What is the Stock Market?

The Stock market is an essential part of the modern economy.  It is a necessity that is unchallengeable, an innovative structure highly dynamic. 

It adapts itself to the economic environment and at the same time influences it, generating opportunities and giving freedom to a common person to be part of the bigger picture. 

The concept of a company dividing up ownership of itself to be distributed to investors and traded dates back hundreds of years. 

The history of the stock market goes centuries back. During the 1600s, European explorers would raise money by selling shares in their company’s ventures.

Investors would purchase stock to gain the profits of explorers’ missions, like the company’s pursuit of foreign spices to be brought back and sold in Europe. 

The Dutch East India Company was among the first to do this in the late 1600s, offering shares of itself in exchange for future profits on Amsterdam’s stock market. The trading of these shares formed some of the first stock markets.

In the 1700s a group of merchants made an agreement which is called Buttonwood Tree Agreement. 

These merchants met daily and traded stocks. This eventually become the New York Stock Exchange.

By definition, The stock market refers to public markets that exist for issuing, buying, and selling stocks that trade on a stock exchange or over-the-counter.

This definition is not enough to understand the complex capital market. Let’s understand the working and functions of the stock market.

Basic Terms

• Stock

The terms “stock”, “shares”, and “equity” are used interchangeably. , also known as equities, represent fractional ownership in a company, and a stock market is a place where investors can buy and sell ownership of such investible financial Assets.

• Financial Assets

Financial assets refer to assets that arise from contractual agreements on future cash flows or from owning equity instruments of another entity. 

• Shareholder

An individual who owns stock in a company is called a shareholder and is eligible to claim part of the company’s residual assets and earnings.

• Types of stock

There are two main types of stocks, one is called a common stock and the other is preferred stock. 

The main difference between the two is that common stocks give shareholders the right to vote on company matters and participate in the growing earnings of the company while preferred stocks don’t. 

Preferred shares may come with a higher fixed dividend payout.

How does the Stock Market work?

The stock market is the primary method by which people can invest their money. A stock market is an organized group of companies traded on a stock exchange. 

Companies can be traded on a stock exchange through the process of an IPO. An Initial Public Offering (IPO) is the first sale of stocks issued by a company to the public. 

Prior to an IPO, a company is considered a private company, usually with a small number of investors such as founders, friends, family, and business investors such as venture capitalists or angel investors. 

This means that the company is divided into shares, for example, 10 million shares, and sells 2 million shares to the public at a price of $10 for each share.

After all this process and if the company is successfully listed on the stock exchange. It has sold its 2 million stocks at $10 per share price. Now, the company has collected $20 million from investors which now it can use for the expansion of its business.

How is the stock market protected from fraud?

Listed companies are regulated, and their dealings are monitored by market regulators such as the SEC.  

In addition, the exchanges set certain requirements—for example, mandating timely filing of quarterly financial reports and instant reporting of relevant corporate developments—to ensure that all market participants are equally informed.

These are some of the many detailed rules designed to make stock markets more transparent, consistent, and accurate for investors. 

The investor protection rules from regulators and self-regulatory organizations aim to provide a stable foundation for stock markets to more properly function and help gain the trust of customers.

Stock exchanges are regulated to ensure that investors are protected from fraudulent trading. The stock market is not for everyone; it is complex and has a steep learning curve for the average investor. 

What is the purpose of the stock market?

The stock market serves two important purposes. 

First, it helps companies raise money often referred to as capital from the public by offering shares for sale, which can be used to fund and expand their business.  

Secondly, it gives an investor, who purchases those shares, an opportunity to have a share in the company’s profits.

Investors can profit from owning stocks in one of two ways. Some stocks pay regular dividends at regular intervals which provides a return on the amount of money invested in the shares.  

Alternatively, a return can also be earned through capital appreciation which is when the stock price increases.

How is the price of the stock calculated?

Once a company’s stock is on the stock market, it can be bought and sold among investors. 

If you decide to buy a stock, you’ll often buy it not from the company itself, but from another investor who wants to sell the stock. 

Likewise, if you want to sell a stock, you’ll sell it to another investor who wants to buy.

Depending on the standard rules of supply and demand, the stock exchange needs to ensure that all interested market participants have instant access to data for all buy and sell orders, thereby helping in the fair and transparent pricing of securities. 

It should also perform efficient matching of appropriate buy and sell orders.

Why do people invest in the stock market?

Stock markets have been used for centuries to raise capital for businesses. There are several methods for investing in the stock market. The most common way for an average person to invest in the stock market is to buy shares in a public company.

An investor can buy shares in a company for a variety of reasons, including 

• To make money on the appreciation in the company’s stock price.

• To receive dividends from the investment.

Stock investment can be one of the easiest ways for the average person to make money. 

Many people invest in the stock market to make money, but there are other motivations behind investing.

Some people invest in the stock market to pay off credit card debt, while others invest in the stock market to save money for retirement. 

What is the risk of investing in stocks?

Investing in the stock market does come with risks, but with the right investment strategies, it can be done safely with minimal risk of long-term losses.  

Day trading, which requires rapidly buying and selling stocks based on price swings, is extremely risky. 

Conversely, investing in the stock market for the long term has proven to be an excellent way to build wealth over time. 

If you invest in the stock market, it’s important to keep in mind both the short-term and long-term risks. Just as stock prices can rise, they can also fall.  Sometimes by a lot.  

The price of a stock can drop to $0, and this may result in a total loss of investment. Given this risk, investors should have a thoughtful strategy in place to help guide their decisions.

If you’re actively buying and selling stocks, there’s a good chance you’ll get it wrong at some point, buying or selling at the wrong time, resulting in a loss.  

The key to investing safely is to stay invested — through the ups and the downs — in low-cost index funds that track the whole market so that your returns might mirror the historical average.

Popular stock exchange indices

Among the key stock market indexes are the Dow Jones Industrial Average (DJIA), also referred to as “Dow Jones” or “the Dow”, which is one of the most widely recognized stock market indices. 

The KSE 100 Index of Pakistan Stock Exchange (PSX). The Standard & Poor’s 500 Index (S&P 500), the Financial Times Stock Exchange 100 Index (FTSE 100), the Nikkei 225 Index, the NASDAQ Composite Index, and the Hang Seng Index.

There are major market indices that track the performance of a group of stocks.

These indices are used to represent the movement of specific stock exchanges such as the PSX or NYSE and they’re the ones that are being referenced when the market goes up or down. 

Indices work by measuring a weighted average value of a collection of securities.

Conclusion

Investing in the capital market can be a risky step but if you want to make grow your wealth and save your money from soaring inflation, you need to take implement strategies that will save you from losing your money. If you invest smartly your efforts will bear fruits in the future.

Note: This is not financial advice this article is only for information purposes.