Stock Market: A Detailed Overview
Before discussing anything else, let’s see what is a stock market?
The stock market is the hub for investors who connect for buying and selling investments, mostly stocks. Stocks are the shares of ownership in a public sector company.
Stock Market Definition
The term Stock Market is usually related to one of the main stock market indexes like the S&P 500 or the Dow Jones Industrial Average.
Since it is difficult to keep a track of every stock, such indexes include a part of the stock market and the performance is viewed as the representative of the whole market.
You might have come across news headlines mentioning the stock market has closed down or up for the day or it has moved lower. Generally, this implies that the indexes have moved either up or down, that is, the stocks in the index have either lost or gained value entirely.
The investors who purchase and sell stocks expect a turn in the profit with the movement in the prices of the stock.
Working of a Stock Market
The concept behind the working of stock markets is quite simple. It operates almost like an auction house where buyers & sellers can negotiate rates and make stock trades.
This market works from a network of stock exchanges. The companies list the shares on any of these exchanges through the process known as IPO (Initial Public Offering).
The purpose of stock market trading is allowing the company to raise funds for growing its business. The investors can then purchase and sell these shares amongst themselves. The stock exchange will track the demand and supply of all the listed stocks.
The demand and supply of these stocks help to decide each security’s price or the level at which the participants of the stock market (traders and investors) are ready to purchase or sell. These calculations are generally done by computer algorithms.
The buyers make a “bid”, which is the highest amount of money they are willing to invest. This amount is usually less than the amount the sellers “ask” for as an exchange.
The difference in the bid amount and the ask amount is known as the bid-ask spread. For the occurrence of trade, either the sellers will have to decrease their price or the buyers will have to increase theirs.
In the early days, stock trading mostly took place in a physical marketplace. Nowadays, the stock market functions electronically via the internet & the online stockbrokers.
Every trade takes place on a per stock basis; however, the overall prices of the stock usually move simultaneously because of economic reports, political events, news, and many other factors.
Importance of Stock Market
The stock market is amongst the most important financial component of an economy. It lets the companies raise funds by offering corporate bonds or stock shares. It allows common investors to participate in the companies’ financial achievements.
They can make profits via capital gains and earn funds through dividends. However, they may also have to face losses at times.
While professional money managers and institutional investors enjoy certain privileges for their deep pockets, higher abilities to take the risk, and better knowledge, the stock market tries to provide a level playing field for common individuals.
Advantages of Stock Market
The companies sell their stocks because it is a good way of getting a huge amount of financial capital. However, the concerned company should be generating a good amount of income itself for making it worthwhile.
It is expensive to issue an IPO or Initial Public Offering. After the IPO is issued, there is no privacy for the company because the investors check the profits and strategy of the company each quarter. The other methods of getting the finance are private, via private investors or personal loans, or via bonds (the loans that are publically traded).
The benefit of stocks over bonds is that stocks do not need a monthly interest repayment. The people use the stock market because of the returns offered on an average outnumber the returns from other investments, like commodities or bonds. Stock market investment is an amazing way of ensuring your investments perform better than inflation.
How to Invest in the Stock Market?
You can buy individual stocks from a brokerage account or from an individual retirement account. These accounts can be opened at any of the online broker, where you can purchase as well as sell investments. The broker will play the role of a middleman between the stock exchanges and you.
The investments are accompanied by risks. However, if the stocks come with more risks, they have more potential for providing rewards as compared to other securities. While the history of gains in the market shows that an investment portfolio with diversification will rise in value with time, the stocks may also experience dips suddenly.
For building a diversified portfolio without buying multiple individual stocks, you have the option to invest in the exchange-traded fund (ETF) or index fund (a type of mutual funds).
Such funds aim at mirroring the performance of an index passively by holding all the investments or stocks in that index. For instance, you can invest in the S&P 500 and Dow Jones Industrial Average both, along with other indexes in the market through ETFs and index funds.
For a long-term horizon such as retirement, stocks and mutual funds are ideal investments. These are, however, unsuitable for short-term investments, which are funds you may need for the expenses that take place within 5 years.
With a hard deadline and short-term investments, there are high chances that you will need the funds back before the market gets the time for recovering losses.
Stock Market is Not the Entire Economy but has an Impact on It
The stock market has a contribution to the economy of the country. When investors think that the economy is growing, they would want to invest their money in stocks. This is because a strong economy will help in improving their earnings. This situation is known as the bull market.
It generally occurs during the expansion phase of the business cycle. The majority of the commodities also perform well. This is because the businesses that are expanding will have a higher demand for copper, oil, and other natural goods.
When the investors think the economy is stagnant or slow, they would prefer investing in bonds, which are comparatively safer. This is because the bonds provide a fixed return during the term of the loan.
Bonds have a better performance during the phase of contraction in the business cycle. And, when the bonds are doing well, the stocks tend to lose value. This is called the bear market, and it usually lasts for 18 months.
In case there is a threat to the economy globally, the focus of the investors moves towards gold or other safe investment options. This usually happens with a correction in the stock market when the prices of shares reduce by ten percent and above.
This is even clearer in the crash of the stock market when the stocks may lose that much value in one day. A bad crash may even lead to recession. The history of crashes in the stock market shows that this occurs frequently.
The Bottom Line!
The stock market is the collection of exchanges and markets where there are regular activities of selling, buying, and issuing shares of the public companies. These financial activities are conducted via OTC or over the counter marketplaces that operate under a proper set of rules.
This article provides a detailed description of the stock market that will help you to invest in shares even more conveniently. Moreover, this will help you make a more well-informed decision. In this modern tech-savvy world, there are computer-aided stock markets where you can trade electronically no matter where they are.