The stock market is a financial market that refers to the collection of markets as well as exchanges. On these markets and exchanges, there are frequent activities that involve the buying, selling, and issuance of shares of publicly-held companies.
These financial activities are conducted through standardized and formal exchanges or over-the-counter (OTC) marketplaces that operate under certain predefined sets of regulations.
There can be several stock trading venues in a single country or region that allow transactions to take place in stocks and several other types of securities.
The terms stock market and stock exchange are often used interchangeably where the latter term, stock exchange, is a subset of the former or the stock market. When someone says that they are trading in the stock market, it means that they are buying and selling shares on one of the stock exchanges that form part of the overall stock market.
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How does the Stock Market Work?
The concept and principle behind the stock market are simple; the stock market allows for investors and traders, buyers, and sellers, negotiate prices and make trades.
The stock market operates through a network of stock exchanges, and companies list their shares or stock on an exchange through an initial public offering (IPO). Investors then purchase these shares, allowing the company to raise funds to expand and grow the business.
Some of the most popular stock exchanges that make up the overall stock market include, but are not limited to:
- The New York Stock Exchange (NYSE)
- The Johannesburg Stock Exchange (JSE)
- The Chicago Board Options Exchange (CBOE) and several others.
Investors can then buy and sell these stocks among themselves, with the exchange tracking the supply and demand of each listed stock. The supply and demand will determine the price for each security, or it will determine the levels at which stock market participants, known as investors and traders, are willing to buy and sell.
Buyers will offer a “bid,” which is the highest amount that they are willing to pay for a stock, which is typically lower than the amount that sellers “ask” for in exchange. The difference between the bid and ask is known as the bid-ask spread. For a trade to happen, the buyer must increase their price, or the seller must decrease theirs.
While this process sounds overly complicated, with modern technology, there are computer algorithms that determine the price-setting calculations. When traders or investors want to buy or sell a share, they will see the bid, ask, and bid-ask spread on their broker or exchange’s website.
Even though it is called a stock market or an equity market, and it is primarily known for the trading of stocks, other securities are traded in the stock market, such as exchange-traded funds (ETF), corporate bonds, and many derivatives that are based on stocks, commodities, currencies (forex), and bonds.
History of the Stock Market and Stock Trading
In 20th century France, the courtiers de change were highly concerned with how they would manage and regulate the debts of agricultural communities on behalf of the bank. These men were traded with debts, and thus they could be considered the first brokers.
Lodovico Guicciardini, an Italian historian, described how commodity traders in the late 13th century Bruges would gather outdoors at market squares that hosted an inn owned by the Van der Beurze family.
In 1409, the family became the “Brugse Beurse,” which institutionalized what had been, until then, an informal meeting. This idea rapidly spread around neighboring countries, and “Beurzen” soon opened in Ghent as well as in Rotterdam.
Since the early 13th century, International traders, especially Italian bankers, who were present during this time, took back the word to their countries that would define the place for a stock market.
In most languages, the word coincides with the word used to describe a money bag, which dates to the Latin bursa, which derives the name from the Van der Beurze family. During the mid 13th century, some Venetian bankers began to trade in various government securities.
By 1351, the Venetian government had outlawed rumors that were spread, attempting to lower the price of government funds. By the 14th century, Pisa, Verona, Genoa, and Florence had also started trading in government securities.
Modern stock trading started during the mid-1500s in Antwerp with the trading of shares in the East India Company, based in London. Throughout the 1600s, British, French, and Dutch governments provided charters to a selected number of companies that had “East India” in the company name.
All the goods that were brought back from the East were transported by sea, and this involved many risky trips that were threatened by pirates, rough ocean conditions, and severe storms. These risks were mitigated by the shipowners by seeking out investors to provide financing collateral for the voyages.
In return, the investors would receive a portion of the monetary returns realized once the ship made it back successfully, full of goods that could be sold. These are early examples of limited liability companies (LLCs), and many of these were held together for only one voyage due to the risks involved.
The establishment of the East Indica Company in London led to a new model for investment. Many importing companies offered stocks that represented a fraction of ownership interest in the company. This offered investors returns on proceeds from the voyages that a company funded and not just one trip.
This new business model helped companies ask for more significant investments per share, which enabled them to increase the size of their fleet. These investments were protected from competition by royally issued charters, which became famous because investors could potentially realize significant profits on investment.
The first company shares were issued on paper, which enabled investors to trade shares between one another. Regulated exchanges only emerged with the formation of the London Stock Exchange (LSE) in 1773. Even though sizeable financial turmoil followed immediately after, exchange trading overall survived and managed to flourish throughout the 1800s.
The Philadelphia Stock Exchange (PSE) was the first stock exchange established in the United States, followed by the New York Stock Exchange (NYSE), which rapidly grew to become one of the dominant stock exchanges in the United States and the world.
NYSE has always maintained a physical strategic position among some of the largest banks and companies in the world, in addition to being close to a major shipping port. NYSE established listing requirements for shares which included hefty fees when it started, enabling it to become a wealthy institution.
NYSE saw meagre competition for two centuries, and growth was initially fuelled by a growing American economy, while LSE continued to dominate the European market for stock trading. However, NYSE quickly became home to many large companies, which ensured its expansion and growth.
Other prominent countries such as France and Germany eventually developed their exchanges. However, these were considered as steppingstones for companies while they worked to have their shares listed on LSE or NYSE.
Stock trading expanded in the late 20th century into many other exchanges, including NASDAQ, which became a favorite for burgeoning technology companies. NASDAQ gained a lot of exposure and saw a significant amount of expansion during the 1980s and 1990s following the technology sector boom.
Euronext was formed in 2000 when the Brussels, Amsterdam, and Paris exchanged merged, and Euronext subsequently merged with NYSE in 2007, which marked the first trans-Atlantic exchange.
Functions of the Stock Market
The primary function of a stock market is to provide a marketplace where securities and shares can be bought, sold, and exchanged. There are 60 major stock exchanges worldwide where the shares of more than 630,000 companies are being offered in the public market.
Apart from being a central marketplace, the stock market also serves these functions:
- Providing Liquidity as well as marketability to existing securities.
- Pricing of Securities
- Safety of Transaction
- Contributes to Economic Growth
- Spreads Equity Culture
- Provides a Scope for Speculation
The stock market and its stock exchanges provide both a ready and a continuous market where securities can be bought and sold, which provides Liquidity and marketability for existing securities on these exchanges. The stock market also provides a platform where shares can be sold and bought by buyers and sellers, traders, and investors.
Where securities pricing is concerned, the stock market is driven by supply and demand, and stock exchanges inherently add value on securities that provide instant data to buyers and sellers, helping to price securities in a transparent manner that cannot be influenced.
In terms of transaction safety, the stock market is well-regulated, and all key players, such as brokers, must work within the legal framework that is provided. This system ensures that transactions are safe, transparent, and fair. Each country and region has its regulatory entity that oversees providers who facilitate trade in stock exchanges and the overall stock market.
In terms of the stock market contributing to economic health, many participants can buy and sell shares, allowing them to invest money. The stock market provides the perfect platform where savings are channeled into the most productive investment proposals, resulting in capital formation alongside economic growth.
In terms of equity culture, the stock market has extensive information regarding listed companies which is freely available to the public. This data and information help to educate the public about investments in securities that lead to the spreading of wider ownership of shares and equities.
Regarding scope for speculation, securities can be purchased to gain profit through price movements to a target, also known as speculation. The stock market provides a scope within the provisions of law where speculation is concerned in a restricted, controlled manner.
Advantages of the Stock Market
The stock market has been around for centuries, and it has grown and evolved exponentially. Today, millions of participants experience the following advantages:
- Capital Gain
- Safety against inflation
- Liquidity or ease of conversion
- Advantage of economy
- Flexibility of investment
- Benefits of dividends
- Ownership stake in the brand
- Hassle-free trading
In terms of capital gain, the stock market offers traders and investors the opportunity to invest in companies that have consistent growth patterns along with increased earnings, resulting in the steady development of wealth and the growing value of the investment.
In terms of safety against inflation, the stock market alongside benchmark indexes is inherently known to outperform inflation, with gains nil if inflation and the rate of return is comparable. Ideally, the rate of return on investments will always be higher than inflation.
In terms of Liquidity, stocks are considered liquid assets as they can easily be converted into cash, and there is a sizeable number of purchasers at any given time, depending on the company and its securities.
In terms of the advantage of the economy, the stock market is always a factor present in an economy that is thriving. It always responds to economic growth indices such as the gross domestic product (GDP), inflation, corporate profit, etc. Investors can therefore benefit from a thriving economy, with the value of their investments rising alongside the economic expansion.
In terms of transparency, the stock market in each country and region is regulated by a regulatory body, and the market and subsequent exchanges will function according to the guidelines of the regulatory body. This ensures that there is transparency in the market and protects the rights of investors.
In terms of flexibility, the stock market allows investors, especially beginners, to start with small investments into small-cap and mid-cap stocks with lesser amounts of capital, allowing beginners to grow their portfolio and investment size steadily.
In terms of dividends, they provide an additional income for investors quarterly or annually, depending on the company.
In terms of ownership, investing in stocks of a specific company means that the investor buys a small fraction of ownership stakes in that specific company, offering them a sense of belonging to a company that they like or value.
In terms of hassle-free trading, stocks can be bought and sold quickly with the help of developments in technology, with a plethora of trading and investing technology available that connects traders and investors to brokers, exchanges, and the stock market.
In terms of investment versatility, shares, bonds, mutual funds, and several other derivatives form part of the stock market, offering investors a wide range of assets to choose from. They can invest their money, ensuring that they have a diversified portfolio.
Disadvantages of the Stock Market
While there are many advantages associated with the stock market, it is crucial to identify and discuss the disadvantages as well. These include:
- Profit Margins
- Market Price Fluctuation
- High risks involved
- Limited Control
- Investment of Time
In terms of profit margins, the easiest way to buy shares is through a broker, and every time an investor decides to buy or sell their shares. They may have to give a portion as brokerage fees to the broker. This means that the investor receives fewer profits depending on the size of their purchase/sale and the market prices at the time.
In terms of price fluctuation, the market price of any share can increase or fall at any given time, depending on the driving factors behind it. Prices on shares depend on the demand and supply, but many factors influence this.
In terms of the high risks, investment in the stock market, much like any other trading venture or investment, is a risky business. With investment in stocks, the investor places faith in the company, and no collateral security is attached to it.
In terms of a limited control, investors are small investors in the company. It is rarely possible that the investor could impact any decision that the company makes using their voting rights. Shareholders do not own the companies that are issuing shares; they own the outstanding shares that were issued by the company.
In terms of the time involved with investing, many traders trade stocks to make quick profits, such as scalpers and day traders, but investment in the stock market for long-term wealth can be time-consuming, with many investors using a long-term buy-and-hold strategy.
However, despite this, it is still a risky and tricky business to know when to exit a stock position if it turns out to be a wrong investment choice.
What are Examples of Stocks?
There are two main types of stocks, namely common stock and preferred stock. Common stock is an investment that represents a fraction of ownership in a company. When people refer to “shares” or “stocks,” it refers to ordinary shares or stocks.
Preferred stocks or shares are an investment where, depending on the company that issues the shares, it can represent a fraction of ownership in a company along with it being a debt instrument of that specific company.
Common shares are typically used by companies to raise funds to expand, pay down or pay off debt, and when companies “go public” during an IPO, those proceedings or funds are typically used to expand or reduce debt that the company owes.
Diverse types of common stocks can be traded, including:
- Blue-Chip Stocks
- Income Stocks
- Growth Stocks
- Tech Stocks
- Speculative Stocks
- Cyclical Stocks
- Defensive Stocks
- Small-cap stocks
- Penny Stocks
- Mid-Cap Stocks
In terms of Blue-Chip Stocks, these are stocks with predictable earnings as well as dividends along with steady growth and high-quality stocks such as AbbVie (NYSE: ABBV), Nike (NYSE: NKE), IBM (NASDAQ: IBM), McDonald’s (NYSE: MCD), and others.
In terms of Income Stocks, these are shares that have long and sustained records of paying dividends that are higher than average. These shares are also considered safe but do not have high growth, such as General Mills (NASDAQ: GIS), Duke Energy (NYSE: DUK), American Electric Power (NASDAQ: AEP).
In terms of Growth Stocks, these experience higher than average earnings as well as sales growth and are known not to pay any dividends, with most returns coming from capital appreciation. These stocks include Apple, Inc. (NASDAQ: AAPL), Alphabet, inc. (NASDAQ: GOOG), Amazon (NASDAQ: AMXN) and several others.
In terms of Tech Stocks, these are some of the most popular stocks that represent the technology industry, including companies that are in the Artificial Intelligence field alongside Big Data, semiconductors, and software. These stocks are typically either Blue-Chip or speculative and are traded on NASDAQ. This includes Microsoft (NASDAQ: MSFT), Alphabet, Inc. (GOOG), and more.
In terms of Speculative Stocks, these are high PEs that do not have earnings and are at elevated risk. However, they offer the potential for a significant rise in appreciation. These stocks include Sirius XM Holdings, Inc. (SIRI), Under Armour (NYSE: UA), and more.
In terms of Cyclical Stocks, these shares move with the business cycle, and the earnings alongside overall market performance are linked with the typical state of the economy. This type includes companies that are tied to capital equipment spending along with consumer spending for durable and big-ticket items such as cars and houses. This includes Tesla (NASDAQ: TSLA), Caterpillar (NYSE: CAT), and more.
In terms of Defensive Stocks, these shares tend to hold their own regardless of the state of the economy as they are considered countercyclical. This includes public utility companies, industrial and consumer goods companies that produce a range of beverages, medicine, and other products. This includes companies such as Walmart (NYSE: WMT), Pfizer (NYSE: PFE), and several others.
In terms of Small-Cap Stocks, this includes companies that have a market value of less than $1 billion and who offer returns that are above average, for example, IPOs.
In terms of Penny Stocks, this typically refers to stocks that trade for under $5 per share.
In terms of Mid-Cap Stocks, this includes companies that have a market value of between $1 billion up to $5 billion.
Some examples of the biggest value stocks in the world, according to the company’s market cap, are as follows:
- Apple, Inc. (NASDAQ: AAPL) with a market cap of $960.8 billion.
- Berkshire Hathaway (NYSE: BRK.A and BRK.B) with a market cap of $506.2 billion.
- JPMorgan Chase (NYSE: JPM) with a market cap of $377.5 billion.
- Johnson & Johnson (NYSE: JNJ) with a market cap of $342.1 billion.
- Walmart (NYSE: WMT) with a market cap of $320.0 billion.
- ExxonMobil (NYSE: XOM) with a market cap of $318.9 billion.
- Bank of America (NYSE: BAC) with a market cap of R285.6 billion.
- Procter & Gamble (NYSE: PG) with a market cap of $254.2 billion.
- Walt Disney (NYSE: DIS) with a market cap of $254.2 billion.
- Cisco Systems (NASDAQ: CSCO) with a market cap of $247.0 billion.
It is important to note that market capitalization refers to the market value of the equity of a company, calculated by multiplying the number of shares that are outstanding by the current share price.
Is the Stock Market Good for Beginners?
Yes, because the stock market does not require a significant amount of capital to start investing, the stock market is perfect for beginners.
It is important to note that beginners must first educate themselves on the stock market, the types of shares, and how it works before they get started as there are many factors involved, and traders can still lose a lot of capital if they make poor investments choices.
The stock market is one of the best starting places for beginners to gain investment experience. Before they begin, investors must decide on the type of investor they would like to become.
Next, they must choose a regulated online broker that will connect them to a stock exchange. Traders can then explore different trading strategies and trading styles to improve and direct their investment techniques and decisions.
Beginners must also evaluate the number of funds that they can allocate towards their investment. It is important that they do not use income that must serve essential purposes such as rent, schooling, food, or other basic needs. The best is to use disposable income that will not be used otherwise as there is always a chance that the investor could lose their initial investment.
What is the Difference Between the Stock Market and the Commodity Market?
There are some distinct differences between the stock market and the commodity market, and they relate to:
- Trading hours
- Bid/Ask spreads
In terms of inflation, which is an upward trend in prices of all goods in an economy, the commodity market tends to thrive under such conditions, whereas the stock market sees many share prices plummeting.
In terms of the timeframe, the commodity market is suitable for short-term trading as most transactions are executed through a futures contract. The stock market is suitable for both short- and long-term trading and investing with individuals that can invest for a day, month, or even up to ten years.
In terms of volatility, the commodity market is inherently volatile because commodities are sensitive to the dynamics involved with supply and demand, which are subsequently affected by geopolitical events. The stock market is less volatile and offers some stability because of diversity.
In terms of trading hours, the commodity markets are open 24 hours a day, whereas stock trading depends on the stock exchanges’ closing and opening times.
In terms of the bid/ask spread, stocks are known to have a lower spread than commodities because the stock market is much more liquid than the commodity market, which ensures that securities traded can easily change hands between participants who buy/sell shares in the stock market.