Stock market

The stock market is the market for the trading of company stock, and derivatives of same; both those securities listed on a stock exchange as well as those only traded privately.

Definition

Although common, the term 'the stock market' is a somewhat abstract concept for the mechanism that enables the trading of company stocks. It is also used to describe the totality of all stocks, especially within one country, for example in the phrase "the stock market was up today", or in the term stock market bubble.

It is distinct from a stock exchange, which is a corporation in the business of bringing buyers and sellers of stocks together. For example, 'the stock market' in the United States includes the trading of stocks listed on the NYSE, NASDAQ, and Amex, and also on the OTCBB and Pink Sheets.

Trading

Participants in the stock market range from small private stock investors to large hedge fund traders, who can be based anywhere. Their orders end up with a professional at the stock exchange, who executes the order.

Market participants

Many years ago, worldwide, buyers and sellers were individual investors, such as wealthy businessmen. Over time, markets have become more "institutionalized"; buyers and sellers are largely institutions (e.g., pension funds, insurance companies, mutual funds, investor groups, and banks). The rise of the institutional investor has brought with it an increase of professional diligence which has tended to regulate the market.

For the other side, since the definitive rise in the use of Internet banking in the late 1990s, both casual and professional stock investors around the world have emerged as a potential new kind of major participants in the stock markets.

The ownership of stocks in markets around the world varies, for example the majority of the shares in the Japanese market are held by financial companies and industrial corporations, whereas stock in the USA or the UK are broadly owned, also by individual investors.

History

In 12th century France the courratier de change were concerned with managing and regulating the debts of agricultural communities on behalf of the banks. Because these men also traded with debts, they could be called the first brokers.

In late 13th century Bruges commodity traders gathered inside the house of a man called Van der Bourse, and in 1309 they institutionalized this until now informal meeting and became the "Bruges Bourse". The idea quickly spread around Flanders and neighbouring counties and "Bourses" soon opened in Ghent and Amsterdam.

In the middle of the 13th century Venetian bankers began to trade in government securities. In 1351 the Venetian government outlawed spreading rumors intended to lower the price of government funds. Bankers in Pisa, Verona, Genoa and Florence also began trading in government securities during the 14th century. This was only possible because these were independent city states not ruled by a duke but a council of influential citizens.

The Dutch later started joint stock companies, which let shareholders invest in business ventures and get a share of their profits - or losses. In 1602, the Dutch East India Company issued the first shares on the Amsterdam Stock Exchange. It was the first company to issue stocks and bonds.

International markets

The first stock exchange to trade continuously was Amsterdam's Beurs, in the early 17th century. The Dutch "pioneered short selling, option trading, debt-equity swaps, merchant banking, unit trusts and other speculative instruments, much as we know them" (Murray Sayle, "Japan Goes Dutch", London Review of Books XXIII.7, April 5, 2001).

There are now stock markets in most developed and developing economies, with the world's biggest markets being in the United States, Canada, Europe, Japan, India and the People's Republic of China.

Stock market index

The movements of the prices in a market or section of a market are captured in price indices called stock market indices, of which there are many, e.g., the S&P, the FTSE and the Euronext indices. Such indices are usually market capitalization (the total market value of floating capital of the company) weighted, with the weights reflecting the contibution of the stock to the index. The constituents of the index are reviewed frequently to include/exclude stocks in order to reflect the changing business environment.

Derivative instruments

Financial innovation has brought many new financial instruments of which the pay-offs or values depend on the prices of stocks. Examples are exchange traded funds (ETFs), stock index and stock options, equity swaps, single-stock futures, stock index futures. etc. These latter may be traded on futures exchanges such as Euronext.liffe (which are distinct from stock exchanges), or traded over-the-counter. As all of these products are only derived from stocks, they are sometimes considered to be traded on a (hypothetical) derivatives market, rather than the 'stock market.'

Leverage Strategies

Stock that a trader does not actually own may be traded using short selling and margin buying.

Short selling

In short selling, the trader borrows stock (usually from his brokerage which holds its clients' shares or its own shares on account to lend to short sellers) then sells it on the market, hoping for the price to fall. The trader eventually buys back the stock, making money if the price fell in the meantime or losing money if it rose. Exiting a short position by buying back the stock is called "covering a short position." This strategy is also used by unscrupulous traders to lower the price of a stock. Hence most markets either prevent a short sell or place restrictions on when and how a short sell can occur. These restrictions are usually refered to as tick rule.

Margin buying

Main article: margin buying

In margin buying, the trader borrows money (at interest) to buy a stock and hopes for it to rise. Most industrialized countries have regulations that require that if the borrowing is based on collateral from other stocks the trader owns outright, it can be a maximum of a certain percentage of those other stocks' value. Other rules may include the prohibition of free-riding: putting in an order to buy stocks without paying initially, and then selling them and using part of the proceeds to make the original payment.

New issuance

Global issuance of equity and equity-related instruments totaled $505 billion in 2004, a 29.8% increase over the $389 billion raised in 2003. Initial public offerings (IPOs) by US issuers increased 221% with 233 offerings that raised $45 billion, and IPOs in Europe, Middle East and Africa (EMEA) increased by 333%, from $ 9 billion to $39 billion.

Investment strategies

One of the many things people always want to know about the stock market is, "How do I make money investing?" There are many different approaches; two basic methods are classified as either fundamental analysis or technical analysis. Fundamental analysis refers to analyzing companies by their financial statements. One example of a fundamental strategy is the CANSLIM method, which aims at finding companies with superior earnings growth and heavy buying demand from market participants. Technical analysis studies price actions in markets through the use of charts and quantitative techniques to attempt to forecast price trends regardless of the company's financial prospects.

Additionally, many choose to invest via the index method. In this method, one holds a market capitalization-weighted portfolio consisting of the entire stock market or some large index within the stock market (such as the S&P 500 or Wilshire 5000). The aim of this strategy is not to try to guess which stocks will appreciate faster than others, but rather to maximize diversification, minimize taxes from trading, and ride the general trend of the stock market (which has averaged nearly 12%/year nominally since World War II in the United States).

Finally, one may trade based on inside information, which is known as insider trading. However, this is illegal in most jurisdictions.

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