Stock market: how does it work and what should you know about it? Basically, the stock market is a place where investors buy and sell shares of publicly traded companies. Let’s find out how you can make it work for you.
How old is the idea of the stock market?
The first genuine stock market dates back to 1500s. The commercial centre of Belgium, Antwerp is considered to be the home of the world’s first stock market system. In 1602, the historically famous East India Company became the first publicly traded company. Instead of investing in one ship with a high risk of losing everything due to storms or pirates, investors could buy shares in numerous ships to split the risks. The first US stock exchange was opened in Philadelphia in 1791.
What is the stock market?
Today, when we talk about the stock market, we often refer to one of the major stock market indices, such as the S&P 500 or the Dow Jones Industrial Average. The indices perform as groupings of individual stocks with a number of common features. The larger indices often serve as a benchmark for overall stock market performance. Any significant change in the index’s value may drive traders’ sentiment up or down.
Therefore, the performance of the major stock market indices is viewed as a bellwether for the entire market. When we see the headlines saying “the stock market closed down or up for the day”, it usually means that the major stock market indices moved accordingly. Typically, the index value, in its turn, is driven by the performance of particular constituent stocks and their price fluctuations.
How does the stock market work?
To make it simple, let’s compare the stock market with an auction: the market enables buyers and sellers to negotiate stock prices and trade them.
The stock market is often referred to as a unified notion, though it represents a whole network of exchanges — for example, the NASDAQ 100 or the New York Stock Exchange (NYSE).
Traditionally, companies list shares of their stock on an exchange, and investors buy those shares. This process is called an Initial Public Offering (IPO) and is often undertaken by companies to grow their business and raise capital.
Then, the listed stocks are traded among investors, and the exchange monitors the supply and demand ratio of every stock. The supply and demand determines the price for each stock at which traders and investors will buy and sell it. Today, most of the calculations are performed by algorithms.
Those eager to buy the stock offer a “bid” price, which is the highest price they are willing to pay. It is usually lower than the price offered by the sellers, otherwise known as the “ask” price. The difference between the two amounts is called the spread.
To get a clear yet simple picture of how the stock market works, just watch a short video below.
Why do share prices fluctuate?
There a number of reasons why stock prices may go up or down. The most common reason remains the simple idea of supply and demand. In a stock market, supply means the number of shares available at a certain price, and the demand is the number of shares wanted at that price. If the buyers outnumber, the share price will go up, and vice versa.
However, it never happens as easy as that. The stock price may be significantly driven by investment sentiment, which highly depends on various external factors like global economic affairs, companies’ performance results and analyst forecasts.
Why and how invest in the stock market?
Trading is always risky. Everyone knows it. But still, the potential reward makes it one of the most attractive and engaging ways to gain extra profit and make your money work for you.
Individual stocks have always been considered as risky investment instruments, though potentially more rewarding than other type of asset. It’s a common belief that a well-diversified stock portfolio may eventually increase its value over time.
Though building a diversified stock portfolio is a very challenging project, you can also invest in a mutual fund, known as an exchange-traded fund (ETF) or an index fund. These funds are designed to mirror the performance of an extended group of shares or indices, instead of dealing with separate individual stocks.
Individual stocks are often considered a good investment in the long term, though not very suitable for short-term trading. Therefore, if you’re interested in trading stocks, you have two options to go.
First, you can purchase and own the shares of a particular company on the stock exchange where they are traded. These would serve as a long-term investment.
Alternatively, you can choose contracts for difference (CFDs) and just speculate on the price difference of the chosen stock — the underlying asset. With CFDs, you can enter the world’s most traded stock markets without actually purchasing the asset. You can either go long, believing that the stock price will go up, or go short, speculating the price will go down. CFD are considered as short-time investments.
What are the world’s largest stock exchanges?
The New York Stock Exchange (NYSE) and the NASDAQ are two of the world’s largest stock exchanges according to the total market capitalisation of all the listed companies. The list of top 10 global stock exchanges also include the following:
Market cap in USD
Shanghai Stock Exchange
Shenzhen Stock Exchange