Stock Market

What is the Stock Market?

The stock market refers to public marketplaces where stocks and other securities are issued, bought, and sold. They allow corporations to raise capital for expansion and, at the same time, they let individual and institutional investors trade and invest in these businesses.

Some key components of the stock market include stock exchanges, over-the-counter (OTC) private networks, institutional investors, retail investors, investment banks, stockbrokers, and market indexes.

Techopedia Explains: How to Understand the Stock Market?

The stock market facilitates the trading of common and preferred shares issued by businesses. It works through a network of stock exchanges that provide the platforms and systems for trades to be executed.

Some of the most well-established and largest stock exchanges include the New York Stock Exchange (NYSE), Nasdaq, London Stock Exchange (LSE), and Tokyo Stock Exchange.

When a private company goes public, it performs an initial public offering (IPO). Through this procedure, the business lists its shares and makes them available to the public.

In exchange, they raise capital via the stock sale while investors gain ownership over a portion of the company and decision-making power based on the percentage of the business they have acquired.

Investors can then buy more shares or sell their holdings to other parties by using the platforms and systems available at the time.

The price of the stocks fluctuates over time based on supply and demand forces via an auction-like marketplace. Buyers place “bids” or the highest price they are willing to pay for the securities while sellers place “asks” or the lowest price they are willing to accept. When the bid and ask prices are matched, a trade is executed typically with the help of a brokerage firm.

What are the Functions of a Stock Market?

To further expand our stock market definition, we will describe in this section several of its crucial functions within the financial system.

1. Price Discovery: Buy and sell transactions aid efficient price discovery rooted in supply-demand dynamics. This real-time pricing helps market participants determine a fair valuation for each business whose stock is listed or publicly traded.
2. Provide Liquidity: Large volumes traded daily means that stocks enjoy high liquidity. This allows investors to easily enter and exit positions and facilitates the process of investing while reducing bid/ask spreads for more efficient pricing.
3. Help Companies Raise Capital: Companies sell shares via stock exchanges to access and raise more capital. This money helps them finance their growth plans and allows them to stop relying solely on debt issuance.
4. Create Wealth for Investors: Investors aim to generate returns over time through both stock price appreciation and regular dividend income.
5. Drive Economic Growth: By connecting companies and investors, organized stock markets drive economic growth as they allocate capital efficiently across the economy.

Major Players in the Stock Market

There are several key participants that allow stock markets to function adequately. Understanding the stock market starts by getting familiar with who these players are and their role.

How Does the Stock Market Work?

Stock trading occurs via a stock exchange or over-the-counter (OTC). On a stock exchange like the NYSE or Nasdaq, buy and sell orders are matched up electronically via market makers. OTC trading involves a private network of dealers executing trades off-exchange through direct negotiations between the parties involved.

The stock market explained as a systematic process: 

• The stocks purchased during a company’s initial public offering (IPO) are done via investment banks rather than on public exchanges. 
• Investors can trade the stocks on secondary public markets like the NYSE or Nasdaq.
• Most trading activity occurs during regular exchange hours (9:30 am – 4:00 pm EST). 
• Both individual and institutional investors may trade outside these hours during the so-called “extended sessions” or “after/pre-market windows”. Trades placed outside regular sessions are settled privately with the help of broker-dealers and market makers.

Bull vs. Bear Markets

The terms “bull” and “bear” markets refer to sustained uptrends or downtrends in stock prices.

A bull market denotes a rising, optimistic market pushed higher by positive investor sentiment leading to collective buy-side momentum.

A bear market means that pessimism reigns and this results in declining stock valuations as investors sell out positions, fueling negative momentum.

Bull markets generally coincide with economic booms and expansionary fiscal and monetary policies while bear markets often occur during recessions. One followed by the other is the natural market cycle.

However, these market trends can sometimes become irrational speculative bubbles or unwarranted sell-offs that may not necessarily reflect reasonable economic fundamentals.

Day trading refers to entering and exiting positions rapidly within a single trading session to profit from short-term price movements. While day trading is risky, long-term investing based on economic cycles tends to mitigate market volatility.

Portfolio diversity also reduces risks for buy-and-hold investors who are able to ride out bear cycles by sitting on their positions long enough to give the markets time to recover their senses.

How Do Stock Market Indexes Work?

The performance of the overall market is tracked by using stock indexes. These are baskets of stocks that are considered to be representative of the whole market or sectors of it.

The Dow Jones Industrial Average, S&P 500 Index, Nasdaq Composite, FTSE 100, Nikkei 225, and Hang Seng are some of the most popular and widely-tracked indexes.

These indexes serve as benchmarks for how different market sectors are performing. For example, the S&P 500 follows the largest 500 US-listed public companies so its movement is a gauge of the overall state of the US equities market.

Index performance is widely reported by financial media outlets to characterize the market’s daily, monthly, and yearly direction.

The value of indexes is calculated based on the price of their constituent stocks, which are weighted based on the total market capitalization of the companies that issue them.

However, some indexes may offer equal-weighted exposure. As underlying stock values fluctuate intraday, so do these indexes. Index derivatives like index funds, futures, and options are also available to speculate on or hedge investors’ exposure to certain financial assets.

How Do Stock Exchanges Work?

Stock exchanges like the New York Stock Exchange (NYSE) and the Nasdaq act as centralized marketplaces where buyers and sellers can trade any stocks listed on that exchange. They are private companies that self-regulate members and trading activities via a set of listing rules and standards.

These exchanges ensure fair access to all companies that comply with their requirements. They provide real-time trade reporting, dissemination of quotes, trade comparisons, data feeds, and technological infrastructure like data centers and network access that powers electronic trading platforms.

The major functions of a stock exchange include:

• Listing of Securities: Providing companies access to the capital markets by allowing them to list their securities via procedures like IPOs. The permission to list these instruments is granted if listing standards are complied with.
• Trading Platform: The exchange matches buy/sell orders through a trading mechanism that centralizes price discovery rather than buyers/sellers having to connect with each other directly. This makes exchanging financial assets a more efficient and transparent activity.
• Regulatory Oversight: Exchanges take responsibility for ensuring fair and orderly trading activities and enforcing rules among members. The most common rules pertaining to membership criteria, trading mechanisms, and disclosure policies.
• Corporate Governance: Listing rules, reporting requirements, and accountability standards also enforce strong corporate governance and transparent operations among publicly traded companies. This protects minority shareholders’ rights.
• Market Data Services: Stock analysis and research firms rely on real-time and historical market data made available through exchanges for trades, quotes, volume, and corporate actions.
• Index Services: Major market indexes like the S&P 500 that benchmark the broader market are administered and published by stock exchanges.

Understanding Over-the-Counter (OTC) Trading

Over-the-counter (OTC) trading refers to the exchange of financial assets directly between two parties, without going through a stock exchange.

Securities traded over the counter are typically riskier or speculative; hence they fail to meet the formal listing requirements set forth by exchanges. An intermediary like a broker-dealer usually assists customers in the negotiation to settle this type of transaction.

Since OTC stocks don’t meet regulatory reporting standards, due diligence on companies is critical before investing. OTC securities also tend to face lower liquidity and larger bid-ask spreads due to supply/demand imbalances.

This means that entering and exiting positions can be more difficult and expensive. Pink Sheets LLC and the OTC Market Groups are companies that facilitate the trading of these securities.

How is the Stock Market Regulated?

Stock market exchanges are considered self-regulatory organizations (SROs) with rulemaking authority that they can apply to members and listed companies.

However, government agencies and regulators like the Securities Exchange Commission (SEC) in the US oversee SROs to ensure that investors’ and companies’ interests are well protected.

The SEC requires periodical financial reporting by publicly traded companies along with material disclosure of news and events that may influence share prices. Stock trading is closely monitored to identify potential market manipulation, insider trading, front running, and compliance violations, all of which can trigger SEC investigations and fines.

Exchanges must provide access to real-time trading journals and establish price-time priority rules to prevent unfair advantages. Suspending or halting trading may be ordered during times of excess volatility or pending major announcements.

Overall, regulation seeks to uphold organized trading, strengthen confidence in prices, and mitigate risks.

Why Invest in Stocks and the Stock Market?

Here are some of the reasons why over half of Americans invest in the stock market:

• Build Wealth: With stock valuations being primarily tied to companies’ profits, investing provides an opportunity for portfolio appreciation in the long run.
• Generate Income: Many stocks pay regular dividends, which provides passive income to shareholders. Blue-chip stocks with long and positive dividend track records are favored by this type of investor.
• Speculate on Price Movements: Traders aim to profit from short-term price movements based on momentum, trends, or catalysts like earnings and merger news.
• Diversify Assets: Adding stocks helps diversify portfolios beyond real estate, bonds, cash, and alternative investments for improved risk-adjusted returns.
• Hedge against Inflation: As inflation rises, corporate earnings and dividends tend to follow suit, making stocks a suitable inflation hedge in many cases.

Despite periodic bear markets depressing prices, historically the equity market has delivered around 10% annual returns over lengthy periods measured by the performance of the S&P 500. This makes stocks a top choice for long-term wealth generation.

What Time Do Stock Markets Open?

The operating schedules for major global stock exchanges are:

• New York Stock Exchange (NYSE)
  • Opens: 9:30 am EST
  • Closes: 4:00 pm EST
• Nasdaq Stock Exchange
  • Opens: 9:30 am EST
  • Closes: 4:00 pm EST
• Toronto Stock Exchange (TSX)
  • Opens: 9:30 am EST
  • Closes: 4:00 pm EST
• London Stock Exchange (LSE)
  • Opens: 8:00 am GMT
  • Closes: 4:30 pm GMT
• Australian Securities Exchange (ASX)
  • Opens: 10:00 am AEDT
  • Closes: 4:00 pm AEDT

The normal trading session for most major stock exchanges lasts between 8 and 9.5 hours daily from Monday to Friday. Some global exchanges like the LSE and ASX may have slightly shorter or longer sessions. OTC exchanges and after-hours trading provide extended trading schedules outside the typical session.

Exchanges in the same region/country generally follow the same operating schedule with similar entry/exit trading times for investor convenience. Knowing when markets open and close is useful for monitoring daily performance or placing buy/sell orders timely. Certain trading strategies also exploit predictable volatility around market opening and closing hours.

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