. WHAT IS A STOCK MARKET? & How the Stock Market Works


11 Mar 2021


The stock exchange refers to the gathering of markets and exchanges where regular activities of shopping for , selling, and issuance of shares of publicly-held companies happen . Such financial activities are conducted through institutionalized formal exchanges or over-the-counter (OTC) marketplaces which operate under an outlined set of regulations. There are often multiple stock trading venues during a country or a neighborhood which permit transactions in stocks and other sorts of securities.

Though it’s called a stock exchange or equity market and is primarily known for trading stocks/equities, other financial securities – like exchange traded funds (ETF), corporate bonds and derivatives based on stocks, commodities, currencies, and bonds – also are traded within the stock markets.

Understanding the Stock Market

While today it’s possible to get almost everything online, there’s usually a delegated marketplace for every commodity. For instance, people drive to city outskirts and farmlands to get Christmas trees, visit the local timber market to shop for wood and other necessary material for home furniture and renovations, and attend stores like Walmart for his or her regular grocery supplies.

Such dedicated markets function a platform where numerous buyers and sellers meet, interact and transact. Since the amount of market participants is large , one is assured of a good price. For example, if there’s just one seller of Christmas trees within the entire city, he will have the freedom to charge any price he pleases because the buyers won’t have anywhere else to go. If the amount of tree sellers is large during a common marketplace, they’re going to need to compete against one another to draw in buyers. The buyers are going to be spoiled for choice with low- or optimum-pricing making it a good market with price transparency. Even while shopping online, buyers compare prices offered by different sellers on an equivalent shopping portal or across different portals to urge the simplest deals, forcing the varied online sellers to offer the best price.

A stock market is a similar designated market for trading various kinds of securities in a controlled, secure and managed environment. Since the stock exchange brings together many thousands of market participants who wish to shop for and sell shares, it ensures fair pricing practices and transparency in transactions. While earlier stock markets wont to issue and deal in paper-based physical share certificates, the fashionable day computer-aided stock markets operate electronically.

How the Stock Market Works

In a nutshell, stock markets provide a secure and controlled environment where market participants can transact in shares and other eligible financial instruments confidently with zero- to low-operational risk. Operating under the defined rules as stated by the regulator, the stock markets act as primary markets and as secondary markets.

As a primary market, the stock exchange allows companies to issue and sell their shares to the common public for the primary time through the method of initial public offerings (IPO). This activity helps companies raise necessary capital from investors. It essentially means a corporation divides itself into variety of shares (say, 20 million shares) and sells a neighborhood of these shares (say, 5 million shares) to common public at a price (say, $10 per share).

To facilitate this process, a company needs a marketplace where these shares can be sold. This marketplace is provided by the stock market. If everything goes as per the plans, the corporate will successfully sell the 5 million shares at a price of $10 per share and collect $50 million worth of funds. Investors will get the corporate shares which they will expect to carry for his or her preferred duration, in anticipation of rising in share price and any potential income within the form of dividend payments. The stock market acts as a facilitatorFollowing the first-time share issuance IPO exercise called the listing process, the stock market also is the trading platform that facilitates regular buying and selling of the listed shares. This constitutes the secondary market. The stock market earns a fee for each trade that happens on its platform during the secondary market activity.

The stock market shoulders the responsibility of ensuring price transparency, liquidity, price discovery and fair dealings in such trading activities. As most major stock markets across the world now operate electronically, the exchange maintains trading systems that efficiently manage the buy and sell orders from various market participants. They perform the worth matching function to facilitate trade execution at a price fair to both buyers and sellers.

A listed company can also offer new, additional shares through other offerings at a later stage, like through rights offering or through follow-on offers. they’ll even buyback or delist their shares. The stock market facilitates such transactions.

The stock market often creates and maintains various market-level and sector-specific indicators, just like the S&P 500 index or Nasdaq 100 index, which give a measure to trace the movement of the general market. Other methods include the Stochastic Oscillator and Stochastic Momentum Index.

The stock exchanges also maintain all company news, announcements, and financial reporting, which may be usually accessed on their official websites. A stock market also supports various other corporate-level, transaction-related activities. as an example , profitable companies may reward investors by paying dividends which usually comes from a neighborhood of the company’s earnings. The exchange maintains all such information and should support its processing to a particular extent.

Functions of a stock exchange

A stock exchange primarily serves the subsequent functions:

Fair Dealing in Securities Transactions: counting on the quality rules of demand and provide , the stock market must make sure that all interested market participants have instant access to data for all buy and sell orders thereby helping within the fair and transparent pricing of securities. Additionally, it should also perform efficient matching of appropriate buy and sell orders.

For example, there could also be three buyers who have placed orders for purchasing Microsoft shares at $100, $105 and $110, and there could also be four sellers who are willing to sell Microsoft shares at $110, $112, $115 and $120. The exchange (through their computer operated automated trading systems) must make sure that the simplest buy and best sell are matched, which during this case is at $110 for the given quantity of trade.

Efficient Price Discovery: Stock markets got to support an efficient mechanism for price discovery, which refers to the act of deciding the right price of a security and is typically performed by assessing market supply and demand and other factors related to the transactions.

Say, a U.S.-based software company is trading at a price of $100 and features a market capitalisation of $5 billion. A item comes therein the EU regulator has imposed a fine of $2 billion on the corporate which essentially means 40 percent of the company’s value could also be exhausted . While the stock exchange may have imposed a trading price range of $90 and $110 on the company’s share price, it should efficiently change the permissible trading price limit to accommodate for the possible changes within the share price, else shareholders may struggle to trade at a good price.

Liquidity Maintenance: While getting the amount of buyers and sellers for a specific financial security are out of control for the stock exchange , it must make sure that whosoever is qualified and willing to trade gets instant access to put orders which should get executed at the fair price.

Security and Validity of Transactions: While more participants are important for efficient working of a market, an equivalent market must make sure that all participants are verified and remain compliant with the required rules and regulations, leaving no room for default by any of the parties. Additionally, it should make sure that all associated entities operating within the market must also adhere to the principles , and work within the legal framework given by the regulator.Support All Eligible sorts of Participants: A marketplace is formed by a spread of participants, which include market makers, investors, traders, speculators, and hedgers. of these participants operate within the stock exchange with different roles and functions. as an example , an investor may buy stocks and hold them for future spanning a few years , while a trader may enter and exit an edge within seconds. A market maker provides necessary liquidity within the market, while a hedger may wish to trade derivatives for mitigating the danger involved in investments. The stock exchange should make sure that all such participants are ready to operate seamlessly fulfilling their desired roles to make sure the market continues to work efficiently.

Investor Protection: along side wealthy and institutional investors, a really sizable amount of small investors also are served by the stock exchange for his or her bit of investments. These investors may have limited financial knowledge, and should not be fully conscious of the pitfalls of investing in stocks and other listed instruments. The stock market must implement necessary measures to supply the required protection to such investors to shield them from loss and ensure customer trust.

For instance, a stock market may categorize stocks in various segments counting on their risk profiles and permit limited or no trading by common investors in high-risk stocks. Exchanges often impose restrictions to stop individuals with limited income and knowledge from stepping into risky bets of derivatives.

Balanced Regulation: Listed companies are largely regulated and their dealings are monitored by market regulators, just like the Securities and Exchange Commission (SEC) of the U.S. Additionally, exchanges also mandate certain requirements – like, timely filing of quarterly financial reports and instant reporting of any relevant developments – to make sure all market participants become conscious of corporate happenings. Failure to stick to the regulations can cause suspension of trading by the exchanges and other disciplinary measures.

Regulating the stock exchange

A local financial regulator or competent monetary authority or institute is assigned the task of regulating the stock exchange of a rustic. The Securities and Exchange Commission (SEC) is that the regulatory body charged with overseeing the U.S. stock markets. The SEC may be an agency that works independently of the govt and political pressure. The mission of the SEC is stated as: “to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.”