What is the ‘Stock Market’?
Also known as the equities market, a stock market is a place where shares of publicly owned companies can be bought and sold. Publicly traded shares can be traded either through centralised exchanges or OTC (over-the-counter).
The stock market is essentially a free economy market where companies can access capital by offering part ownership to interested investors who are basically outsiders. This is beneficial for both investors and the underlying companies.
For investors, the stock market offers a unique opportunity to be part of an established or already running business and to reap any of their resulting rewards without the high risk of investing in a new, unproven business, that has to contend with the associated start-up costs, overheads and other running costs and management.
For the underlying companies, the stock market allows them to access a convenient source of capital to fund their growth or expansion activities. This creates a win-win situation for both parties.
But like any investment activity, there are also risks involved. The amount of risk a trader incurs depends entirely on the price of the stock held.
If the price of a stock increases, a trader will earn profits if they sell their shares. On the other hand, losses will be realised if the stock is sold at a lower price than it was bought at.
The extent of profits or losses realised will depend on the amount of stock that was initially bought, and of course, how much the price of the stock rises or falls.
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How is the Stock Market Broken Down?
There are various segments of the stock market to consider when entering into a purchase or interest in the shares of a particular public company.
The stock market is divided into the primary market and the secondary market.
The primary market is when new securities are created or issued, and they then become available for trading by individuals and institutions.
Here, securities are directly issued by the company that seeks to raise capital to fund its long-term goals and ambitions.
The most common way companies interact in the primary market is through an IPO (Initial Public Offering) where stocks are listed for the first time to trade in the market.
Companies can also engage in the primary market through a Rights Issue (raising money through existing shareholders) or a Preferential Allotment (issuing shares to a few shareholders at a predetermined price).
After the initial offering in the primary market, all subsequent trading of securities takes place in the secondary market between investors, with the underlying company not involved. Trades are facilitated by stock exchanges or by brokers who act as intermediaries.
Also known as trading off-exchange, trading OTC (over-the-counter) is an option for investors to buy and sell stocks in a decentralised market.
Trades are conducted between two parties via a dealer network, with a centralised exchange not involved. Typically, the OTC market is for stocks or stock prices not listed on a stock exchange.
Decentralised is where a transaction of buying or selling will take place between two parties, such as the trader and the broker. There are generally no rigid conditions in an OTC market, with trading being very flexible with as few limitations as possible.
There are many reasons a company would want to list on an exchange. Raising capital is the primary motivation, but companies that get listed attain many more benefits.
Going public gives a company massive publicity that can open up even more business opportunities. A company can gain the attention of diversified pools of investors ranging from institutional investors to foreign investors.
This naturally leads to increased brand equity as well. There is also the prestige of being a company listed on a top stock exchange, as well as the ability to attract top talent by offering sought-after perks, such as stock options.
Process of Stock Market Listing
The process of listing a company differs from exchange to exchange. But it will typically start with filing a registration with a relevant regulatory agency, such as the Securities Exchange Commission (SEC) in the US.
A company will do this if it meets the conditions of the underlying stock exchange they wish to get listed on, such as the NYSE or NASDAQ.
The next step will be to employ an underwriter, which is an investment bank or a major financial services company, to manage the sale of shares.
An underwriter serves as a bridge that connects the underlying company to investors as well as a risk assessor. It is the underwriter that will be responsible for drafting a prospectus, a document that will attempt to entice investors to invest in the underlying company.
Listing on a stock market also comes with some downsides. To start with, the process of stock market listing is costly, time-consuming and labour intensive.
As well, going public literally means that a company becomes public property. There is increased scrutiny and demands for accountability both by the public and the relevant capital markets regulatory agency. For founders and other early investors, there is the risk of undervaluation as well as share dilution.
It is the underwriter(s) that determines the IPO price by taking into account factors such as demand for the stock, growth prospects, the company business model and past industry equivalents.
After a company goes public, the share price is determined by market forces of demand and supply. There are different and varied factors that influence stock prices including fundamental factors, such as revenue and earnings per share; technical factors, such as inflation, industry performance, liquidity and trends; and sentimental factors such as investor speculation activity as well as reaction to political and economic news releases and events.
The Stock Exchange
Also known as the bourse, the stock exchange is a place where securities, such as stocks are bought and sold. It is also a place that provides facilities for issuing and redeeming financial instruments, including income and dividend payments.
The main Stock Exchanges
In most cases, companies will use their local stock exchanges as a platform to go public. Here are some of the major stock exchanges around the world, whose assets are also available for trading at AvaTrade.
|Local Stock Exchange||Region||Public Listing|
|New York Stock Exchange||New York, United States of America|
|NASDAQ||New York, United States of America|
|London Stock Exchange||London, England||
|Borsa Italiana||Milan, Italy||
|Japan Exchange Group||Tokyo, Japan|
|Hong Kong||Central, Hong Kong|
|Frankfurt Exchange||Frankfurt, Hesse, Germany|
|Shanghai stock exchange||Shanghai, China||
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Investing in Stocks
There are two fundamental strategies when investing in stocks: value investing and growth investing. The two strategies complement each other and applying them to individual stocks can help investors maintain a well-balanced portfolio.
This is a strategy that aims to identify stocks that are undervalued in the market. Value investors actively seek companies that they believe are underpriced in the market, with the hope that sooner or later they will be priced accordingly.
These can be stocks of companies priced below similar companies in the same industry or companies whose business models carry less risk in their operating markets. Value stocks are considered a bargain as well as relatively safe for investors over the long run.
Growth investing involves identifying stocks of companies that have performed admirably in the recent past and they are expected to grow faster than other companies. Growth can be in terms of revenue, cash flow, or profit.
It is important to note that this growth is expected, but not guaranteed. Growth stocks have a higher ceiling in terms of price appreciation, but they are naturally riskier and more volatile.
Better known as the P/E Ratio, this ratio is used to value a company by measuring its current share price relative to its earnings per share.
Here is how the price-earnings ratio is calculated:
By taking the stock price of the company and dividing it by is earnings per share (EPS) = market value per share. The P/E ratio is a dollar amount that a trader can expect to invest in a company in order to receive one dollar of that company’s earnings.
Dividend stocks are companies that pay out regular dividends to shareholders. Dividends are a share of profits distributed directly to shareholders.
Companies that pay out dividends regularly to investors are typically more established with proven and sustainable business models. Dividends are usually paid out quarterly, which means that they can be a regular source of income for investors.
Swing trading is a popular style for trading stocks. A swing trader attempts to earn a profit from a price movement that is expected to happen in the short to medium term.
Due to its short-term nature, swing traders typically utilise technical analysis methods to pick out ideal entry and exit price points in the market.
Day trading is a trading style where financial assets, such as stocks, commodities, indices or currencies, are bought and sold within the same day.
The difference between swing trading and day trading is simply the holding period. When day trading, all trade positions are liquidated strictly on the same day. No trade positions are left overnight.
Naturally, day trading carries a higher level of risk and can result in higher trading costs due to the amount of trading activity done within a short period.
Trading Stocks CFDs with AvaTrade
AvaTrade has simplified stock trading for investors. There are numerous stocks drawn from several global exchanges available for trading. When trading stock CFDs with AvaTrade, you are trading contracts for differences, which means that you get the chance to trade the price movement of underlying stocks without necessarily owning them.
AvaTrade offers leveraged trading of up to on stocks and traders can enhance their trading activity by utilising handy trading tools and resources such as the Economic Calendar, Trading Central, AvaProtect™, and AvaSocial.
Additionally, AvaTrade offers multilingual support to ensure that traders have the necessary support and assistance for their trading activities.
Stock Market Main FAQs
What is stock market volatility?
All investing forms come with risks. Volatility is one of the risks of trading stocks. Volatility is characterised by choppy price swings and can particularly be witnessed in individual stocks during news or events such as an earnings release. Volatility can increase the risk of losses but it typically evens out over time. This means that a cure for volatility is to hold stocks over a longer period and to ride both the ups and downs in the market.
Where is the stock market located?
Different markets are located in different places, and in some instances, there is no physical location for the market or index. For example, the NYSE is physically located in New York City at 11 Wall Street, and you can actually go there and see the floor traders. By contrast, the Nasdaq is fully electronic, and while it has its headquarters in New York City, there is no trading floor where you can go to see the open outcry form of trading. Nearly every country in the world has one or more stock markets, and most have physical locations but have been increasingly migrating towards electronic trade.
How are prices set at the stock market?
Most stock markets work through an auction process, with buyers placing bids for the price they are willing to pay for a stock, and sellers setting an ask price for how much they are willing to sell for. When the two prices meet, a trade is conducted, and shares can exchange hands. In the past all of these trades were made on stock market floors or pits, using an open outcry system where the market makers would yell, or cry out the prices at which shares could be bought or sold. That has evolved into an electronic auction system, which is good since stock markets today consist of millions of individuals, all of whom have their own ideas of what a stock is worth.
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