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What is the stock market?

Stock market explained

Looking for a stock market definition? The world stock market is a set of exchanges and markets who trade and issue bonds, equities and various other securities. An integral part of the global economy, it affords companies and investors the access to a transaction of capital for a certain amount of legal ownership. The stock market is also known as the equity market, with stocks can be defined in different ways, of the most common being from the country where the stock is contained. As of 2015 the total market capitalisation was worth £52 trillion.

Where have you heard of the stock market?

Even if you've never invested, the chances are that you will have heard of world stock markets. This is down to the general importance of the market itself.

So, what is stock market investment’s importance and what does it mean? The stock market enables companies to boost their capital by making corporate bonds, and stock market trading makes stock shares available to the public to buy. If an investor chooses to buy a stake in a company, they then prosper from the dividends that the share assigns when paid out or sold at a profit and partake in the financial achievement of the company. The downside to this stock market investment would be that an investor can lose money if the price of their equity falls or depreciates and the stock is sold at a loss.

For hundreds of years stock market trading has been most closely associated to stock exchanges, the largest (by capital) being the New York Stock Exchange or NYSE. However, due to the increased use of electronic trading, there are virtually no stocks that are still traded in certificate form and most exchanges now mainly trade electronically.

What you need to know about the stock market

We usually hear of those who work with the stock market before we encounter world stock markets for ourselves. There are various different positions associated with the stock market and stock market investment, ranging from stock brokers, stock analysts and traders to investment bankers and portfolio managers. Each of these positions are individual but many of them are linked and rely on each other for the smooth running of the market.

  • Stock Brokers are licensed professionals who handle the buying and selling of securities on behalf of the investors. The broker behaves as the mediator between the investor and the stock exchange, by selling and buying on the investors behalf.
  • Stock Analysts are the researchers who rate the security as buy, sell or hold. Their conclusive research gets circulated between interested parties and clients who then decide whether to buy or sell the stock in question.
  • Traders buy and sell financial securities on the financial markets for themselves or on behalf of a company or client.
  • Investment Banker is a person who works for an institution whose business raises the capital of governments, companies and other entities or an individual who works for a large bank in this particular division.
  • Portfolio Managers are professional investors who work with collections of securities and portfolios for clients. Mutual fund companies, pension plans and hedge funds all use portfolio managers to strategise and make important investment choices for the money that they hold.

Just as these roles intertwine with one another, the stock market is made of different parts and can be easily divided into two sections that are known as the primary and the secondary markets. The primary market is where the younger securities or “new issues” are sold in the form of Initial Public Offerings (or IPOs). The valuation of the company when they “go public” along with the amount of shares that are issued settles the opening stock price of the IPO. Below is an IPO performance chart by NASDAQ of the best and worst performers over the past six months (graph dated 17.10.2017).

All consecutive stock market trading takes place in the secondary market, where individual and institutional investors alike are partakers. Stocks of large companies are usually traded on exchanges and most trades are executed electronically.

Market Capitalization

Capitalization is a term used to quantify and state a company’s size. If the market capitalization of a company is referred to as large cap, then they are a larger size company or other type of mutual fund. A company’s outstanding shares and their market value is the basis of market capitalization. You can determine the exact figure by taking a company’s stock price and multiplying it by the number of shares outstanding.

There are six different cap classes. Mega Cap is a class of companies that have a worth of $200 billion or more – these are the largest publicly traded companies in the world. The majority of well-known companies fall into the category of Large cap, which is when their market cap is between $10 billion and $200 billion. The companies within these two groups are often referred to as blue chips. A more volatile class are the Mid caps, with a worth of between $2 billion and $10 billion. These are often growing companies who are not yet industry titans but are potentially on the path to becoming ones. Small cap companies hold a market value of between $300 million and $2 billion and are typically start ups and younger companies. There is one class below Small cap that you may not be as familiar with – the Nano cap. With market values of $50 million and below, these are the companies that hold the most risk to investors.

The top five major exchanges are the New York Stock Exchange, NASDAQ, the London Stock Exchange, the Japan Exchange Group and the Shanghai Stock Exchange. These exchanges are part of the 16 stock exchanges worldwide, which have a market capitalization of over US 1 trillion dollars each. You may have heard this group of exchanges being referred to as the “$1 trillion club”. In 2015, these exchanges made up 87% of the global market capitalization.

Stock market investment, and the stock market itself, is regulated by the Securities and Exchange Commission (SEC), which is a federal agency unattached to any political power, dedicated to the inspection of the US stock market. Its mission is to protect investors, maintain fair, orderly and efficient markets, and facilitate capital formation, defining what is stock market best practice. The two main sorts of securities that are primarily traded on the stock market are over the counter (OCT) and listed securities.

  • Over the counter securities are usually traded via a dealer network, between two parties, and are not located on any exchange (however, they may be formally listed on the pink sheets). OCTs do not need to comply with SEC reporting specifications, so researching them can prove difficult.
  • Pink Sheet securities regularly do not meet the standards for being catalogued on an exchange and tend to have thinly traded stock. Penny stocks and companies filing for bankruptcy are usually listed in the pink sheets.
  • Listed securities are stocks that are traded on exchanges. They must meet the strict reporting regulations of the SEC and the regulations of the exchanges which they are traded on.

So, what is stock market performance and how is it measured?

The fastest way to see how the stock market is performing is to look at an index of stocks. These indexes can cover a portion of the markets or the whole market, depending on which index you visit. There are various indexes and they all measure change within the market. Each individual index is made up of its own segments of stocks with certain stocks overlapping into different indexes at times. One of the most popular indexes is the Dow Jones Industrial Average (DJIA). It's composed of the 30 biggest companies in the U.S and is a price weighted average, meaning that the number is established on the price of stock. Other popular indexes are the S&P 500, NASDAQ composite, Russell 2000 and FTSE 100 – all of which are used by investors and traders around the world.

World stock markets are synonymous with investing and stocks are usually the first type of security that come to mind, but this hasn't always been the case. The first stock exchange was established in Antwerp in 1531 and it involved moneylenders and brokers convening to deal in matters of government, business and on occasion even individual debt. In the 1500s there were no real stocks, just a series of promissory notes and bonds. There were of course entrepreneurial partnerships that made revenue like stocks, but no formal shares were exchanged. Companies with movable shares date as far back as ancient Rome, but it was the Dutch East India Company in the 1600s that was the first company to in history to offer shares of stock and bonds to the public.

The stock market is incredibly important to companies, investors and the economy in general. The markets are consulted by families and wealthy executives alike. It's a way for companies to raise capital and a way for investors to possibly make a profit (the downside to this being that an investor could make a loss depending on how the investment pans out) and it's a way to see which areas of the economy are the most prosperous.  History has revealed that the price of stock can be an indicator of social mood.

Find out more about the stock market...

Our glossary has lots more information on all things stock market related, from the history of the stock exchange to the meaning of market capitalisation. For some insight into whether history can teach us anything about the markets, John Authers of the Financial Times has written a noteworthy piece.

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