What is Stock Market? How Does the Stock Market Work?
Stock market refers to the collective of all stocks that are traded on a particular exchange. it can be either an open or closed system, depending upon whether there is any restriction in trading and buying/selling shares. If you want to buy some shares then you need to go through brokers who will help you with your transaction. They charge commission for their services which is usually around 1-2% per trade. This means that when you sell 100 shares at $10 each, you have to pay $200 as the brokerage fee. So basically what happens here is that the broker makes money out of every transaction he does.
What is a share?
A share represents ownership rights over a company's assets. It entitles its holder to receive dividends from the company and also gives him voting power over certain decisions taken by the board of directors.
The main reason why people invest in securities is that they believe that the price of these securities will increase in the future. This belief is called "the expectation theory".
There are two types of investors:
Active-Investors: They actively participate in the markets by investing in various instruments like equities, bonds, etc.
Passive Investors: These investors do not take part in active investment but rather sit back and watch how things
Why do we call them 'stocks'?
Stocks were originally used to refer to pieces of paper that represented ownership of land. Later on, companies started issuing shares instead of owning real estate. So now we use 'stocks' to represent ownership of shares in a company.
What are options: Options give us the right to purchase or sell a security at a fixed price within a specified period. For example, say XYZ Company has issued 1000 shares of $10 each. Now suppose someone wants to buy 500 shares at $9.50. He would place an option contract on those shares. In return, he pays a premium of 50 cents. When the option expires, he gets his choice of either selling the shares at $9.5 or keeping them until the expiration date. At expiry, he could exercise his option and buy the shares at $9, or let the option expire without exercising it.
Functions of a stock market
Stock market functions include:
1) Stock exchanges provide a platform where buyers and sellers meet and negotiate prices
2) Brokers act as intermediaries between buyer and seller.
3) Central banks maintain monetary stability.
4) Banks lend funds to individuals and businesses.
5) Companies issue equity.
6) Governments regulate financial institutions.
7) Pension Funds manage pension liabilities.
8) Mutual fund managers collect investments from individual savers.
Participants in a stock market
We have different participants in a stock market and they include:
Stockbrokers: Also known as Wall Street traders are professionals who deal in stocks. Their job is to find new opportunities for clients to make profits.
Portfolio managers: These are professionals who help their customers build portfolios that consist of several asset classes such as stocks, bonds, commodities, etc. Portfolios can be built based on risk appetite, tax considerations, liquidity needs, etc.
Investment bankers: They act as representatives of large corporations looking to raise capital through initial public offerings. Investment bankers work with corporate boards to prepare IPO documents and arrange meetings with institutional investors.
Custodian or depot service providers: These firms store securities for other parties. Custody services may involve the storage of foreign exchange reserves, government securities, and mutual funds, to prevent loss through theft.
Market maker: This is a broker-dealer firm that bids up the price of a particular security by buying when its price falls below what it thinks will happen after all trades settle. This helps ensure fair pricing. Market makers often charge fees for providing this service.
How do Stock Exchanges Make Money?
Stock exchange operates like any business; it makes money by charging transaction costs, brokerage commissions, and interest payments. The more transactions there are, the higher the fee charged per trade. A typical commission rate is 1% of the value traded.
The most important function of a stock exchange is to facilitate trading among investors. It provides a neutral venue where people can come together to transact. In addition to facilitating trades, an exchange must keep track of ownership rights so that no one person owns too many shares. An exchange charges a small percentage of each share sold. These fees cover operating expenses and pay brokers' salaries.
The second major source of income comes from paying interest on deposits made by investors. Deposits are usually held overnight before being released into circulation. Interest rates vary depending on the type of deposit. For example, short-term loans earn much lower returns than long-term ones.
How Share Prices Are Set
The price of shares depends on supply and demand. When buyers want to buy shares at a certain price, sellers offer them at that price. If enough buyers show up, then prices rise. Conversely, if fewer buyers appear, then prices fall.
When companies go bankrupt, shareholders get paid first. They receive cash dividends, followed by preferred shares called "preference shares" because they rank ahead of common shares in terms of payment. Preferred shares give holders a fixed return over time. Preference shares also have voting power. Common shares do not have voting power but they still receive regular dividend payments.
When a company goes bust, creditors take priority over shareholders. Creditors get repaid first, followed by preference shares, then common shares.
Benefits of Stock Market
Investors who invest in stocks benefit from two main advantages. First, stocks provide diversification benefits. Stocks represent different types of businesses such as manufacturing, retail stores, technology, etc., which means you don't need to put your entire portfolio into just one sector. Second, stocks allow you to participate in growth industries. As new technologies emerge, some sectors grow faster than others. By investing in these fast-growing sectors, you help yourself avoid getting left behind.
Stocks also protect against inflation. Because stocks fluctuate with changes in their underlying values, they tend to be less volatile than other investments such as bonds or real estate. Therefore, stocks make good investment choices during periods of high inflation.
Stock markets enable individuals to save for retirement. Many countries require workers to contribute part of their wages toward pensions. This money is invested in government securities like treasury bills and bonds. However, it's difficult to predict how well this strategy will work when there is uncertainty about future economic conditions.
The stock market offers another way to build savings. You can use your paycheck to purchase shares instead of putting all your money into a single bond fund. Then, after several years, you sell those shares and reinvest the proceeds back into more shares. Over time, you'll accumulate an amount equal to what you would've earned had you saved only through traditional methods.
Stock Market Crash: What Happens?
A crash occurs when share prices drop so low that no buyer wants to pay any higher price. In response, many people stop buying shares until prices recover. A crash may last anywhere between days to months. During a crash, most traders lose money. Some even end up losing everything. But crashes aren't always bad news. Sometimes, investors are able to buy at bargain-basement prices and profit on subsequent rises in value.
Disadvantages of Stock Market
The biggest disadvantage of owning stocks is risk. If something happens to affect the economy negatively, companies could go bankrupt and fail. When this happens, everyone loses out. Investors might lose their jobs, homes, cars, and life savings. Stock ownership requires constant vigilance. It's important to keep track of current events affecting your industry and stay informed about potential risks.
Another major drawback is liquidity. Unlike mutual funds, individual stocks often trade infrequently. For example, if you own Apple Inc, you won't find much trading activity around its shares unless someone else owns them first. That makes it hard to liquidate positions quickly without paying steep fees. Also, because stocks have limited shelf lives, you must decide whether to hold onto them long-term or cash them out immediately.
How do I invest my money? How does the stock market work? Why should I care about the stock market? Where can I get information about the stock market? These questions and more are answered here!