Stock Markets

Most people have some idea of the stock markets. These are places, or sometimes “virtual” electronic locations, where stocks and shares are traded. Each stock or share represents a small part of a company, and if you owned all of them you would own the company. That’s not very likely, because companies can have millions of shares in circulation.

Not all companies have shares on the stock market. Particularly when starting out, companies can be “private”, and the owners will often be managers at the company. But if the company grows, and needs capital to buy premises and machines or use in other ways, one option is for the company to “go public” to raise funds. This is done with an “initial public offering” or IPO, which you may have heard of. Usually a specialist investment bank will handle this for the company, helping them decide how many shares to issue and set an initial cost.

IPOs are a specialized area of trading, and some people make money out of them, but it is not without its risks. Often the shares are offered at less than what may be their true value just to make sure they are all sold; as an alternative, the investment bank may interest some big investors, such as pension funds, to make sure there is a market for the offering.

Once the shares are initially sold, the company doesn’t get any more money from them. Some outsiders don’t understand that. The stock market provides a way for investors to buy and sell, and it’s the investors who may profit or lose from the changing prices.

When the company sells its shares to the public, then the shareholders are entitled to take part in the running of the company, usually by speaking up at an annual meeting. After all they have a vested interest in the company doing well.

The other interaction that the company may have with the shareholders is when it issues dividends, which is sending a share of the profits to the shareholders. Some companies don’t do this, but many large companies issue regular dividends to keep their shareholders happy, and usually try to at least match the previous dividend amount if not increase it each time – this conveys to the shareholders that the company is increasing profits over time, and makes them happier still.

So if the company is not involved after the shares are issued, how is their value decided, and who decides it? That all comes down to the stock market, and to supply and demand or simple economics. If lots of people want the shares, then the price is likely to go up; if you are trying to sell and no one wants to buy then you may have to drop the price you are asking for your shares. It’s because trading is going on all the time that prices vary so much – after all, the company is still sitting there churning out X gazillion widgets per year whether the stock price is 50p or £50.

People who study the health of companies, financial analysts who use fundamental analysis to look at the basics, can tell you whether they think a share price is good value or whether it is too much; but they don’t control the price, the market does. This is a good thing for us, as it means the share price is constantly varying and giving us opportunities to make a profit.

When all is said and done, an investor in shares is concerned about how much money his investment is making. The money could be put in a savings account, or in a different company, and the investor will usually choose to get the best return, while taking an acceptable amount of risk. If the company pays dividends, then this can be compared directly to the rate of interest that could be earned; if not, then the investor will be relying on share prices increasing to make a profit.

So that’s a brief summary of how stock markets work – some countries even have more than one stock market, for instance the US has the New York Stock Exchange (NYSE), NASDAQ which is an electronic trading board, the Cincinnati Stock Exchange (CSE), and other financial centres. With electronics, it is possible to trade some companies’ stock on several exchanges, though the original idea was that particular exchanges dealt with certain types of companies.

To trade on a stock exchange you have to use a broker, an intermediary. It wouldn’t work for all the thousands of investors to turn up at the steps of the exchange and expect to make their trades. So there are certain people who are permitted to buy and sell at the stock exchange on behalf of the investors in order to keep some semblance of order. In spite of this, if you saw the action at a physical stock exchange you might still think it was pandemonium!

Before we leave the topic of stocks and shares, you may want to learn about “going short”. If you only spread bet then you won’t need to know this, but as there is so much confusion and mystery about it you may as well understand it. When you “go short” or “short” a stock, you are taking the opposite position to buying it and will profit if it goes down in value, losing if it gains. As a stock trader, you actually don’t do anything special, but just ask your broker for a “short position” in the stock – the broker takes care of the details.

What happens is that the broker can sell the shares if he has some in hand, or can sell another client’s shares to establish your short position. When you close your short trade, the broker buys them back and replaces them in the other client’s account. If they have lost value and are bought back more cheaply, then you profit from the difference less commissions. If they have increased in price then that is a loss to you, as more money must be taken from your account to buy them back.

In practice, it should happen smoothly. There are some wrinkles and provisos such as it needs to be a reasonably well traded company share so that there is a supply to be sold, and you have to make any dividend payments that come due, on the principle that the client whose shares you “borrowed” to sell should not be harmed by it. The broker takes care of it, and it’s not a mystery as some would believe, just another way of trading in the markets.

By the way, stocks and shares mean practically the same thing. It’s usual to talk about shares when they are from one company, and to talk about stocks if there are several companies’ shares involved, such as in a stock portfolio. That concludes our brief look at stock markets.