Definition

The stock market is divided into two parts: a primary market, where companies first issue shares to their investors, and a second market, where investors can trade shares.

What is the Stock Market?

Stock market is the collective term used to describe the network of exchanges, brokerages, and over-the-counter markets where investors can buy and sell publicly traded shares. Although people often use the term “stock market” in reference to the New York Stock Exchange or the Nasdaq, these exchanges are part of a larger global marketplace.

The Securities and Exchange Commission (SEC) regulates all companies in the United States that wish to sell their shares to the general public. Businesses must register their company with the SEC, and they are required to publish financial statements and periodic disclosures.

Key Takeaways

• Stock market shares are issued by companies to raise Capital for expansion and to expand their business.
• Securities transactions on the secondary markets are governed by the Securities Exchange Act of 1933.
• Investors can buy shares in order to receive dividends or vote in corporate elections. They may also sell shares for a higher price.

How Stock Markets Work

The stock market is often referred to as a particular exchange, like the New York Stock Exchange. It is actually a system of exchanges, brokerages, and over-the-counter (OTC) markets. Anywhere that you can purchase a part of a business is part of it.

Shares of companies are traded in this vast and complex network, which is protected by laws that prohibit fraud and unfair trading practices. Stock markets are crucial to modern economies because they allow money to be moved between investors and businesses.

Stocks are purchased for many reasons. Some people hold on to shares in order to receive dividends. Some people look for stocks at low prices that will likely gain in value so they can sell them later on. Others may want to have a say on how a company is run. You can vote in shareholder meetings according to the number of shares that you own.

Shares give you the right of a part of the profits that the company makes, which is often paid out as dividends. You may also have the right to vote in company matters.

It is sometimes easier to understand something by looking at its components. Let’s take a look at the main elements of the stock exchange, from the companies that sell shares, to the stocks, to the exchanges, to the indexes which give us an overview of the health of the market:

What are public companies?

Not all companies are allowed to offer their stock for sale. Only companies registered with the SEC in the U.S. can sell shares on a stock exchange such as the NYSE or Nasdaq. These companies are subject to strict regulations and financial disclosure laws.

The traditional way to go public is through an initial public offering. Special purpose acquisition companies (SPACs), a new route to going public, have been emerging in the 2020s.

The primary market is made up of investors who purchase their shares directly from a company. This includes early investors, insiders, and financial underwriters for public companies. Private placements are also included, in which a company can sell its shares to investors directly without having to register.

After a company has gone public, it can trade its stock in the secondary market through exchanges or “over-the-counter.” Today, more than 58,000 publicly traded companies exist around the world. 1

Stocks: How to Buy and Sell Shares

You’re buying a part of the company when you purchase a stock. The number of shares issued by the company and the number you own determines how much you own of it.

A single share can represent a significant part of a private, small company. Many major public companies have millions or even billions of shares. Apple Inc. has billions in circulation, but a single share represents a small fraction of this company.

Stock prices change based on demand from new investors to purchase shares or supply from existing investors to sell shares. Investors do not always make decisions according to the same criteria. What might be a high price for one investor may seem like a bargain for another. This dynamic makes it difficult to predict future prices and keeps shares in circulation.

What is a Stock Exchange

After a company is listed, its shares are freely traded on the stock exchange. Investors can trade shares with each other. The majority of trading takes place on stock exchanges. However, there are also other trading venues.

Stock exchanges (today, mostly virtual) are organized, regulated places where stocks and securities are traded. They play an important role in the financial sector by allowing companies to raise funds by selling their bonds and stocks to the public.

The NYSE, Nasdaq and other major exchanges are examples of this. They serve as the central location for buying and trading stocks. Other major exchanges around the world include the London Stock Exchange (LSE), the Tokyo Stock Exchange (TSX) and the Shanghai Stock Exchange.

Investors follow different laws and regulations depending on where they live. Each exchange has its own rules designed to maintain investor confidence and ensure fair trading. These rules also offer transparency to the trading process by providing real-time data on security prices.

Liquidity, or the ability to buy and sell stocks easily, is a major advantage of trading on stock markets. There are thousands of buyers and vendors, so there will always be someone willing to purchase or sell shares at the best price.

Many stock exchanges offer securities that are listed on other exchanges. It allows companies to raise Capital from more investors and gives investors a greater range of trading options.

Fast Fact

Although it’s called a stock exchange, other securities are traded, like exchange-traded funds (ETFs).

Over-the-counter Market

Stocks are also traded “over-the-counter” (OTC). OTC markets allow you to buy or sell stock directly with another investor. They are usually not regulated or subject to public scrutiny. OTC trading is a system of brokers and dealers that negotiates directly via computer networks or by phone.

This is a common way to trade for smaller companies with less liquidity that do not meet the strict listing requirements set by the stock exchanges. Investors may find it difficult to obtain reliable information on the companies that they invest in.

Other Assets Sold at the Stock Market

Many other assets, including common stocks, are traded at stock exchanges and OTC. They are also included in the “stock exchange”:

• American Depositary Receipts: These are shares of foreign companies traded in U.S. stock markets. They allow U.S. companies to invest in the U.S. without having to deal with foreign stock markets or convert their currency.
• Derivatives: This umbrella category includes futures and options whose values are derived from underlying assets such as commodities, stocks, bonds, currencies, interest rates, market indexes, or currency. In derivatives trading, you are not buying or selling an actual asset. You’re actually trading something that is affected by changes in an asset’s price.
• Funds include mutual funds that pool money from investors to buy a basket of securities, such as stocks, bonds, and more. Exchange-traded funds are traded on stock exchanges just like individual stocks. They “track” the performance of a particular sector, index, or theme.
• Preferred Stocks These stocks are generally preferred over the common stock and have a higher priority in obtaining a portion of profits or the remaining amount if a company is bankrupt.
• Real Estate Investment Trusts (REITs). These are well worth mentioning in order to understand the scope of the stock market. REITs are real estate companies that manage or finance property. Investors are able to buy shares, and the companies must legally distribute 90% of their profits each year as dividends.

People often refer to these markets as “stock markets” even though they are separate markets.

• Bonds: These bonds represent debt and are issued by governments and corporations to raise Capital. Bonds are a form of debt that governments and corporations issue to raise Capital.
• Commodities There are over 50 commodities exchanges around the world where you can purchase raw materials such as oil, steel and wheat directly or by buying futures contracts that predict their price.

Investors & Traders

Institutional investors include pension funds, mutual funds, insurance companies and hedge funds. They manage large sums of money and have a major influence on the market because they trade in large quantities. Retail investors purchase and sell securities on their behalf, not as agents for an organization. Beginners to experienced traders can use the online platforms. Accredited investors are high-net-worth individuals who have the money and the investing experience to access more complex investments like venture capital and private equity.

Investors generally approach the market with a long-term view. Investors invest in stocks, mutual funds, ETFs and other securities with the expectation that their value will increase over time. These are not quick trades like in movies, where you can get in and out quickly. Investors are more interested in the fundamental strength and performance of the assets or companies they invest in. This includes their market position, financial performance, and growth potential. After doing research, analyzing the market and getting advice from financial advisors, they decide which investments to make. They are trying to build wealth over time by building a portfolio with a steadily increasing value.

The traders, on the other hand, have a shorter-term view of the stock market. They try to take advantage of the volatility in the stock market by trading stocks, futures, options and other financial instruments over shorter periods, from seconds to minutes to days to months. Traders use technical analysis to forecast future price movements. This involves studying charts, market trends and other statistical measurements. Trading can be a great way to make quick money, but it is also more risky than investing over the long term. To quickly buy and sell securities, you need to have a good understanding of the market. You also need a more active, hands-on trading strategy.

The role of brokers

Brokers on the stock exchange play a similar role to those in the insurance industry and other sectors. They act as intermediaries between investors and the markets for securities. These are licensed organizations that buy and sell securities and stocks for both individual and institutional customers. Brokerage firms are small boutique shops or large multinationals that offer investment advice, wealth management, research and other services. Full-service brokerage firms offer detailed financial advice, personalized services and portfolio management. They are better suited to investors who want a comprehensive approach to managing investments. Discount brokers are more affordable and offer a hands-off approach. They’re preferred by investors who make their own investment decisions.

Online brokerage firms are becoming more popular thanks to their user-friendly platforms. They allow investors to trade securities electronically with lower costs and greater convenience. These platforms are often equipped with educational resources, analytic tools, and live market data. Robo-advisors are also on the rise, offering automated financial planning at very low prices.

In the U.S., all brokers are regulated by both the SEC and the Financial Industry Regulatory Authority.

Regulators

The regulations and regulators are a significant part of the stock exchange, dictating what is traded and for how much. The SEC is an independent federal agency in the U.S. that was established in 1934, following the 1929 crash and the Great Depression. The SEC’s mission is to “protect investors, maintain fair, efficient, and orderly markets, and facilitate capital formation.” 3

The SEC enforces the laws against insider trading and other forms of fraud while verifying that public companies disclose any important financial information that investors should be aware of when they trust a firm with their investment by purchasing its stock. The SEC also oversees stock exchanges and broker-dealers, investment advisors, public utility holdings companies, mutual funds, and other financial institutions.

The exchanges also have their requirements, such as timely filing (usually quarterly updates) of company financial reports and instant reporting of relevant corporate developments to ensure everyone who wants to trade has the same information.

FINRA supervises brokerage firms and their registered securities agents and is more focused on protecting retail investors than the SEC. Similar agencies exist around the world, which is important because the stock market is international, and any calamity that occurs in one part of the globe will soon reach the other.

While many countries’ regulations differ significantly—they respond to diverse populations and cultural expectations—general rules are enforced to ensure fair practices, protect investors, and promote confidence in the broader stock market.

How Stock Prices are Determined

In textbooks, stock price descriptions often begin with the idea that investors and dealers must come together to agree on a number. Most investors see prices in their online brokerage accounts or graphs that show the price of stocks over time. They don’t think they come from a difficult negotiation. You do need to agree to purchase stocks. Each investor or trader who makes this decision collectively shapes demand for stocks, which, when taken against the available supply in the market, produces the prices we see on our screens.

These factors can be divided into two categories: fundamental and technological. Essential characteristics include a company’s earnings, its profitability, and what it offers. Technical aspects are based on market sentiment, statistical analyses, historical stock prices and market activity.

Stock splits, dividends and share repurchases can all result in high stock prices. Stock prices dropping does not mean the market has lost money. It is a sign of a drop in the value of a specific stock. If a company announces higher profits than anticipated, the stock price may increase because more investors will want to purchase shares in anticipation of future growth. Investor confidence can also be affected by economic events such as interest rate changes and geopolitical concerns.

Market Indexes

The Dow Jones Industrial Average, or S&P 500, has been the main source of financial news for many years. Reporting on the ups and downs of these indexes is standard practice. The DJIA index, which represents 30 publicly owned companies, and the S&P 500 index, which represents the 500 largest U.S. companies listed on the stock exchange, are two examples of popular financial news.

These indexes provide a snapshot of the stock market as a whole or for a particular sector, such as technology or healthcare.

Indexes serve as a benchmark for stocks and portfolios. If you invest in technology stocks, for example, you will want to compare your stocks against a tech index.

Stock Market Roles

The stock exchange plays many different roles.

Corporate Governance: Publicly traded companies follow strict reporting regulations, which makes them more transparent and accountable. Investors can make more informed decisions with this information, which helps to maintain confidence in the markets. This is also good news for the average American, as without transparency requirements, they would be able to hide much information about these major U.S. companies.

Economic Indicator: The performance of the stock market is often regarded as a gauge of an economy’s state. Rising stock prices are linked to corporate profitability and economic expansion while falling prices indicate problems.

Investment Opportunities The stock market is a great place to invest and grow your portfolio. Stock market returns have historically outpaced inflation, making it an important tool for retirement planning and wealth building.

Liquidity: The stock exchange allows investors to quickly buy and sell securities and shares when they need them.

Raising Capital The stock market is a great place for companies to raise Capital by issuing shares. These funds are essential for corporate expansion, research, and development. Companies can access these funds by selling shares.

Resource Allocation By reflecting the collective judgement of traders and investors through the price of different companies, the stock market is claimed to help efficiently distribute Capital towards companies that are more likely to succeed and away from companies that are less likely to succeed.

Why is the stock market so important?

We can now better understand the importance of the stock exchange by knowing its different components, who, what, and where it operates. The stock market’s importance in our world cannot be overstated.

The global economy was very different when the first stock markets were formed. The eras were marked by a trade-driven economy dominated by physical goods. Industries like agriculture, textiles and early manufacturing dominated the economic landscape.

At the time, stock markets were still nascent institutions that primarily helped to finance trade and expeditions. They were used as a means to finance colonial ventures that brought goods and people out of South Asia, America, and Africa. The stock exchanges that were used to fund colonial enterprises in South Asia, the Americas and Africa were global operations. 5 However, they only played a minor role in daily economic life.

Today, the stock market is a key part of the global economy. This change has been fueled by financialization and the increasing dominance of financial markets and institutions. It’s not just because more than a million Americans are employed in finance. 6 Modern economies feature a complex web of financial instruments and transactions. The stock market is seen as a key indicator of economic health, but it also plays a role in distributing and creating new wealth.

What is the stock market for most Americans?

Financialization is also an expression of broader socioeconomic change. Stock markets today are more than just a place to raise Capital. They have become a part of millions of Americans’ investment and retirement strategies.

The stock market is a major influence on the lives of many Americans, even if they aren’t directly involved. It is a major source of funding for technological advances such as smartphones and medication, which require billions for research and development.

Market movements can also affect corporate decisions, including job creation and even layoffs. A strong stock market is generally correlated with a stronger economy. It could also mean that a few wealthy people have more money, which would increase the value of property in areas of the country once considered middle class.

The stock market indirectly influences public services and infrastructure. It is a major investment for pension funds, which affects the retirement security of many people. Many people do not have pensions and instead invest in the stock market through 401(k) plans, individual retirement accounts, and IRAs.

What is the difference between the bond market and the stock market?

Investors buy and sell bonds, which corporations or governments usually issue. You’re lending money to the government or corporation that issued the bonds in exchange for interest payments.

The stock market involves buying and selling shares in publicly traded companies. Stocks can offer higher returns than bonds, as investors receive dividends and profits when a company is profitable. However, they can also be riskier, as their prices are more volatile.

What is an alternative trading system?

Alternative trading systems provide a platform for large-scale buy and sell-transactions. They are not regulated as exchanges. Dark pools, and many cryptocurrency exchanges, are private forums or exchanges for trading in securities and currencies. Private groups run them.

Who helps an investor trade on the stock market?

Stockbrokers are professionals who act as intermediaries between stock exchanges and investors. They buy and sell stocks. Portfolio managers invest in securities for their clients. Investment bankers can represent companies in a variety of ways, including helping private companies to go public or planning mergers.

The Bottom Line

Stock exchanges are where companies’ shares and other financial instruments can be bought and sold. Stock markets are also where companies raise money and where investors can increase their wealth.

Even if your stock market trading is not direct, it can still influence the types of products you purchase, the jobs that are available and how you plan to retire.

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