Stock market definition
The stock market, or equity market, is a series of exchanges where shares in public companies are issued, bought and sold. Its role is to give private investors a way to own a stake in a listed company, while providing the companies themselves with capital to reinvest in their business.
Trading on the stock market
The global equity market is composed of a number of stock exchanges – the London Stock Exchange (LSE), for example, or the New York Stock Exchange (NYSE).
Exchanges have certain requirements for the people that can buy and sell shares directly on their books – so to trade a company’s shares on an exchange, you’ll need to use a broker. This is a third party which executes buy or sell orders on your behalf, in return for a fee or commission.
Understanding the stock market
To join the stock market, a company first of all has to go public in a process known as an initial public offering (IPO). From there, its shares will first of all be available in the primary market, and then in the secondary market.
- Primary market: this is where newly listed companies are first made available, and it is used to establish an opening share price when it floats on the secondary market. It is open exclusively to institutional investors who buy millions of shares at once.
- Secondary market: this is where shares are made available to individual investors who can trade in smaller volumes via a broker, as well as the institutional investors who deal in much larger sums.
Once a company has floated on the secondary market, the price of its shares will move according to the rule of supply and demand. When buyers of a stock outweigh sellers, demand rises and the price of the asset climbs (unless there is an equal rise in supply). When it’s the other way round, supply increases and demand for the asset starts to drop – and the price falls.
Why do people buy shares?
There are two ways investors make their money from the stock market.
Share price movement
When the value of a company rises, the shares may become worth more than you paid for them, and you could sell them at a profit. Of course, when it falls, you may choose to cut your losses and sell the shares at a loss.
By holding ownership of a company, investors may also receive dividends. Dividends are a portion of a company’s profits, distributed among shareholders throughout the year. The larger the stake you own, the more you’ll earn in dividend income.
Trading stock indices
A stock index is a market that tracks the performance of a group of stocks to give an idea of how they are generally performing. The most popular indices tend to track the biggest companies in a particular country or on a particular exchange – like the FTSE 100, which contains the 100 biggest companies on the LSE, or the Dow Jones, which contains 30 blue chip stocks listed in the USA.
It is possible to trade indices instead of buying and selling shares on the stock market. They don’t trade on exchanges, though – to deal indices you have to use other products like derivatives or ETFs.