We have all heard of the Stock Market, in fact on the news, we can't escape it. Daily we are shown values; the FTSE falls 3%, the NYSE falls by 2% and so on. That to many probably don't mean a great deal, but in actual fact, do reflect current state of business of a country as a whole, in one broad but not so accurate barometer - as you will learn more about later.
What then is the stock market? First of all, the term stock market, also means the equity market too, both are one and the same thing. Essentially, the equity or stock market, take your pick, is in fact a real public entity consisting and a somewhat loose economic network for transactions of physical stock (equity) in a public listed or Incorporated company (PLC/INC). An open market for the sale or purchase of stock in household companies such as Apple, Microsoft, Google, Tesco, Sainsbury, EXON and more. This stock is a portion - a share, of a company, which has limited shares to sell. The demand for a stock based on the expectation of a companies current and continued success or failure, drives the value or more to the point, partly perceived value for the stock of that company.
The sole and primary aim of any stock market, is to bring together buyers and sellers, that trade between themselves for the given stock in their market. For example, those trading on the trading floor in the London Stock Exchange, will primarily be trading UK based stocks, those trading in the New York Stock Exchange, will be trading mostly US based stocks. However, it doesn't mean that a trade in London can't buy or sell stock from the US market, or vice versa. More so, there are primarily markets, stock markets, based in every main city around the World, because each country has public listed companies, where there is a demand for the sale or purchase of that company stock.
One key point to understand about the stock market is that these days, it is not just the sale of company stock in the terms of a true exchange. Yes this was and still is it's primary aim; to provide a central location for the sale and/or purchase of company stock. However, over the last few decades and in fact, more so in the last 15 years or so, there has been an incredible rise in the use of derivatives, which are also traded in the same markets. Derivatives are a means of creating a financial product/vehicle, based on a true actual product, which is the underlying. Looking at this way, a derivative for instance could be based on the FTSE100 (Financial Times / Stock Exchange top 100 companies) index either being above the previous day high or not. Therefore, traders would trade, or essentially gamble, whether the market was higher or lower than the previous day. The actual product they trade is the derivative, as it's derived from the value of the FTSE100, but unlike the equity market, it holds no true value. It's a trade based on a notional value that has a true or false result, nothing more. This is an example, a quick one, of what a derivative is. There are many, many more. In fact, as an aside, it was the derivative markets in the sub prime mortgage sector in the US, that began the decline in the financial sector in 2009 onwards.
The London Stock Exchange trades between 8am and 4.30pm with the final end of day price of all stocks taken at 4.35pm, to allow for the final amount of trades to trickle in and be accounted. Those trading the markets, as it is know as a whole are retail investors (the general public - you and me), institutional investors that manage anything from banking, hedge funds and insurance - for example, many pension funds are managed and traded in and out regularly in the stock market, even companies will either purchase its own stock, or that of other companies, to take advantage of tax breaks and financial reserves that it may hold. For example, we have seen many times Apple Inc, purchase its own stock back with its cash reserves, or purchase stock in other companies, with a view to taking a strategic market share of that company. The stock exchanges around the World are traded much the same way.
In fact, all are computerized these days, such is the volume of trades and the speed of trading that is undertaken. Yet, even today, in some of the markets, you will still see some traders adopting the old method of buying and selling, known as 'open outcry'. This may not mean anything to you, but I am sure that you have seen it on TV and is one of the most mimicked gestures made when any one hears the words 'stock broker'. You've guessed it, it's the hand signals, given across the trading floor, to broker sales of stock. The method of sale or purchase of stocks, is based on the auction model. This is what drives the market for that stock up or down. For example, we have company XYZ and the broker has a given amount of stock for sale and he knows that currently the market for that stock is trading at 100. Yet, he knows that demand for that stock is likely to increase, based on any number of factors, from expected profits announcement that is expected to be positive, to news on development that the company is involved in, or simply, the stock is trending on the open market, based on market psychology being positive for that stock - I will be talking about market psychology and what really drives the markets in the training course, which is free, on this website (being released soon). As the broker knows there is demand for the stock, he could wait and demand a higher price, as the amount of available stock for sale in that company starts to dry up, or he could sell his stock now.
Therefore, he could 'ask' for 110, for his stock and wait to see who will be buying at that price. If he gets a good amount of sales, he may start to raise the price quickly. At the same time, there are other traders, brokers, selling and buying the same stock. It is this natural flow of 'bidding' on and 'asking' for prices that creates the market. As I have said previously, I will explain later how this actual market is based on market psychology rather than any given physical value. Why then does the stock market exist? Aside from the whole speculation on the markets and it's derivatives, which really came much later. The whole purpose of the stock market and still is, as a means for companies to sell stock in itself to raise money for investing back into developing the business. Another example will help here. Any business can become, in our example a PLC (Public Limited Company) by selling it's stock on the open market. Now there is a great deal of legal and financial work involved to start what is called an IPO; initial public offering. Which is when the stock is initially auctioned off, to raise funds for the company in question. A good example of this and how it can raise a great deal of money, based on expectation and market psychology, is that of what was known as the 'Tech Bubble' or 'Internet Bubble' of the very late 90's, early 00's. The Internet was pretty new to most people at that time and it became very much like the Wild West again. In fact, I have a lot of personal experience, as during that time I was both a project manager and Internet Manager for two startup companies and an Internet Service Provider company.
To see the money pouring in and then out of these 'pie in the sky' ventures was incredible. Many Internet Companies sprang up out of no where. They would start up on a 'shoe string' and then go IPO as soon as possible to raise money, purely based on an idea, some of the ideas back then were ridiculous, but because the market was naive and it was seen as a means of speculating and many of the stocks were rising in value way beyond that of any true value - again market psychology in action there, the demand for new IPO's and stocks became huge. These new Internet companies were raising millions upon millions, when they hadn't even before they had gone IPO made a single penny. Yet the demand for their stock grew and grew. However, it was only a matter of time, before key investors started to look deeper on earnings reports that brought no relation to the promises made in the IPO brochure. Within a few short months, stocks in these companies crashed, new IPO's were having problems raising money and eventually for years to come, any Internet based IPO had trouble raising even the opportunity to sell.
This is a good example, of how the actual price of a stock, bares little to no real market value of that company, it is essentially what other people believe that the stock is worth and no more, based on the auction of that stock in a stock exchange. Even recently we have seen market crashes lead by the financial sector. This though was different. In that it was lead by the over sale of sub prime mortgages - basically the sale of mortgage and loans to people that had no means of paying them, to which the broker received commissions based on the sales and the derivates of that market were incredibly popular as they climbed in value so quickly. No one questioned what would happen if these 'sub prime' buyers couldn't pay.
Banks and other institutions jumped on board, could see huge speculative profits in the sale of these loans and the ever increasing derivatives based on them. This spiraled out of control. Till one day not so far down the line, people started to default on their loans. The banks were over exposed, which became known as toxic debt, banks collapsed, financial institutions failed and the whole thing started what became the biggest financial collapse since 1929. In many respects, it was bigger, but the reaction by governments was much swifter, by 'bailing out' the banks - personally I think this was a big mistake, something which I will be talking later in the free course.
As we can see, the stock market is a means for companies to raise money, for those involved in the market to speculate and potentially profit from the sale or purchase of stock, or the trading of derivatives in the market, it can show that real physical value of a company is rarely represented in the stock price and how this expectation can lead to catastrophic gains and subsequent losses, plus how even the banks that we love or loathe, can in fact cause market collapses, in the stock market and other markets related to the banking sector and how that has cost every man and woman, thousands of pounds in tax payers money per person, to bail out the banks and institutions.
The content of this site is copyright 2016 Financial Spread Betting Ltd. Please contact us if you wish to reproduce any of it.
