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Stock Market Explained

The stock market is very much driven by sentiment, greed and fear.  If many investors are buying a company’s shares then the price will rise. Mr Market sees this as confidence in that company and thus the price rises. Conversely if many investors are selling a company’s shares then the price will fall as Mr Market sees this as a lack of confidence. The market also moves in sectors, i.e. if Morrisons (grocery stores) has an event and falls, then the share price of it’s competitors such as Tesco or Waitrose will also most likely fall, even if they don’t experience the same event. Investor sentiment is very, very important.

The UK and USA stock exchange opening hours are as follows :

London Stock Exchange ( LSE ) – Trading Hours: Monday – Friday, 8:00 am – 4:30 pm ( GMT – UK )

New York Stock Exchange ( NYSE ) – Trading Hours: Monday – Friday, 9:30 am to 4:00 pm ( EST – US time )

New York Stock Exchange ( NYSE ) – Trading Hours: Monday – Friday, 2:30 pm to 9:00 pm ( GMT – UK time )

This is a brief explanation of the stock market.

The stock market is a place where companies go to raise money to expand and grow their businesses. The private company will go though an Initial Public Offering (IPO) where the general public and institutional investors can purchase shares. After the IPO the company is listed on the stock exchange and shares can be traded while the market is open.

Many stock exchanges include indexes. An index is a list of specific companies i.e. the London Stock Exchange (LSE) has the FTSE 100 which includes 100 of the largest companies in the UK; the New York Stock Exchange (NYSE) has the Dow Jones Industrial Average (DJIA) which includes 30 of the major companies in the USA. i.e. Apple, Coca-Cola, IBM and others.

An Index Tracker Fund tracks all the companies within the specific index.

Below are the 15 top stock exchanges sorted by value traded per day ( some include the exchanges as examples ).

The New York Stock Exchange (NYSE) – United States (1,816 US companies and 524 foreign companies = total of 2,340 companies)

DOW Jones Industrial Average (DJIA)

S&P 500

NASDAQ – (National Association of Securities Dealer Automated Quotation System) – United States – (2,322 US companies and 288 foreign companies = total of 2,610 companies)

The London Stock Exchange (LSE) – United Kingdom – (2,962 companies)

Indexes within the London Stock Exchange (companies are grouped together into an index)

FTSE 100 Index
FTSE 250 Index
FTSE 350 Index
FTSE Aim All Share
FTSE AIM 100
FTSE AIM UK 50
FTSE Small Cap
FTSE Techmark All Share
FTSE All-Share Index

Other Stock Exchanges around the world :

Tokyo Stock Exchange – Japan
Euronext – Amsterdam, Brussels, London, Lisbon, Paris, ( this is a European Stock Exchange )
Frankfurt Stock Exchange – Germany
Shanghai Stock Exchange – China
BME Spanish Exchanges – Spain
Italian Stock Exchange – Italy
Hong Kong Stock Exchange – Hong Kong
Shenzhen Stock Exchange – China
Korean Exchange – Korea
Swiss Exchange ( SWX ) – Switzerland
Nordic Exchanges ( OMX ) – Denmark, Finland, Sweden
Toronto Stock Exchange – Canada

If the thought of investing in the stock market scares you, you aren’t alone. False promises and highly public stories of investors striking it rich or losing everything skew perceptions of the reality of the average investor. By understanding a little more about the stock market – and how the stock market works – you’ll likely find it isn’t as scary as you may think and that it’s a viable investment.

What Is a stock or share?

When you buy a stock, you’re buying a piece of the company. When a company needs to raise money, it issues shares. This is done through an initial public offering (IPO), in which the price of shares is set based on how much the company is estimated to be worth, and how many shares are being issued. The company gets to keep the money raised to grow its business, while the shares (also called stocks) continue to trade on an exchange, such as the New York Stock Exchange (NYSE).

Traders and investors continue to buy and sell the stock of the company on the exchange, although the company itself no longer receives any money from this type of trading. The company only receives money from the IPO.

Why buy shares?

Traders and investors continue to trade a company’s stock after the IPO because the perceived value of the company changes over time. Investors can make or lose money depending on whether their perceptions are in agreement with “the market.” The market is the vast array of investors and traders who buy and sell the stock, pushing the price up or down.

Trying to predict which stock will rise or fall, and when, is very difficult. Over time stocks as a whole tend to rise, which is why many investors choose to buy a basket of stocks in various sectors (this is called diversification) and hold them for the long-term. Investors who use this approach do not concern themselves with frequent fluctuations in stock prices. The ultimate goal of buying shares is to make money by buying stocks in companies you expect to do well, in other words those where perceived value (in the form of the share price) will rise.

Mature and established companies may also pay a dividend to shareholders. A dividend is a cut of the company’s profit, which the company sends to shareholders as long as the company continues to pay the dividend. Aside from the dividend, the share price will continue to fluctuate. The losses and gains associated with the share price are independent of the dividend. Dividends can be large or small – or non-existent (many stocks don’t pay them). Investors seeking regular income from their stock market investments tend to favour buying stocks that pay high dividends.

When you buy shares of a company, you own a piece of that business and therefore have a vote in how it is run. While there are different classes of shares (a company can issue shares more than once), owning shares typically gives you voting rights equal to the number of shares you own. Shareholders as a whole, based on their individual votes, select a board of directors and can vote on major decisions the company is making.

Why sell shares?

For every stock transaction, there must be a buyer and a seller. When you buy 100 shares of stock someone else must sell it to you. Either buyers or sellers can be more aggressive than the other, pushing the price up or down.

When the price of a stock goes down, sellers are more aggressive because they are willing to sell at a lower and lower price. The buyers are also timid and only willing to buy at lower and lower prices. The price will continue to fall until the price reaches a point where buyers step in and become more aggressive and willing to buy at higher prices, pushing the price back up. Think of it as an auction – the price will keep going up if people want the item or shares. If nobody wants to bid for the item or shares then the price will keep falling until someone offers to buy the item or shares. If nobody wants to bid for the item or shares then the price can go to zero!

Investors are not all working to the same agenda, which leads traders to sell stocks at different times. One investor may hold stock that has grown significantly in price and sells to lock in that profit and extract the cash. Another trader may have bought at a higher price than the stock is not selling for, putting the trader in a losing position. That trader may sell to keep the loss from getting bigger. Investors and traders may also sell because, based on their research they believe a stock is going to go down, and want to take their money out before it does.

Volume

How many shares change hands in a day is called volume. Many stocks on major exchanges, such as the NYSE or NASDAQ, have millions of shares issued. That means potentially thousands of investors in a stock may decide to buy or sell on any particular day. A stock that has lots of daily volume is attractive to investors because the volume means they can easily buy or sell their shares whenever they please.

When volume is inadequate, or no one is actively trading a stock, it’s still usually possible to dispose of a small number of shares because the exchanges mandate certain traders (firms) to provide volume. These traders are commonly referred to as market makers and act as buyers and sellers of last resort when there are no buyers or sellers. They don’t have to stop a stock from rising or falling, which is why most traders and investors still choose to trade stocks with lots of volume, and thus not rely on these market makers, which are now mostly electronic and automated. There are still people on the floor of the NYSE. Those men and women in the blue jackets trade stocks for their firms and also help facilitate orders from the public.

The bottom line

Stocks are issued by companies to raise cash, and the stock then continues to trade on an exchange. Overall stocks have risen over the long-term, which makes owning shares attractive. There are also additional perks such as dividends (income), profit potential and voting rights. Share prices also fall, however, which is why investors typically choose to invest in a wide array of stocks, only risking a small percentage of their capital on each one. Shares can be bought or sold at any time, assuming there is enough volume available to complete the transaction, which means investors can cut their losses or take profits whenever they wish.

The 11 broad GICS sectors commonly used for sector breakdown reporting include the following:
  • Energy.
  • Materials.
  • Industrials.
  • Consumer Discretionary.
  • Consumer Staples.
  • Health Care.
  • Financials.
  • Information Technology.

Definitions :

Bull market –  Generally takes place when the economy is strengthening or when it is already strong. It happens in line with a strong gross domestic product GDP, and a drop in unemployment and will often coincide with a rise in corporate profits. Investor confidence will also be on the rise. The overall demand for stocks will be positive, along with the overall tone of the market. In addition, there will be a general increase in the amount of IPO activity during bull markets, also a rise in the stock market of 20% over 3 months indicates a bull market.

Bear Market – One indicator of a bear market is when 80% of stocks are down for an extended period ( 3 months ), another indicator of a bear market is when stocks fall 20% from their recent highs.

Activist Investor –  An individual or group that purchases large numbers of a public company’s shares and/or tries to obtain seats on the company’s board with the goal of effecting a major change in the company. A company can become a target for activist investors if it is mismanaged, has excessive costs.

Ask Price – Represents the price a seller is willing to accept for a stock / share, which is often referred to as the offer price. Along with the price, the ask quote might also stipulate the amount of the stock / share available to be sold at the stated price. The bid is the price a buyer is willing to pay for a stock / share, and the ask price will always be higher than the bid price.

Bid Price – Represents the maximum price that a buyer or buyers are willing to pay for a stock / share.

Day Trader – An individual who attempts to profit by making rapid trades intraday. A day trader often closes out all trades before the market close and does not hold any open positions overnight. Some day traders use leverage to magnify the returns generated from small stock price movements.

Institutional Investor – An institutional investor is a nonbank person or organization trading stock / shares in quantities large enough to qualify for preferential treatment.

Investor ( General public ) – Any person who commits capital with the expectation of financial returns. Investors utilize investments in order to grow their money and/or provide an income during retirement, such as with an annuity. A wide variety of investment vehicles exist including (but not limited to) stocks, bonds, commodities.

Leverage – Results from using borrowed capital as a funding source when investing to expand the firm’s asset base and generate returns on risk capital. Leverage is an investment strategy of using borrowed money — specifically, the use of various financial instruments or borrowed capital — to increase the potential return of an investment.

Margin – Buying on margin is borrowing money from a broker to purchase stock. You can think of it as a loan from your brokerage.

Offer Price – Represents the minimum price that a seller or sellers are willing to receive for the stock / share. A trade or transaction occurs when the buyer and seller agree on a price for the stock / share.

Retail Investor – Represents a nonprofessional investor who buy and sell securities, mutual funds or ETFs through a brokerage firm or savings account.

Trader – A trader is an individual who engages in the transfer of financial assets in any financial market, either for themselves, or on behalf of a someone else.

Sophisticated Investor – A type of investor who is deemed to have sufficient investing experience and knowledge to weigh the risks and merits of an investment opportunity. For certain purposes, net worth and income restrictions must be met before a person can be classified a sophisticated investor.

Spread – The difference between the bid and the ask price of a stock / share or asset.

Spot Price – The spot price is the current price in the marketplace of the stock or asset, this is the price the buyer would have to pay per share.