About the Stock Market

Posted:Abigail Andrews – Saturday, May 26th, 2007

The stock market appears in the news every day. Unless you never watch the news you will be aware that it is of great importance to the worlds economy, but you may find that you know very little about it. What is a stock market? What are stocks and shares? Why do we need a stock market? Where does the stock come from to begin with, and why do people want to buy and sell it? To find out continue reading these sections, it may give you some ideas for making money, at the very least it will increase your financial awareness.

What is the Stockmarket?

When people talk about the Stock Market, it's not always immediately clear what they're referring to. Is the Stock Market a place? Or is it something different? To many people it is an abstract idea. They buy stocks in "the stock market" without ever leaving the comfort of their computer terminal. In fact the stock market is simply the process by which company shares are bought and sold by buyers and sellers. The place or mechanism through which they are bought and sold is called an exchange. The stock exchange is indeed a physical place with buildings and addresses, a place you can go visit.

London Stock Exchange is the Place

A stock exchange is an organisation that provides a marketplace in which to trade stocks. It also sets rules and regulations to ensure that the stock market operates both efficiently and fairly for all parties involved.

The British Stock market is run and regulated by the London Stock Exchange which is one of the worlds oldest stock exchanges and can trace its history back more than 300 years. Starting life in the coffee houses of 17th century London, the Exchange quickly grew to become the City's most important financial institution. Your images of the London Stock exchange are probably of men running around, shouting, pushing and waving paper in the air! However, trading is done electronically these days so the atmosphere is not quite as it was. Over the centuries, the Exchange has consistently led the way in developing a strong, well-regulated stock market and today lies at the heart of the global financial community.

There can be more than one exchange in any of the worlds stock markets. For example, the UK operates the FTSE (Financial Times Stock Exchange). The UK also operates the AIM (Alternative Investment Market ) which was set up to allow developing companies get access to investment funding without having to pay so much for a full listing on the Exchange. There is also the Ofex (Off exchange) market, which is an unregulated market and for very small companies.

Currently there are over 900 companies listed on the London Stock Exchange, but only 100 (the biggest) account for about 90% of the entire stock market's value - otherwise known as the FTSE 100 (pronounced footsie). You may have also heard of the FTSE 250, which is obviously the top 250 companies. The FTSE 100 index measures the daily performance of the top 100 companies and is an indicator of the strength of the stock market.

How does the Stockmarket Work?

I am not going to go in depth about how a company is valued and exactly how the stock market works in this article as it is simply far too complicated, I will however try to provide a VERY simple explanation.

If you started a business today spending £400,000 buying the building and the equipment, these are classed as Assets. A simplistic view is to say that the business is "worth" £400,000. Remember we are keeping it simple, the building probably went up in value, and the equipment went down because it is now used, but for simplicity let's say things balanced out. This is basically the Asset value of the business. The value of all of the business's Assets if you sold them today.

Ok, but what about the value of the customers and the businesses reputation and also the value of how much profits it makes a year? How is that valued? Well that all depends how much the business makes and how much an investor is willing to pay for it. For example, say the business makes 50K profit a year, looking at it that way, someone might be willing to pay £600k for the business, it all depends on what percentage rate of return the investor is willing to accept. Someone might even be willing to pay a heck of a lot more for the business if he or she thought that the business's income would grow and increase earnings over time at a rate faster than the rate of inflation.

So in simplistic terms the value of the business is set by the owner according to the Assets plus the estimated value of the business based on the profits it makes. This valuation is then justified by investors through their willingness or reluctance to pay that indicative price. So say the value of the business is set at £1 million. Not one investor alone may be able to or willing to spend 1 million, but 10 investors together could. Therefore, you might want to divide your restaurant into 10 pieces and sell each piece to each investor. Each investor would receive profits at the end of the year as a percentage of the initial investment they put into the business. They each have shares in the business and receive a percentage of its profits as dividends at the end of the year.

Stock markets are maintained by the laws of supply and demand. The stock market can be compared to any market, if no one wants to buy a share then sellers have to lower the price to encourage buyers, in the same way, if there are few shares on the market and people don't want to sell, but people are tripping over themselves to buy, then the price will climb quickly. It's simple really.

In essence, companies will issue shares to raise money to help them grow. The shares can then be bought and sold on the stock market. The company may decide to issue more shares in future to raise more money for expansion.

How do I Buy Shares?

Investors can buy a share in a stock when a company first decides to trade itself on the stock market - that is, at flotation or privatisation; or you can buy through the stock market once the shares are in circulation and being traded. To buy or sell a stock you go to a stockbroker who does business with the stock exchange on your behalf.

Once you have bought your shares you can hold them as a paper certificate or your broker can hold them electronically (in a nominee account) on your behalf. When you have bought or sold the shares, your transaction is completed (or settled) electronically through a service known as CREST. This system links banks, stockbrokers and company registrars.

As a retail investor, you cannot buy or sell shares directly on a stock exchange such as the London Stock Exchange (LSE). You must place your order with a stock exchange member firm, such as TD Waterhouse, who will then execute the order on your behalf. You can begin by simply setting up a trading account.

Why do we need a Stockmarket?

Companies do not HAVE to list on the stock market to issue shares. Many businesses start life with friends and family as shareholders. These businesses are called unlisted firms and their shares are often referred to as ‘unquoted’. However, once a company grows this can cause problems and that's why stockmarket came about.

In the above scenario if I owned a business, and I sell shares to private investors by word-of-mouth, or by placing an ad in the newspaper, it makes selling the stock easy for me, but, it creates a problem down the line for the investors who want to sell their stock. The seller has to go out and find a buyer for all or some of these shares in the business, which can be hard. A "stock market" solves this problem.

The stock exchange has an interesting side effect. Because all the buying and selling is concentrated in one place, it allows the price of a stock to be known every second of the day. Therefore, investors can watch as a stock's price fluctuates based on news from the company, media reports, national economic news and lots of other factors. Buyers and sellers take all of these factors into account.

What Now?

So there is a bit of history and a simplistic view of what a stockmarket is and why we need it. The stock market is a place where you can make a lot of money but you can also lose a lot of money as well. If you have decided that you want to try investing in the stock market, it's a good idea to do some research and get advice from people that you trust and who are already investing in the stock market. But be careful, because if you don't invest wisely you can lose a lot of money. Be wise with your investments and take the time to do your homework. This will help you to make the right decision when it comes to your investments.

Today it is really easy to be an investor as a result of the internet; information is more freely available and in real time. You don't have to be a millionaire to be an investor, its very simple, however you should also invest in your research and knowledge as a lot of money can be made investing in shares but a lot of money can also be lost!

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