What is the Stock Market?
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What is the Stock Market?
The stock market refers to the collection of markets and exchanges where regular activities of buying, selling, and issuance of shares of publicly-held companies take place.
Such financial activities are conducted through institutionalized formal exchanges or over-the-counter (OTC) marketplaces which operate under a defined set of regulations.
There can be multiple stock trading venues in a country or a region which allow transactions in stocks and other forms of securities.
While both terms - stock market and stock exchange - are used interchangeably, the latter term is generally a subset of the former.
If one says that she trades in the stock market, it means that she buys and sells shares/equities on one (or more) of the stock exchange(s) that are part of the overall stock market.
The leading stock exchanges in the U.S. include the New York Stock Exchange (NYSE), Nasdaq, and the Chicago Board Options Exchange (CBOE). These leading national exchanges, along with several other exchanges operating in the country, form the stock market of the U.S.
Although it is called a stock market or equity market and is primarily known for trading stocks/equities, other financial securities - like exchange traded funds (ETF), corporate bonds and derivatives based on stocks, commodities, currencies, and bonds - are also traded in the stock markets.
How the Stock Market Works
In a nutshell, stock markets provide a secure and regulated environment where market participants can transact in shares and other eligible financial instruments with confidence with zero- to low-operational risk.
Operating under the defined rules as stated by the regulator, the stock markets acts as primary markets and as secondary markets.
As a primary market, the stock market allows companies to issue and sell their shares to the common public for the first time through the process of initial public offerings (IPO).
This activity helps companies raise necessary capital from investors.
It essentially means that a company divides itself into a number of shares (say, 20 million shares) and sells a part of those shares (say, 5 million shares) to the common public at a price (say, $10 per share).
To facilitate this process, a company needs a marketplace where these shares can be sold.
This marketplace is provided by the stock market. If everything goes as planned, the company will successfully sell the 5 million shares at a price of $10 per share and collect $50 million worth of funds.
Investors will get the company shares which they can expect to hold for their preferred duration, in anticipation of rising in share price and any potential income in the form of dividend payments.
The stock exchange acts as a facilitator for this capital raising process and receives a fee for its services from the company and its financial partners.
Following the first-time share issuance IPO exercise called the listing process, the stock exchange also serves as the trading platform that facilitates regular buying and selling of the listed shares.
This constitutes the secondary market. The stock exchange earns a fee for every trade that occurs on its platform during the secondary market activity.
The stock exchange shoulders the responsibility of ensuring price transparency, liquidity, price discovery and fair dealings in such trading activities.
As almost all major stock markets across the globe now operate electronically, the exchange maintains trading systems that efficiently manage the buy and sell orders from various market participants.
They perform the price matching function to facilitate trade execution at a price fair to both buyers and sellers.
A listed company may also offer new, additional shares through other offerings at a later stage, like through rights issue or through follow-on offers.
They may even buyback or delist their shares. The stock exchange facilitates such transactions.
The stock exchange often creates and maintains various market-level and sector-specific indicators, like the S&P 500 index or Nasdaq 100 index, which provide a measure to track the movement of the overall market.
Other methods include the Stochastic Oscillator and Stochastic Momentum Index.
The stock exchanges also maintain all company news, announcements, and financial reporting, which can be usually accessed on their official websites.
A stock exchange also supports various other corporate-level, transaction-related activities.
For instance, profitable companies may reward investors by paying dividends which usually comes from a part of the company’s earnings. The exchange maintains all such information and may support its processing to a certain extent.