The stock market is a collective term for stock exchanges around the world. On these exchanges buyers and sellers can trade shares in publicly traded companies, known as stock. Similar to an auction, buyers can name the highest price they're willing to pay, known as the "bid", and sellers can name the lowest price they're willing to accept, known as the "ask". The trade will typically execute somewhere between these two figures.
The stock market exists across the world with stock exchanges situated in New York and Hong Kong, connecting traders through a mutual set of guidelines. Learn more about the role of stockbrokers, portfolio managers, and investors as we take a deep dive into the entire stock market.
What is the stock market?
The stock market can also be referred to as the equities market or share market. As mentioned above, the stock market encompases buyers and sellers of stocks of publically traded companies. Similar to a farmer's market, the stock market forms a base where buyers and sellers can exchange things. Unlike farmer's markets, however, stock markets are heavily regulated and more complex, with prices known to change quickly.
The primary functions that the stock market serves
- The buying of stocks: Both retail investors and institutional investors can purchase shares of companies.
- The selling of stocks: every trade needs a buyer and seller.
- The issuance of stocks: A company raising money may do so by selling a portion of ownership via an initial public offering (IPO). If the company is already public, it can raise money through a secondary public offering. After the individual stocks are issued in either case, it can be bought by or sold to members of the general public.
Trades are typically placed by stockbrokers on behalf of individual investors or portfolio managers.
The primary market is when companies list their shares, while the secondary market is where investors trade these stocks. The secondary market is essentially the stock exchange where stock trading takes place.
It's not just stocks that can be bought and sold on the stock market. Other types of securities, such as exchange-traded funds (ETFs) or REITs, are also traded on the stock market (with some discrepancies in how they're priced and traded).
Around the world, there are 60 major stock exchanges, each varying in size and trading volume. In the United States, for instance, there are 13 different exchanges that make up the stock market, the most popular ones being the New York Stock Exchange and Nasdaq.
How does the stock market work?
The primary function of the stock market is to bring together buyers and sellers so they can trade stocks and other financial instruments. The price is set much like an auction would be.
- Buyers determine the bid price. Stockbrokers can bid on the price they're willing to buy a stock for, and the highest price becomes known as the "Best Bid."
- Sellers determine the ask price. When an owner of the stock or their stockbroker wants to sell, they place what's called an ask, which is the price that they would like to sell a stock for. The lowest prices become known as the "Best Ask."
The negotiation between the Best Bid and Best Ask is called the “Spread.” The two sides agree to meet somewhere in the middle, and the person who executes the trade gets paid by taking the difference.
As you follow a stock, you’ll notice the share price moves. The stock's price is always changing depending on how many people are buying or selling it and the number of trades that it goes through. As economic, political, and news stories specific to a company affect the movement of markets in general, that company's stock prices can change too as a result. This is known as stock market volatility.
Is trading on stock exchanges risky?
As with any investment pursuit, trading the stock market for both short-term and long-term periods carries a level of risk. Being prepared by knowing that stocks can increase or decrease dramatically at a moment's notice will allow you to prepare for such events in your trading strategy.
In some cases, stock prices can decrease to zero, losing all their value and resulting in a total loss of capital for the investor. While this is an extreme case, making the necessary precautions in one's trading strategy will go a long way.
Is the stock market and stock exchange regulated?
Yes, as the stock market handles trillions of dollars, government organizations around the world have been called in to regulate these markets. In the U.S. for example the SEC (US Securities and Exchange Commission) has been granted the authority by Congress to regulate the stock market because they handle such a large amount of money. Other countries have similar organizations that regulate and enforce different laws.
Regulators are responsible for:
- Safeguarding the investments of the general public
- Promoting a sense of equality and fairness
- Keeping markets running smoothly
Who are the main players in the stock market?
Below are the main players contributing to how the stock market works:
- Retail investors
Buy or sell individual stocks through a brokerage account. When you place an order, it’s sent to exchanges where the trades are executed.
“Registered representatives” who have completed professional training and passed a licensing exam and are allowed to buy and sell securities on behalf of investors. Stockbrokers work for brokerages, which can either make their money through markups/markdowns or commissions on trades (known as principals or agents respectively). Fees are often charged by the brokerage to customers that use them to place orders and execute stock trades.
- Portfolio managers
Portfolio managers are stockbrokers on a grander scale as they buy and sell stocks through large orders as they manage larger stock portfolios. These might include mutual funds, retirement funds, and pension funds, which contain a bundle of securities (stocks, bonds, etc) that are handled by the portfolio manager.
- Investment bankers
Help companies list their shares publicly on exchanges.
Who makes up the stock market ecosystem?
To better understand how the stock market works you will need to understand the varying components that make up the primary market. Investors buying and selling stock make up the biggest component of the stock market, however, there are plenty of middlemen acting between those buyers and sellers earning money by providing services to them. Below are some examples:
- The stock exchanges charge a small transaction fee and listing fee to the companies that offer their shares on the exchange.
- Agents are the middlemen connecting the buyers with sellers. For connecting each side of the transaction they take a commission.
- Principals are broker-dealer firms that manage a portfolio of shares they're willing to sell. Broker-dealers usually earn a profit by adding a markup to stocks they sell and charge investors less than the full value when buying stock. For example, have you ever noticed how much more car dealerships will sell cars for versus what they offered to pay you for your old one? Brokerages do something similar with stocks.
- Retail investors are people who invest for themselves, and not as part of their job, are retail investors. These individuals manage their own stocks (or other assets) through personal accounts with brokerages.
- Custodians. Brokerage firms use custodians to physically hold stocks, which is seen as less of a risk in terms of loss, theft, or damage. For doing so they charge a fee.
What is the history of the stock market?
The original concept of the stock market is the opportunity for a company to divide its ownership, known as equity, and sell it to investors. This practice dates back hundreds of years to the 1600s where European explorers would raise money for their ventures by selling shares in the company.
Investors would then get a cut of the explorer's missions, whether it be bringing back foreign spices or animal hides. The Dutch East India Company was a pioneer in this movement, selling shares in exchange for future profits on Amsterdam's stock exchange.
A century later and the first modern stock exchange was launched in London. Due to a high amount of fraud and minimal information on the company available to the public, the London Stock Exchange was created in 1773 which provided a consistent and fair platform on which to trade stocks.
Across the pond in 1790 the first stock exchange was formed in Philidelphia, followed shortly after by the New York Stock Exchange. Fast forward to modern days and the NYSE now provides both digital trading and a physical trading floor on Wall Street, the latter of which is a National Historic Landmark.
Nasdaq (National Association of Securities Dealers Automated Quotations) launched in 1971 as the world's first electronic market. The electronic stock exchange is a popular option for tech companies looking to list their shares and a crosstown rival to the NYSE. From a trading perspective, where the shares are listed makes little to no difference to the investor.
In conclusion: what is the stock market?
The stock market is a collective term for stock exchanges around the world that facilitate the trade of stocks and other financial instruments.
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