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How Does a Stock Market Work?

A stock market or stock exchange is a place where you can purchase, sell or trade stocks during week days (Mon to Fri).  The stock exchange is medium for buyers to own a share of corporations or public companies. It functions quite like an auction, where investors are urged to purchase or sell a share of their stocks.

During the stock exchange trading hours, buyers and sellers estimate share prices, based on the supply and demand. Investors have the opportunity to bid a price of a particular stock if they believe that the company would perform well in the foreseeable future.

In the stock market, sellers aim to attain a high value for their stock holding. The aim is to sell their stock holding at a higher price than previously bought. Similarly, the objective of the buyers is to buy the stocks, as low as they can, while aiming to earn a high profit when sold.

Stock markets operate regionally, as well as globally. In global stock markets, the participating companies include firms from around the globe. Whereas, a regional stock exchange comprises of firms within the country. They are not located in the primary financial centre of country. For example, in US, Boston, Chicago, Pacific and Philadelphia are the four major regional exchanges.

What is a Stock?

A stock is a form of ownership of a portion of a corporation or a public company. Owners of the stock have the right to own assets and revenue, generated by the firm, based on the percentage of their ownership. The units of stock are referred to as “shares”. Shares of publicly trading company can be bought or sold in a stock exchange. Essentially, there are four types of stocks that you can invest in.

Growth Stocks

These stocks are shares in the firms that are expected to expand and grow at an above-average rate, in contrast to the market. These companies bring in a positive flow of income.

Dividends or Yield stocks

In dividend or yield stocks, you are paid an income, based on the revenue generated by the company. The dividend yield is calculated by dividing the yearly dividends paid by the firm, by the price of the share.

Initial Public Offerings

An IPO is a process of presenting the shares of a private company to the public when new shares are issued.  Once the shares are listed on the exchange, any individual, institutional or pension fund has the liberty to invest in it.

Defensive stocks

Defensive stocks are those shares that are not much effected by the fluctuations of the economy. These are non-cyclical stocks, which means that they are not parallel with the overall economy. Hence, these include items such as food, oil and basic utilities. Defensive stocks provide a consistent dividend, as individuals still consume these items during an economic recession.

Shares are purchased and sold on a stock exchange. With the help of internet, there are several platforms (or brokers) that allow the process of buying or selling of shares to be carried out on your fingertips. With that said, the stock exchange process must conform to the regulations set aside by the governing body.

Private companies usually raise capital in the form of issuing stocks. These stocks provide them with the necessary funds and monetary incentives that are required to get their business up and running.

Once the investments are made, the issued (share) capital is assigned. This is an amount, demonstrated by a nominal value, which signifies the share held by the shareholders. For example, if a start-up firm sold 100,000 shares, with the face value of £ 1 per share, in such a case, the issued share capital of the company would be £ 100,000.

The stock exchange process plays a vital role in improving the health of the economy in any country. With more individuals and institutions investing in stocks, more firms would have the monetary incentive to get their businesses up and running.

Considering this, the stock market can offer financial benefits to the overall economy of the country.

What is a Stock Exchange?

While the stock market is a collection of buyers and sellers, who make trades in stocks, the stock exchange is the building or infrastructure that fosters the process of making this trade.

The stock exchange is an organisation that empowers companies to list down their shares, so they can be sold to the public.

The stock market features all firms and enterprises, dealing with different industries, to list their shares for the investors to consider making an investment in. The stock market features both primary and secondary markets and it is an amalgamation of over the counter trading, electronic trading, as well as stock exchanges. Essentially, the stock market is the platform that facilitates the trading, so that companies can raise capital that could be used to generate income in their specific business.

The stock market can be referred to as ‘bullish’ or ‘bearish’. These titles are given out the basis of the thought process of traders. A bullish stock market is when investors prefer to buy shares that they consider will rise in value in the future. On the other hand, the bearish stock market is when investors think that the market will decline in value in nearby future, thus try to sell their investment.

Stock exchanges in every country are regulated by SECs (Securities and Exchange Commission) that allow the trading process by establishing rules and regulations for the listings. The stock exchange provides services to individual investors, traders, brokers and institutional investors, while also keeping track of the changes in the prices and trading volumes. Considering this, the stock exchange is a platform which allows buyers and sellers to interact with one another, at a mutually stated point. The stock exchange may be virtual or physical.

For example, the London Stock Exchange, located at Paternoster Square, facilitates the conduction of all activities being carried out in the primary, secondary, main markets and alternative investment markets. Based on the analysis conducted in April 2018, the London Stock Exchange has a market capitalisation of US$4.59 trillion.

How does it work?

The stock market works by creating a platform for companies to list down their available shares or floats, for investors to invest their money into.

The shares of the prices enumerated on the stock exchange are determined by the supply and demand phenomenon. The law of supply and demand is responsible for hiking up or reducing the prices of different stocks.

When the demand is low, and the availability of the product is high, the prices naturally decrease. During this time, investors purchase good value the shares at low prices, in the hope of attaining a profit when the market price fluctuates upwards and they can sell their investment at a higher rate. Similarly, when the demand is high and the availability is low, the share prices go through the roof.

In the stock market, the prices are affected by three elements- the state of the economy, the interest rates and corporate results. If the economy is doing well, the demand for stocks become high. This is because consumers would have the money to buy the products or services being offered. Hence, with high demand, there would be a greater revenue for the listed companies.

On the other hand, the rise in interest rates negatively influences demand. This is because the risk-free rate of return is increased. However, the interest rates tend to only rise when the economy is doing well for itself. Therefore, this element does not play a significant role in impacting the stock market, as its influence is typically balanced out by the increase in demands, led by an improved economy. Interest rates can influence investors decision whether to invest in stock market or to invest in interest bearing account – which ever is high. Interest rates have the historic low recently so it makes sense to invest in stock market.

The corporate results have the most significant impact on the stock market. As companies make sale and generates profits, they substantially influence the stock price at the stock exchange.

In addition to this, the number of buyer and sellers also influence the stock market. For instance, for a stock transaction, there must be a buyer and a seller. If the number of buyers is larger than the number of sellers, the price of the stock can rise, as the demand becomes high. To understand this better, you can take a look at the following scenario.

If you start a business of selling chocolate cake in innovative designs, that no other business can create, you would have a large number of buyers. Due to this popularity, and no other competitor, you would have the opportunity to raise the prices of your goods. Hence, you would be able to decide the price. Similarly, the prices in the stock market can fluctuate if there is a discrepancy between the number of buyers and sellers.

For the stock market to function effectively, there is a need for buyers, sellers, dealers, brokers, and market makers. The role of the buyers and sellers is quite literal. However, the brokers are individuals who authorize an investment on an investor’s behalf, by utilising their knowledge of the stock market. Brokers assist in helping buyers and sellers settle on a sale of stocks.

 

On the other hand, market makers involve individual institutions, such as the banks, who make sure that there is liquidity in the market that facilitates the exchange of stocks. Market makers, essentially, ensure that there is an ample volume of trading so that the trades can be carried out without any problem.

Ways of investing in stocks

If you wish to invest in stocks, there are traditional, as well as new ways in which you can achieve your objective. Before you make an investment, you must gauge an idea of what type of investor you are. If you have knowledge about the fluctuation of the economy, as well as the trends in the stock market, you can make an investment yourself. However, if you need professional assistance and a guide to help you out throughout the process, you have a few options that allows you to work with an expert.

Buy individual companies with online traders

Online traders, such as DEGIRO, can help you build your investment portfolio.  The online platform has all the markets on that can help you make logical and educated investment decisions. The best feature of DEGIRO are their low trading fees, thus making it an affordable option. Additionally, you can access the service from phone or PC, depending on your own degree of comfort. By using an online platform dedicated to providing services to investors, you can invest in companies that are more likely to generate a higher return of profit.

Take assistance from Robo-advisors

If you do not trust human input, you can try using Robo-advisors, prior to making an investment. Robo-advisors are digital platforms that offer comprehensive financial advice, based on your individual situation. These platforms use an algorithm to determine the best possible solution, which can be applied in your situation. To interact with this service, you are required to fill out a detailed survey to provide relevant information about your financial goals, risk appetite and investment time frame.

Work with banks – Rely on the share dealing options

There are several banks that offer share dealing options, such as Halifax. The bank provides a wide range of investment options, and broker services, in low, affordable prices. Additionally, this option provides you with research related to the stock market. Hence, you are provided with the incentive that can help you make the right decision. You can communicate with the brokers to set up an investment plan for yourself. This way, you would have access to a financial advisor, who can guide you every step of the way. However, it is worth noting that the trading fee would be higher with banks.

Buy Exchange-Traded Funds (ETFs)

Exchange-Traded Funds or ETFs empower investors to own a multifarious set of securities including stocks. ETFs offer investors exposure to different areas of the market.  These do not require a large investment, to begin with. You can invest an amount as small as £50.

An Exchange-Traded Fund is a low option of having diversified group of assets, including stocks or bonds together. A single ETF unit could give you access to the whole market index. They are easily bought and sold like shares and a cheaper option with low fees. Research the top ETFs in your country, before investing.

Invest in Mutual or Index funds

A mutual fund is somewhat similar to ETF in the way that it enables you to invest in hundreds or thousands of securities it once. The only difference is mutual funds are professionally managed by experts, hence why their fees or expense ratio is higher. Index funds on the other hands are also similar to mutual funds or ETFS but index funds provide a broad market exposure. An index fund is built in a way to track financial market such as S&P 500. It is simple, diversified and an affordable way of investing in the stock market.

Largest Stock Exchanges in the World

1.     New York Stock Exchange

Located in the US, the New York Stock Exchange is the largest stock exchange in the world. Currently, on its own, it accounts for the world’s forty per cent of the stock market capitalisation of $16 trillion.

2.     NASDAQ Stock Market

NASDAQ Stock Market is also located in New York City, USA. It has the market capitalisation of $10 trillion.

3.     Tokyo Stock Exchange

The Tokyo Stock Exchange comprises of more than 2,400 registered companies. Located in Japan, its market capitalisation is of $6.19 trillion.

4.     Shanghai Stock Exchange

Shanghai Stock Exchange is considered to be one of the largest stock exchanges in the continent of Asia. It has the market capitalisation of $5.01 trillion.

5.     Euronext Stock Exchange

Euronext is the subdivision of the world’s first stock exchange, that was created in Amsterdam, is a multi-state stock exchange, located in Amsterdam. Euronext includes more than 1,300 listed companies. It has a market capitalisation of $4.65 trillion.

6.     London Stock Exchange

The London Stock Exchange (LSE) has listed over 3,000 companies. Until World War I, it was the world’s largest stock exchange. Currently, it has a market capitalisation of $4.59 trillion.

7.     Hong Kong Stock Exchange

The Hong Kong Stock Exchange includes 2,315 listed companies. Now, the Hong Kong Stock Exchange has shifted its operations from being a physical stock exchange to a digital stock market. It has a market capitalisation of $3.9 trillion.

8.     Shenzhen Stock Exchange

The Shenzhen Stock Exchange is situated in Shenzhen, China. It features more than 2000 listed companies. It has a market capitalisation of $3.51 trillion.

9.     Toronto Stock Exchange

The Toronto Stock Exchange (TSX) is owned by the TMX group. It includes 2,207 registered companies while holding a market capitalisation of $3.256 trillion.

10. Bombay Stock Exchange

The Bombay Stock Exchange found in India, was the first-ever stock exchange in Asia. It features 5,749 listed companies. The Bombay Stock Exchange has a market capitalisation of $2.19 trillion.

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