who are listed on the stock market are required to offer much greater transparency. It ensures information is available to investors. They must produce reports regularly including financial statements to keep the public informed.

The aim is to ensure a fair exchange of corporate ownership within the stock market. This helps to prevent scams and insider trading, amongst other unlawful and unethical activities.

Purpose of the stock market

When companies go public, they generally do so in order to raise funds. As companies may be limited by their profits and require extra capital, the sale of shares means they can fund future endeavours and projects.

Investors will buy these shares because they believe in the companies future success. The aim being to invest their money in shares in the hope that the price rises. Investors will eventually aim to sell for a profit or benefit from company dividends. Stocks and shares can be an effective way to invest money in order to generate positive returns.

What can you buy on the stock market?

When it comes to making investments on the stock market, you are likely looking to invest in stocks and shares. Therefore, you are able to  buy:

  • Individual Shares
  • Funds

You may invest in one company and buy individual shares, or you could buy a number of companies within a fund. The choice is up to you depending on your level or risk and the returns you may look to make amongst other things.

Shares prices on the stock market

When you begin understanding the stock market, you will likely want to comprehend the prices of stocks and shares and why they are what they are. When you view the stock market, you may see that the prices of stocks and shares are all different. You may wonder how these prices are determined, why they change and what each price means. Below are some ideas which should allow you to comprehend share prices on the stock market:

How Prices are determined

Prices need to be set somehow when they are traded on the stock market. Initially they are given a price for the primary market, and eventually traded at certain prices on the secondary market.

  • Primary Market

An IPO (Initial Price Offering) is given to a business on the primary market. As corporate ownership is broken up into shares, an investment bank will help to set a value for these shares. Once the value for the shares is set based upon the valuation, then they are listed on the market for investors to buy.

  • Secondary Market:

When the shares are traded on the open market, share price is determined by supply and demand.  If a company is viewed favourably then demand increases, meaning share price may increase. On the other hand, shares which have a large supply because investors want to sell will decrease. They are determined completely on the market.

Why prices go up and down

Prices fluctuate based on the supply and demand. However, there are a number of factors which may influence supply and demand of a stock. These factors may include:

  • Company news
  • Industry news
  • General market news
  • Political policies
  • Economic performance
  • Major events

As businesses are affected by each factor, their share price may increase or decrease depending on how investors may view the impact of each issue. If news is viewed favourably then investors may wish to buy stock with the hope that the company performs better. There may also be news which could have negative implications for a business and investors may rush to sell.

Market capitalisation

When the share price has settled then it is possible to get an idea of the worth of the company. The value of a stock can be measured by market capitalisation. It can be calculated using the following formula:

Current Share Price * Number of Shares outstanding = Valuation/Market Capitalisation

Market capitalisation allows investors to gain an understanding of the companies value, as well as gaining an idea of the markets perception to the future prospects of a business. However, it’s main use is that it allows companies to be directly compared. It is impossible to compare directly on share price alone.

As each share price is relevant to each business, it gives no indication of what it means in relation to the overall company. Therefore, market cap is an important tool for determining the type of company it is, and how it relates to others on the stock market.

How Stock Markets Perform

In understanding the stock market, it is key to consider that the market as a whole has its own performance. You may have heard people talking generally about the stock market and how it is doing. Similar to shares, the market itself can fluctuate. Typically, investors will be referring to a stock exchange when discussing the market. Just like with shares factors such as company performance, economic and political policies and major events can affect the market. However, it does take larger influences to impact the market as a whole.

Types of market: Bull v Bear

Markets can go one of two ways: up or down. They are given the names of either bull or bear markets depending on how they are currently performing. In their simplest form:

  • Bull Markets – Markets which are on the rise
  • Bear Markets – Markets which are on the way down.

It simply allows investors to distinguish the type of market that is occurring and determine how they must act within the current state of the market.

Getting involved in the Stock Market

In order to get involved in the stock market, you will need a broker, and an account. Once you have those, then you can begin investing in the stock market. After that you will simply need to choose your investments.

You will want to consider which investments are right for you in order to develop your investing portfolio. Getting involved in the stock market carries risks, and so it is important to consider if you are in a position to do so. As this article has suggested, the stock market and share prices fluctuate.

Whilst there are rewards, there is the possibility that you may lose your investment. Understanding the stock market is difficult, so you should aim to ensure you are always learning, developing your skills and applying them to your investing journey. Investing is for the long term. Get involved and you can potentially create a brighter future today.

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