HOW THE SHARE MARKET WORKS

The share market or stock exchange is a place where shares of companies are initially offered to the public and also where existing shares are traded between investors.

Each country has its own stock exchange(s). In America you have the NYSE, AMEX and the NASDAQ. In Japan you have the NIKKEI. In England you have the London Stock Exchange and in Australia you have the ASX to name a few.

A share is a “share” of a company. When you buy a share, you are actually buying a piece of that company and its assets. When you own shares the company will actually send you invites to meetings where you can vote for who will be appointed the board of directors. The company may also pay you some of the profits called a dividend.

When a company wants to raise money and they don’t want to borrow money and accrue interest, they may sell off shares of the company to investors for a price. This is called an initial public offering; it is when the shares of the company are initially offered to the public. This is the only time the company makes money, after that the shares are bought and sold between investors who either lose money or make money on the transaction between themselves.

Over time the shares (company) you own may succeed and grow which will generally cause the share price to go up or the company will not do so well causing the share price to go down.

Often the company will be doing well but if the other investors who own the same shares believe otherwise they may panic and start selling their shares causing the share price to go down. This is why shares can be a volatile investment.

People will pay more for something they believe has value and less for something they believe isn’t valuable. The price of a share is a reflection of its “perceived value” However over time the share price of a company generally is a reflection of the real underlying value of the company.

Just like other markets, the price of a share is subject to the forces of supply and demand. The amount of shares of a particular company on the stock exchange is fixed, unless the company offers more shares or buys back shares but most of the time it’s fixed. Because the amount of shares is fixed the price fluctuates with demand. If people are buying up the share, they are willing to pay a higher price and the price goes up, the opposite is true if they sell.

Some companies pay a dividend which is a portion of the companies’ profits paid to you for being a part owner of the company. The amount they pay you varies from company to company but generally it’s around 5%.

There are small, medium and large cap (market capitalization) companies on the share market. Market capitalization means the amount of wealth the exchange is made of.

Small cap stocks have a small market capitalization because the companies are often just starting out or in the beginning stages. Shares of these companies might cost a few cents or a few dollars. These shares can be very volatile, any activity and they fluctuate in price quite a lot.

Medium cap stocks may be medium sized companies. The share prices are usually in the dollars to 10s of dollars. These are somewhat volatile but not as much as small cap stocks and more volatile than large cap stocks.

Large cap stocks are what the bulk of the stock market is made of. These are massive companies that are well developed. Shares of these companies are usually in the 10’s of dollars to 100’s of dollar ranges. These stocks are generally more stable and don’t fluctuate as much as it will take huge volumes of activity to greatly affect the share price.

When you watch the news at night and here that “the ASX all ords closes x amount of points lower today” or something like that, that is the performance of the stock market as a whole that day. When stock markets as a whole move mostly up, that is called a bull market and when they go down it’s called a bear market.

Before the internet and smart phones, if you wanted to buy shares, you would need to pay for the services of a stockbroker who would give you advice and purchase the shares for you in exchange for a commission.

Now day’s stockbrokers still exist however anyone with a smart phone or computer can open an online trading account and purchase shares by themselves for a transaction fee.

I hope you have enjoyed reading my article about how the stock market works, this is meant to be an introduction to the stock market and not a “how to” invest in shares. I am not a qualified investment professional and before making any share investments you should seek the advice of a qualified professional.

Thanks for reading!

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