Stock Market Overview
A clear starting point for any would-be trader, most people have a rough idea or preconception of what they think a stock market is and how it works. Unfortunately, the answer to this simple question is rather complicated, and can’t readily be summed up in one sentence. Indeed, many traders may be hard pushed to articulate exactly what a stock market is and the purpose it serves, even after years of serious trading. In this article, we’re going to attempt to clear up the ambiguity, and offer a direct and succinct answer to this most foundational of trading questions.
Most people understand that a stock market is a place where shares are bought and sold, and in essence this is true. Most people understand a stock market is dominated by traders who speculate on the price of shares to make a profit on the difference between the buying and selling price, and in essence this is true. But a stock is so much more in-depth than these two basic propositions would suggest, and requires some deeper analysis to get to the bottom of what’s really going on.
A stock market is a primarily a virtual exchange of securities (that is, shares and debentures, which companies use as a means of raising finance) and derivatives (i.e. virtual instruments such as contracts that relate to assets and securities and can be traded). It is virtual in the sense that the market is an intangible concept, rather than a physical place, and as a result of advancing technologies traders can now get involved with little more than a laptop or mobile phone. The market brings together a range of traders of all shapes and sizes – from small, one-man bands trading for their own personal gains through to hedge funds managing billions in assets, and everything in between.
Stock markets list the securities of publicly traded companies, identified in the UK by the appendage ‘plc’. As distinct from a regular limited company (‘Ltd.’), plc’s offer their shares to the public at large, who are generally concerned with trading on the price point of a given share rather than its yield. Shares can change hands several times on a daily basis, and at insignificant levels the company is unconcerned with who owns those shares.
Shares themselves are intangible assets, entitling the bearer to an annual payment known as a ‘dividend’, paid out of distributable profits, and often corresponding voting rights in proportion to the size of the share held at the AGM, where major strategic decisions such as electing the board are put to the vote. The bearer of a share at any given point is in effect a part owner of the business to which those shares pertain, and it is this aspect that gives a share any underlying value.
The price of a share at any given stage is dictated by supply and demand within the market, and rises or falls every time a share is bought or sold. This effectively means that shares are priced by the collective will and attitudes of the market, comprised of all the traders and investment houses that actively trade in those securities.
Traders buy shares when they feel they are underpriced relative to future company performance, and sell shares when the detect overpricing, or when they feel the market has yet to take account of a particular factor playing in to the value of a share, such as company performance or some external but related factor that could impact on the success of the company. In most cases, transactions are instantaneous, even when there is no corresponding buyer/seller to counteract a buy/sell order, because of the role of ‘market makers’ – usually large funds such operated by insurance firms, banks and pension providers which offer to ‘make’ the market in the absence of a second party to any trade, to allow the markets to run fluidly at all times.
Stock markets generally trade over a set duration of hours, usually reflecting the working day in their particular region, allowing the zealous trader to trade different markets round the clock – from London to New York to Tokyo – while affording those companies so listed to raise capital in the form of initial share issues to the market. As a result, the markets operate on a slick basis almost around the clock, bringing together buyers and sellers of securities and giving businesses and governments a free, unadulterated bellwether for the economic and commercial outlook of a given sector, industry or economy.
In essence, that’s the foundation of what a stock market is, and it’s by no means a comprehensive study. Getting to know the markets requires lengthy research and an understanding of business, economics, law and politics. Yet for those that do get to grips with how the markets operate, the allure of trading profits is sufficient rewards for all their hard work.