How Stock Markets Work - What is a Stock Market

Stock markets are home to extensive trade in shares and other company securities, and they have a crucial role to play in the success of commerce and the overall health of an economy. There are stock markets across the world's global financial centres which regulate markets and run indices on which traders can take exposure with a view to delivering capital growth on the size of their position.

how stock markets work

By trading in stock markets, traders can earn returns that are unavailable in any investment product to maximise the efficiency of their capital. Whether it's a fund manager with billions under management, or a one-man amateur trading operation with a modest capital budget, the stock markets can be the idea way to generate a capital return.

What Is A Stock Market?

A stock market is essentially a virtual forum where buyers and sellers of an asset can meet to trade standardised share instruments. Stock markets are managed by stock exchanges, which accept submissions from public companies to be listed for the public sale of their securities. In order to become listed, companies must meet extensive qualifying thresholds, designed to safeguard traders and ensure a level of standardisation in shares across the market.

Stock markets determine the price of underlying assets, by matching the prices willing to be paid by both buyers and sellers to identify the market price of an asset at any particular time.

What Role Does It Play?

The role of stock markets is an important one, as the portal to funding private business. Stock markets allow companies access to pools of private capital, which can be used to fund business growth and development, or the purchase of new assets. Without access to private funding, businesses would be more constrained in the projects they can contemplate funding and would therefore be unable to truly capitalise on the equity in their company. Similarly, stock markets make it feasible for business owners to ultimately cash out their positions for profit, by selling their shares into the open market. The economic benefits of stock exchanges and stock trading are untold, and without the facility in place for trading equity in this way, companies would find expansion much more challenging.

For individuals and traders, stock markets also have an important role to play in the sense that they allow traders to generate a return on their capital, such that it is worthwhile for capital to be invested in the financial markets. This dual functionality makes it essential for both traders and companies as a means of facilitating the capital flow.

How Do Financial Markets Work?

Stock markets work because buyers and sellers are willing to engage in trade in an asset. When stocks are bought, their value rises incrementally on a per share basis to reflect the growing demand for that asset. When shares are sold, the value is depressed by an equal amount, proportionate to the impact of the share sale on the total market price at any given time. This creates the smooth price curve that markets tend to see, where overarching trends cycle (unless the is underlying growth or depression in the value of the company), allowing traders to buy low and sell high in where the opportunities exist to do so.

How Can It Be Traded For Profit?

In order to trade shares profitably, there need firstly be capital growth in the size of a position. This is achieved by trading in markets that are expected to grow, or by shorting markets that you expect to slide, and any difference between the opening and closing price can represent a capital profit or loss on the individual position. Share dealers are fortunate in being able to profit in a secondary way, in addition to this level of capital growth, through the dividend yield. Dividends are shares in company profits paid out to shareholders at regular intervals throughout the year, and those traders that hold dividend paying shares when the dividend is declared are entitled to receive the payment. This creates two distinct layers of profitability for traders engaging in stock market trading.