Published On: Wed, Feb 19th, 2014

The Stock Market

The stock market may seem a mystery to you. All this talk of Bulls and Bears, shorts and longs, not to mention the associated TLAs (three-letter acronyms!) such as IPOs could leave you cold. But that would be a shame, because it’s really not difficult once you understand the basics, and it could play a bigger part in your fact, it’s true to say that if you don’t know about the stock market you are missing out on a lot.

This beginners guide will lead you through the jargon and explain how you can understand if not enjoy what happens on the stock market. By the time you finish, you should understand all the common buzz words and have a good idea how you can use the market to improve your future.

A Market

I’m sure you know what a market is. If you watch East Enders, you are familiar with market stalls and street vendors selling different products. Or if you’re into the Internet, there are the Amazon and eBay marketplaces. Either way, a market is simply a place where people meet, either virtually or in person, to buy and sell things. And perhaps crucially in this case, unlike a grocery or department store, in a typical market prices are often negotiated rather than being a single set price.

The stock market is no different from other markets. It is simply a place where people are brought together, either virtually or in person, to buy and sell stocks. We’ll get to what a stock is next, but you probably already know it is something to do with a company or corporation. The price of stocks goes up and down all the time, and that is what makes the stock market a place of opportunity for those who take the time to learn about it. The way that the price goes up and down is a demonstration of the economists’ time-honoured standard theories of supply and demand, and how changes in either affects the cost.

A Stock

So what are these things called stocks and/or shares? Actually, the terms stocks and shares are virtually the same. The most noticeable difference is that the word “stocks” tends to be used when you are talking about several companies, and “shares” usually refers to one company. For instance, you might say that you bought some shares in Apple to add to your collection of technology stocks.

A stock is a small share of ownership in a company. Unless you are as rich as the American investor Warren Buffett, your ownership may be very small. Take for example the shares of Next. At the time of writing they are trading at just over £50 each. But there are over 150 million of them! So however many you can afford to invest in is hardly going to be noticed. Incidentally, this is how you work out a “valuation” of a company. You can just multiply the number of shares times the current price. Next works out to over £7.5 billion on the basis of these numbers.

While it might seem a nice idea to have some sort of ownership in companies, particularly ones you are interested in or buy products from, you might be wondering what the point of ownership is, especially if you are sharing ownership with so many other people. The company doesn’t know you exist, and in any case how much does your investment mean to it? Very little, is the answer, as you’ll see later. The ultimate reason for owning shares for most people must be to hold an investment that you hope will increase your wealth over time.

If you start questioning why stocks should increase in value over time, then you can get into some esoteric arguments. Basically, they increase because people think they should, and therefore act in conformance with that belief, pushing the price up. At the end of the day, if the management of the company decided to up and leave, the shareholders would own the company’s real estate, machinery, and supplies, so there is a certain base level of value. However, shares will usually be priced much higher than this liquidation level on the basis of expected continued successful trading, making profits that may or may not be distributed to shareholders in the form of dividends or regular payouts.

You cannot buy shares in all companies. The company has to be a “public company”, which means at some stage in its past the original founders or owners decided to sell it, in whole or in part. Sometimes the original owners will have already sold out to professional investors, and it will be these investors who decide to take the company on the open market. While it seems a nice idea to retain ownership to yourself, if you sell up in whole or in part you may get a nice profit. You may also want to take the company to “the next level”, which requires investment in new machinery or research,  and decide that issuing public shares is the best way to fund this. Most big firms have taken the step of “going public”, and you can see lists of them in the financial pages of the newspaper, or on one of many financial web sites.

Another phrase that you hear a lot is “stocks and bonds”. Stocks and bonds are different things, and not to be confused with each other. A stock is a small share of ownership in the company, and may go up or down in value as the company’s fortunes change. A bond is simply a loan to a company and it gets repaid to you with interest according to the prescribed terms – provided nothing catastrophic like a bankruptcy happens and stops the company from doing that. There is more detail about bonds in the section on ‘How the Stock Market Works’.

Stock Market

Putting together ‘markets’ and ‘stocks’, you can see that the stock market is a place where market participants can buy and sell stocks. In fact, there is no one “stock market”, there are lots of them all over the world. Some countries have several stock markets, and most industrialised countries have at least one. Some of the names of them will be familiar to you, such as the New York Stock Exchange and the London Stock Exchange, and others you may not have come across such as the JSE Limited in South Africa and the BM&F Bovespa in Brazil.

The stocks of any particular company are only directly available in certain markets, so you usually do not get confused about where to buy and sell them. Many companies’ stocks are only available in the country where the head office is located. In general, you will find that UK companies are listed on the London Stock Exchange, American companies are listed on the New York Stock Exchange or on the NASDAQ, Korean companies such as Hyundai Motors are listed on the Korean Stock Exchange, etc. Sometimes, particularly for the large international companies, these are called the “primary” listings, and the companies’ stocks are also traded on major exchanges in other countries for the convenience of investors. There are a couple of ways that this can be made to happen, using banking intermediaries or other devices, but the details do not really concern us. You can just search the companies list for your local stock market to see what’s available.

The stock market is different from a shopping market. You cannot go into a stock market, peruse the stocks (whatever that means), and say to the man (who is called a trader), “I’ll have six of that one and 10 of those please”, like you would with a grocery market trader. With the amount of business that is transacted every day, that would cause total chaos. The general public, which includes you and me, cannot buy and sell directly at the market. All trading has to go through people who are known to the market, and called brokers or dealers. They deal with any complications, and make buying and selling stocks streamlined and easy for you and me. In fact, there are a couple of layers of middlemen, as you deal with a broker and he in turn deals with a trader on the floor of the market, if it is still a physical stock market.

Buying and selling stocks, or trading as it is called, has become a lot easier in recent years with the Internet, which provides a direct connection between you and your broker. Simply by pressing a few buttons you can send him buying and selling instructions or “orders”.

Technology also means that stock markets do not have to be physical places where people deal face-to-face, they can also be remote virtual places. In fact the NASDAQ, America’s technology stock market, was founded in 1971 with an electronic bulletin board. This started purely as a price information system, with individual dealers buying and selling on the telephone, but direct electronic trading was added in the 1980s.

Share Prices

If you have ever looked at the price charts of shares, then you will have noticed that they are changing price all the time. You can easily find charts online by going to Yahoo Finance or to one of the many other financial websites. Most if not all will allow you to look at basic stock charts without any subscription or with a free registration, and you should take advantage of this to go and get a feel of how prices move.

The reason prices change so frequently is that there are many people buying and selling shares. The laws of supply and demand mean that the prices go up if many people want to buy and not many want to sell, and the prices go down if there are many sellers but few buyers. Of course, people can only buy the number of shares that are being sold, for the most part. This means the price goes up and down until it reaches a level, just for a moment, when the number of shares that people want to buy equals the number of shares that people want to sell at the particular price, and the trades are done. Then you can think of it starting again with the next lot of buyers and sellers. If there are more potential buyers than sellers, then the price might go up a bit until some of the buyers drop out or some more people are tempted to sell. If there are more potential sellers than buyers, then the price will probably drop slightly. It‘s a constantly fluctuating market, changing continuously, but thinking of it in this way makes it a little easier to see what is happening and why the price changes.

In real life, there will be a queue of orders, ready to be fulfilled, but waiting for the right prices. A seller might say, “If only it goes up another penny per stock, then I wouldn’t mind selling my 2000 shares”, and a buyer may say, “I would buy 500 of those if the price came down to…”. It’s a complex job, balancing out the supply and demand, and that’s what the floor trader has to do.

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About the Author

- Robert is a private trader with over 15 years experience trading the financial markets.