Stock Market: Understanding the Basics

Shawn Plummer

CEO, The Annuity Expert

A stock market is a marketplace in which shares of stock are traded, and the stock’s price is determined by supply and demand. This guide will go over the basics, explaining the stock market and how it works.

What is a Stock?

A stock (equity) is a type of security representing a portion of a publicly-owned company. The stock owner has a proportional share in the assets and profits of the corporation equal to the amount of stock they own. “Shares” refers to units of stock.

What Is the Stock Market?

A stock market is where people buy, sell, and trade stocks. People who trade stocks are called investors. Investors can buy or sell shares of public companies on the open market.

The words “stock market” and “stock exchange” are often used similarly. But a stock exchange is just one part of the stock market. If someone trades in the stock market, they buy or sell shares on one (or more) of the different exchanges that are part of the whole thing.

There are two types of stock markets:

  • Primary markets: where new stocks are sold to investors for the first time; and
  • Secondary markets: where existing stocks are bought or sold after they have been issued.

Several different exchanges can be found in a country. One of the most well-known is the New York Stock Exchange or NYSE. In addition, the Nasdaq is also an important exchange. These two exchanges, along with other ones, are part of what you know as the stock market in America.

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How Is The Stock Market Regulated?

A stock market is a regulated environment. The Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) are the primary regulators in the United States.

How the Stock Market Works

Through an initial public offering (IPO), the stock market enables companies to offer and sell their shares to the general public for the first time. This activity helps businesses raise capital from investors by allowing them to divide themselves into several shares and sell a portion of those shares to the general public at a price. Therefore, a company needs a marketplace where these shares can be sold to facilitate an IPO. The stock market provides this marketplace.

Investors will acquire company stock, which they may anticipate holding for a period of time if the company’s share price rises and any possible dividend payments are paid.

The stock market serves as a go-between for this capital raising process, collecting a fee for its services from the company and its financial supporters.

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What is a Stock Market Index?

The stock market frequently develops and maintains a variety of market-level and sector-specific indicators, such as the S&P 500 index or the Nasdaq 100 index, which measure changes in the overall market.

Stock exchanges help companies report on news or financial statements. They also help with other things, like paying dividends to investors from the company’s profits.

Functions of a Stock Market

The primary purposes of the stock market are as follows:

Providing Transparency

Investors trade stock to make money. So the stock exchange needs to make sure that buyers and sellers can see how much the other person wants to sell their stocks or what they want to pay for someone else’s stocks.

Determining A Fair Price

The functioning of the securities market requires a robust price discovery mechanism, which refers to the procedure of determining the correct price of a security and is generally carried out by analyzing market supply and demand, as well as other elements connected with transactions.

Liquidity For Immediate Access

For the stock market, keeping track of the number of purchasers and sellers for specific financial security is impossible. Instead, it must ensure that anybody who meets the criteria to trade has immediate access to place orders that will be fulfilled at a fair price.

Security and Compliance

The efficient working of the market depends on having many participants (investors). The market must also ensure that all participants are legal and follow the rules. This means that they cannot break any rules or not follow the law if a regulator sets it.

Stock Market Participants

Market makers, investors, traders, speculators, and hedgers are all kinds of participants that make up a market.

  • Market Maker: A market maker is a trader who quotes two-sided markets for a security, giving bids, offers (asks), and the market size. Market makers provide liquidity and depth to markets by earning a spread between the bid and ask prices. They may also execute principal trades, which they trade for their accounts.
  • Bids: A bid is a price at which a market maker is prepared to buy a security.
  • Asks: The ask is the seller’s proposed price for a security, commonly known as the offer price.
  • Investor: An investor is a person or entity that puts money down to earn financial returns, typically over the long term.
  • Trader: A trader, also known as a stockbroker, is a person who buys and sells financial assets in any financial market, either for themselves or on behalf of someone else. Day traders tend to keep assets for shorter periods of time to take advantage of short-term trends.
  • Speculator: Speculators employ methods to outperform typical longer-term investors. Speculators take on risk, anticipating future price changes, hoping to earn significant profits that outweigh the risk.
  • Portfolio Managers: Portfolio managers are individuals who invest in client portfolios, which may include stocks and bonds. These managers obtain analyst recommendations and make portfolio buy and sell decisions.
  • Investment Bankers: Investment bankers work for various businesses, including private firms that want to go public via an IPO and businesses engaged in pending mergers and acquisitions. They oversee the listing procedure per stock market regulations.
  • Custodians: Custodians and depository service providers are security-keeping institutions that store securities for clients to minimize the threat of theft or loss. These businesses also work in tandem with the exchange to move shares from/to the accounts of trading parties based on market activity.
  • Arbitrageurs: Arbitrageurs are traders who identify mispricings in the market for low-risk profits and maintain the market more efficiently.

Investor Protection

The stock market must implement necessary safeguards such as risk profiles to protect both large and small investors from financial harm and guarantee client confidence.

Company Regulation

Most companies that are listed are heavily regulated and followed by market regulators. Furthermore, exchanges have rules to ensure that all market participants are informed of corporate happenings, such as the requirement of regular filing of quarterly financial reports and immediate reporting of any significant developments. Failing to follow regulations can result in trading being halted by the exchanges and other disciplinary actions.

How Does The Stock Exchange Make Money?

Stock exchanges are for-profit companies. They charge fees for their services. The primary source of income for stock exchanges is the revenue from the transaction fees charged every time someone trades on their platform. They also make money by charging a listing fee to companies during the IPO process and follow-on offerings.

Exchanges also generate money from selling data. They sell information like real-time data, historical data, summary data, and reference data. Exchanges also provide products to interested parties for a fee.

Shawn Plummer

CEO, The Annuity Expert

I’m a licensed financial professional focusing on annuities and insurance for more than a decade. My former role was training financial advisors, including for a Fortune Global 500 insurance company. I’ve been featured in Time Magazine, Yahoo! Finance, MSN, SmartAsset, Entrepreneur, Bloomberg, The Simple Dollar, U.S. News and World Report, and Women’s Health Magazine.

The Annuity Expert is an online insurance agency servicing consumers across the United States. My goal is to help you take the guesswork out of retirement planning or find the best insurance coverage at the cheapest rates for you. 

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