The Basics of the Stock Exchange: Investing in the stock market can seem intimidating to novice traders. However, this asset class is not as scary as it may seem and may be a viable alternative, say, to Forex trading.
Let’s take a look at the essential facts about how the stock market operates.
1) What is a Security?
A security, also called a stock, is a part of a company. When an investor buys a share of a company, he is buying a small portion of ownership of the business. Companies raise capital for business needs by issuing shares to the public.
To raise investment capital, a company executes an Initial Public Offering (IPO) – this is done on a stock exchange. An IPO is when a company decides to sell shares of the business in exchange for investment from public investors – the company is listed on the public market through the stock exchange.
The company uses the capital raised to grow the business, and the company’s shares continue to trade on the stock exchange after this time between buyers and sellers of the public. Shares traded on the IPO are called the «primary» market and shares traded after the IPO between external buyers and sellers are called the «secondary» market.
3) Stock Exchange
Shares are bought and sold on a stock market – such as the New York Stock Exchange. In case the IPO, the stock exchange acts as an intermediary between the company issuing the shares and the public. In all other cases, the exchange acts as an intermediary between buyers and sellers of shares.
After an IPO, traders and investors continue to buy and sell the company’s shares on the stock exchange, however, the company no longer receives anything from these transactions.
The stock market used to be a physical place where investors would gather to buy and sell shares, implemented through trading plants around the world, in New York, London and Tokyo, for example. Share purchase prices were traded between real people in an open, live auction.
Today, most trading is done electronically. Buy and sell orders are placed through brokers, who interact with the stock exchange and execute orders for investors. Most trading orders are processed through electronic systems and algorithms that determine the sequence in which orders are executed.
5) Ticker Symbols
Shares are quoted on the market by what are known as «slate symbols», also called «tickers». They are short format codes or names that make the search and communication about each individual stock coherent, convenient and accessible.
For example, the symbol «MSFT» refers to Microsoft’s actions. This system avoids ambiguities – when you see a price listed as MSFT or a news article about MSFT shares, you can be sure that both refer to the same asset – Microsoft shares.
Market participants follow well-known stock market indices as an indication of overall stock market performance. Three of the most closely followed are the Dow Jones Industrial Average (called Dow), the S&P 500 and the Nasdaq Composite.
The Dow is a stock index that follows the top 30 U.S. companies, while the S&P 500 follows the top 500 U.S. companies by market capitalization and the Nasdaq Composite measures companies listed on the Nasdaq stock exchange – and is therefore strongly influenced by high-growth and high-tech companies.
7) Securities Market Volumes
The daily volume is the number of shares traded on each trading day. Stocks that have a high daily volume are preferable for investors because this creates liquidity and means that traders can buy and sell shares more easily.
When the volume is low, investors may not be able to buy and sell shares at the time and size that seems most fortuitous to them.
Trading volumes have grown rapidly every decade thanks to the boom in technological infrastructure and wealth.
8) Where to Buy?
The main reason to buy shares as an investor is if you believe that the value of the shares will rise over time. In the long run, stock market investments have shown a faster growth rate in all asset classes – but this is a general long-term trend rather than a certainty in each individual investment case. Many investors buy a basket of shares to benefit from diversification and capture this overall growth trend. Many investors buy a lot of shares par