Whether you’re new to investing or looking for ways to raise capital for your business, an understanding of the stock market can help. The stock market definition encompasses all the exchanges worldwide where shares are bought and sold. How does the stock market work, and what are its benefits for investors and businesses? We’ll answer these questions below.
What is the stock market?
The stock market definition refers to the global equity market. It includes numerous markets and exchanges, with some of the biggest being the London Stock Exchange (LSE) and New York Stock Exchange (NYSE). Each exchange works as a platform where investors can buy and sell shares in publicly held companies, usually through third-party brokers. Individual exchanges carry their own regulations to follow, some more formal than others.
The role of stock market exchanges is to buy, sell, and issue shares. However, investors can also buy and sell additional types of financial securities, such as derivatives, exchange traded funds, and corporate bonds.
How does the stock market work?
Stock markets offer companies a secure environment to sell shares to investors. The company must go through the initial public offering (IPO) process first, which makes its shares available. Shares go through two stages:
Primary market – When a newly listed company first offers shares, it lists them in the primary market with an opening price. The primary market is only open to institutional investors who buy millions of shares in bulk.
Secondary market – After its initial baseline listing on the primary market, the company’s shares are now available to individual investors who can buy and sell using broker services.
Once shares make it to the secondary market, price will fluctuate according to the usual laws of supply and demand. This means that demand rises when buyers outnumber sellers, and the price of the stock will rise accordingly. On the other hand, price per share falls when demand falls due to an increase in supply, with sellers outnumbering buyers.
The stock market essentially works as a trading platform, with exchanges taking a small fee for each trade that takes place through the secondary market. In return, it ensures security and transparent pricing to investors. The London stock market and others operate electronically for a smooth, automated process.
Functions of the UK stock market
A stock exchange’s primary roles include:
Offering transparent pricing for all market participants
Ensuring transaction security
Providing support to investors, traders, and hedgers
Regulating trades and reporting
Each exchange puts rules in place to facilitate smooth, secure transactions, serving the interest of all market participants.
How investors make money
If you’re interested in purchasing shares over the London stock market, how would you make money? There are two primary ways that investors see returns:
Rise in share prices: Investors purchase shares at a certain price based on a company’s perceived value. As the company’s value rises, the shares grow in value accordingly. This means that investors can sell them at a profit and make money.
Dividends: The second way to make money through the UK stock market is by receiving dividends. A company distributes a portion of its profits to shareholders throughout the year. Those owning more stake in the company will receive more income.
Investors can also make money without purchasing individual shares. Stock indices are a different type of market that tracks stock performance. Examples include the FTSE 100 and Dow Jones, which track the performance of a country’s biggest companies. You won’t be able to trade indices using an exchange. Instead, you’ll need to invest in securities like ETFs.
How stock exchanges make money
We’ve covered how investors make their money but what about the exchanges themselves? Stock exchanges operate like any other for-profit business, charging fees for the services they provide. Revenue is primarily made up of transaction fees for each trade and listing fees when a company goes public.
Another source of revenue is market data. Stock exchanges generate a massive volume of user data over their platforms, including historic share prices, real-time trading volumes, and summary data. Financial analysts and institutions purchase market data directly from the exchanges.
There are numerous benefits to understanding how the stock market works, both for investors and companies. For first-time investors, brokers can help you sail through the trading process.
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