The stock market is one of the most important tools for big business.  It allows businesses to raise finance quickly whilst enabling fund managers to provide a return over time for savers and pension payments, all of which are positive things for the long-term health of the global economy.  But what exactly is the stock market, and how does it work?

The phrase ‘stock market’ is similar to the expressions of a currency market, or really a market for anything – that is, a place (although not necessarily a physical location) where buyers and sellers meet to do business over a particular subject, in this case ‘stock’. 

Stock refers to company securities in the form of shares, which are best described as proportional voting rights (and income rights) in a particular company.  On the stock market, these are bought and sold for a value, almost always at a premium over their notional value (which represents the extent of liability the shareholders bears to the company in the event of insolvency). 

The stock market works because there is a ready trade in company securities.  That’s because they provide a valuable option for investors looking to realise a return; from large investment funds to the average part-time wealthy individual.  In return for the value of the share, the purchaser can expect to receive the right to transfer the share at a later date for value, along with the right to vote at company meetings and the right to receive any dividend (i.e. profit distribution) declared.  Therefore, buying shares presents a two-fold approach to realising a profit: resale at a higher price, or retention to benefit from annual dividend payments. 

For businesses (or rather public companies), the stock market provides a means by which capital can be raised quickly and fluidly.  As the company goes public, its original owners can make a fortune as their stocks are issued to the investing masses for the first time and snapped up by brokers and portfolios keen to jump on the bandwagon.  The finance raised from the offering is paid to the company which increases the subsequent value of the original stakes held by the private shareholders thus creating wealth for the entrepreneurs and generating funds for the business.

For that reason, companies tend to only move to market where they require to raise funds or where they are looking to expand.  And because of the flexibility of the stock market, it is possible for companies to buy back shares at a later date where finance is less of a concern to preserve capital and improve value for longer term shareholders.

The price paid per share on the stock market is wholly determined by market prices, so to the potential profit available from any particular trade comes as a result of the mood of the market.  Where the market is in a positive, buying mode, prices will generally increase because there is a greater demand for the shares so traded.  Likewise the reverse is true, and where the market is suffering a crisis of confidence, you can be sure that’ll be reflected in the ultimate share price attainable during that day’s trade.  The problem is however that investment firms are so eager to protect client interests that the slightest hint of economic uncertainty can lead to mass panic and cause significant devaluations in a matter of hours.  The stock market never was for the faint of heart!