The stock market: what is it and how does it work?

How does the stock market work?

Picture a traditional marketplace – vendors selling their wares, while buyers mill in between the stalls looking at what’s on offer, negotiating pricing and purchasing goods, or trading one item for another. This is very much the way the stock market works – just in a digital, online form.

Companies looking to make more money or create cash flow for their business will list its stock on an exchange (in a form called securities) for other entities to buy. If buyers are interested in owning shares in that company, they’ll purchase them. All this happens on and through the stock exchange.

Like an old-fashioned market, the buyers (you as an investor via a broker, or a fund via an asset manager) will assess a stock. You may then offer to purchase it at what’s known as the ‘buy price’. This is the amount a stock is worth at any given time as determined by supply and demand and conditions of the overall market. Whatever amount the stock goes for, that’s called the share price.

Once the deal goes through, you as the shareholder can in turn sell the stock you purchased to another entity via a broker. This can be for a higher amount than you paid for it to make a profit, or for a lower amount to make a loss.

Stock exchanges, like markets, are public venues – so a company needs to list their stock on an exchange as a public entity. Companies are publicly listed and ‘debut’ on an exchange in a process called an initial public offering (IPO for short).

What’s a primary stock market?

A primary stock market isn’t an exchange, but rather a specific time in the life cycle of a stock. The first-time stocks are publicly traded in an IPO is on the primary stock market.

Once an IPO has been completed and a stock is officially listed on an exchange, its shares can be publicly traded on that stock exchange. This is known as a secondary market.

What is a stockbroker?

A stockbroker is the person who deals for you on the stock exchange.

Just like only public companies as sellers can list stock on an exchange, only registered buyers can interact on the stock exchange. This means you as in individual can’t personally buy shares on a stock exchange – you’ll have to use a stockbroker to execute your deals for you.

A stockbroker is an entity legally authorised to buy and sell on a stock exchange, and they’ll do so on your behalf, usually charging a commission for their services.

To use a stockbroker, you’d typically open a share dealing account. Your funds to buy and sell shares, as well as any of the ones you’ve bought, will be held in this account. The account is also where dividends will be paid into.

We’re an example of a stockbroker, as we enable you to buy or sell on an exchange. This means you’ll tell us which investments you want to make and we’ll carry them out for you. Stockbrokers like us may also offer managed portfolios: these are portfolios that invest in a collection of ETFs and are managed for you by our experts.

3. Place your order

You can then open your first position on our share dealing platform by placing an order.

4. Monitor your position

Once you’ve placed your deal, you’ll need to keep an eye on your investment to determine when the right time to close your position is. If you’ve bought shares, that means selling them on our platform.

What is market volatility?

Market volatility is how much assets’ prices rise and fall, and how rapidly, and it’s also a significant factor affecting stocks’ pricing. When prices tend to rise and fall sharply, suddenly, that’s when a market is considered volatile. When prices don’t fluctuate significantly and move comparatively slowly, that’s called a ‘flat’ market.

The more volatile a market is, the more profits and losses you can make and the faster they can happen. For this reason, it’s often wise to choose stocks at first that move relatively little (ie are flat and have low volatility) if you’re still new on your stock investing or trading journey.

What are the risks of investing in stocks?

For all the benefits of investing in shares, there are risks, too. This isn’t in and of itself a bad thing – there is no reward without risk. Rather, you need to know and manage your risk to reap all the rewards that being a shareholder can bring.

These are the ones you’ll most likely face if you choose to invest in stocks:

• Investment risk is the blanket term for all of the possible risks your stock will face. It simply means the danger of incurring losses or a lower-than-expected return on investment
• Business risk is the dangers faced by the company you’ve invested in, and could in turn affect the share price. An example would be significant management restructuring or cash flow constraints in the business
• Unsystematic risk (also known as idiosyncratic risk or specific risk) is just a fancy term for risks that are unique to a particular company. If, for example, you’ve invested in a company that’s CEO is known for wildly affecting the share price with their social media posts, that’s an unsystematic risk that stock poses
• This particular example above is called headline risk – the danger that negative publicity for a company will impact their share price
• Liquidity risk is the chance that you’ll encounter circumstances that mean you need to sell your stocks in a hurry, to increase your liquidity, and may not get a good price for them as a result
• Market risk is much more general to the macroeconomic environment. It’s the ongoing risk of the market fluctuating up and down, affecting your stock’s prices
• The broad umbrella term for risks that affect not only your stock, but all assets, is systematic risk – risks that plague the whole financial system
• One type of systematic risk is commodity price risk. This occurs when extreme fluctuations in commodities’ prices have a knock-on effect on stocks’ prices
• Inflation risk is the chance that a country’s rising inflation, which causes the value of money to decrease. Because of this, the monetary value of your stocks’ worth can lessen
• Legislative risk is also on a national level. It means the chance that government decisions, for example increased red tape or regulatory burdens for corporates, will in turn affect the bottom line of businesses and their stock prices