The Stock Market (In a Nutshell)
A simple explanation of the stock market that will be useful for everyone.
Chain 1 What is the stock market?
The stock market refers to the stock exchanges in which investors buy and sell shares of publicly traded companies. Below are some examples of the stock exchanges which are part of the overall stock market.
Chain 2 How does the stock market work?
As a basis for our understanding, we need to know what a stock is and how it works. A stock represents ownership in a business that is publicly traded. Each piece of stock you buy represents a share of the company you are buying into.
The stock market can operate as a primary market. This is when companies issue and sell their shares to the public for the first time in an initial public offering (IPO). Companies do this to raise capital, which is known as equity financing. For many companies, this is a preferred route to raising capital compared to borrowing money through debt financing. From here, a secondary market emerges. On the stock exchanges, investors sell shares which they own and buy shares owned by other investors. At this point, the company is not part of the buying or selling process.
People buy into the stock market in the hope of earning a return on their investments via capital gains and dividends. Capital gains occur when a stock is sold for more than it was bought for. A dividend is a share of the profit which is paid to the shareholders of a company. The stock market is a go-to for many investors because of its long-term performance, growing by about 10% per year since the 1920s.
In the past, stock markets used physical certificates to represent the buying and selling of shares. Today they operate electronically and are an example of the involvement of fintech (albeit basic) in improving financial services.
In order to function efficiently by ensuring liquidity, price transparency, and fair trading, the stock market is regulated. For example, the Securities and Exchange Commission (SEC) regulates the stock market in the U.S. The SEC has stated its mission as “protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation.”
Chain 3 How are stock prices set?
The stock market is like an auction where buyers and sellers place bids and offers to buy and sell. When a bid and offer coincide, a trade is made.
Stock prices are determined by the principles of supply and demand. If there is increased demand for a stock relative to supply, the sellers can increase the price. The opposite is true as well – if there are more investors selling stock than buying it, the market price will reduce.
There are many factors that influence the stock market causing it to be volatile by nature. Some examples are inflationary pressures, changing interest rates, changing tax rates, political uncertainty, and, as of recent when writing this article, major global events such as Covid-19 and the War in Ukraine.
Investors can buy and sell shares almost immediately during market hours; however, there are not always buyers to match up with sellers of a stock. This is where market makers come in. They buy and hold shares and act as intermediaries between buyers and sellers.
Chain 4 Tracking the stock market
The performance of the market and specific sectors are usually represented by a stock market index which tracks the performances of a specific group of stocks. These indices can be used as a benchmark to compare with individual stocks or a portfolio.
Examples of well-known indices are the S&P 500 index, which tracks the stock performance of the 500 largest companies (mostly by market capitalization) on the US stock exchange; the Nasdaq 100 index, which tracks the performance of the 100 largest US companies on the Nasdaq exchange (aimed originally at new high-growth companies and the place where many tech stocks listed); and the FTSE 100, which tracks the performance of the top 100 companies on the London stock exchange.
Chain 5 How is fintech changing the stock market?
Fintech has made data and calculation from such data much more accessible. Previously, investors would need to contact a third party to learn about the market statistics. Now there are fintech websites which not only analyse the general stock market and the different sectors but also make evidence-based predictions from which they advise investors to buy or sell certain stocks. Furthermore, some fintech companies have the option for investors to receive notifications based on the user’s portfolio. In this way, resources are managed efficiently and profitably.
Increasingly, AI is being used to provide advice for investors which has made the process faster, more personalized, and supposedly better. Bots are also used on the stock market (as well as other markets) to buy and sell quickly depending on certain fluctuations.
Conclusion
The stock market has evolved significantly over the years, from its early beginnings as physical exchanges with paper certificates to today's electronic trading platforms, and has been augmented by the rise of fintech and the development of AI. Despite its evolution, the stock market still holds potential for new investors. The market is constantly fluctuating, presenting opportunities for investors to buy low and sell high. Additionally, the long-term performance of the stock market has been impressive, and even in times of recession or boom, it can be taken advantage of by those who know the lay of the land. For those willing to do their research, the stock market can be a great way to build wealth over time.
References
https://www.experian.com/blogs/ask-experian/how-stock-market-works/
https://www.raisin.co.uk/investments/how-stock-market-works/
https://www.fool.com/investing/stock-market/
https://www.investopedia.com/terms/s/stockmarket.asp
https://www.investopedia.com/articles/investing/082614/how-stock-market-works.asp
https://www.planetcompliance.com/how-fintech-is-changing-the-face-of-the-stock-market/
https://binariks.com/blog/artificial-intelligence-in-fintech/
