For first timers, investing in the stock market can turn out to be a pretty ugly business. One can easily lose most of their hard earned money after an uninformed decision. But by understanding basic yet crucial concepts about the stock market – how it works and how anyone make or lose money – you’ll more likely to become a more confident investor.
So what exactly is a stock market and how does it work? A stock market or more commonly known as share market is a giant network of organized marketplace (mostly virtual), where buyers and sellers trade stocks or shares. As of 2016, there are 60 major stock exchanges in the world, with an accumulated market capitalization of $69 trillion.
Out of those 60 stock exchanges, 16 have a market capitalization of $1 trillion or more each. If you leave the Australian stock market, all the remaining exchanges are located in North America, Europe and Asia. Furthermore, NYSE is the largest stock market in the world with a market cap. of more than $19 trillion.
What is a Share or Stock?
When a company/firm reaches a certain size, where it needs more capital to fulfill certain financial goals, the firm may choose to go public. In order to do that, the private company needs to perform an initial public offering (IPO). An IPO is simply a type of public offering in which a predefined number of shares of a firm are sold to individual and institutional investors.
An Issued stock of the Chocoladefabrik Lindt & Sprüngli AG in 1930
Now a very common question asked by many people is that who decides the price of a stock, and I am almost sure that you have the same question too, right? While, the entire process of IPO is so big that it deserves a whole new article, but one should know that the process is largely carried out by the investment banks, which are hired by the companies.
To determine a stock’s issue price, the investment banks appoint lead managers, also known as bookrunner, who acts as the main underwriter(s) to assess true value of the company. After the completion of the IPO, the firm gets to keep the capital raised, while its shares continue to actively trade on an exchange.
One important concept about the IPO is that while a company’s share continue to trade openly, the company itself doesn’t receive any capital from the trading. They only receive one time money from the IPO. Moreover, a stock can also be traded outside its domicile country, for example, Nestle, a Swiss company is also traded in the United States.
So when you purchase a company’s share from the share market, you are buying a part of the company.
Why Stock Prices fall and Rise?
Market Crash During the Dot Com Bubble
Stock investors can gain or lose money depending on the perceived value of the company. It simply works on the concept of supply and demand, if more people want to buy stocks of a particular company than sell it, there would be greater demand than supply and as a result the prices would rise.
But why do investors prefer certain stocks over others? Well, predicting stock prices is almost impossible. However, there are several factors that an individual investor considers before buying or selling a certain stock. For an example, if Walmart Inc, is able to increase its profits with a new business model, showing a tremendous growth trend, more investors are likely to invest in the company causing its share price to increase.
However, if a company is performing poorly and building up a poor reputation its share are more likely to see a dip as investors divest or sell back its shares. There are actually a dozen of investment techniques used by investors to buy and sell shares with an ultimate goal to make money from companies you expect to do well in future.
There is another aspect of share market and stock, known as dividends. Although it’s not necessary, many public companies – both medium and big size – pay dividends to their shareholders. The payout rates, and various time frames during which dividends can be issued are generally decided by the company’s board of directors.
Furthermore, dividends can be distributed either in the form of direct cash or, if the firm has a dividend reinvestment plan (DRIP), more shares can be allotted to investors in lieu of cash.
Why It is Important?
A fully functional stock market is vital for the existence of capitalism itself. It is perhaps one the most important ways for a company to raise capital for achieving different financial goals and perform expansions. Compared to other types of holdings, stock market investments are more attractive due to its liquidity (availability of cash).