How do markets work?

You may read or hear about the performance of the national and international stock markets on a daily basis without being 100% clear about exactly what they are, how they work, or what function they perform. If this sounds like you, then read on to learn more.

What is the stock market?

First things first, this is the question that needs to be answered before anything else. The stock market is the place (“market”) where investors go to buy and sell investments. These investments are most commonly “parts” of a company (or “stocks”).

Each country has their own stock market, or markets. For example, Italy’s is called the Milan Stock Exchange, Britain’s is the London Stock Exchange, and the USA actually has three; the New York Stock Exchange, NASDAQ, and the American Stock Exchange.

What is the difference between the stock market and an index?

You may be familiar with the names S&P 500, Dow Jones, FTSE 100, or the DAX: these are all indices.

An index is nothing more than a compilation of companies put together to measure a specific sector of the market, or to serve as an overall indicator of the health of a country’s economy. For example, the FTSE 100 is an index of the top 100 companies that are traded on the London Stock Exchange with the highest market value. Because of this, the FTSE 100 is often looked to as an indicator of how well the British economy is doing. People believe that if the FTSE is up, the economy is up.

Why and how do companies get involved in the stock market?

One of the main reasons companies get involved in the stock market is to raise capital. By entering the stock market they are electing to sell parts of their company to investors in exchange for money.

Only publicly traded companies can be listed on the stock market. This is a company which has held an Initial Public Offering (IPO) in which they made their shares available to the public to buy on the stock market. In the UK a publicly traded company will have the letter PLC after its name. Public companies are required to disclose their figures each year so that the market and their shareholders, are able to see how they are performing.

Privately owned companies can offer stocks to their shareholders, but this done privately, without being listed on the stock market. In the UK, private companies are followed by the letters Ltd. Some companies prefer to remain private as they feel they can retain more control over the decisions and direction of the company, and because they do not wish to share ownership at that time.

How do investors make money in the stock market?

It’s important to remember that returns are never guaranteed with any investment, as all investment products carry an inherent degree of risk. However, there are a few strategies you can employ in order to try and increase your potential returns.

You can buy low and sell high. You can either buy shares in a new, unknown company, or in a company whose shares are currently trading at a low price, with the intention of selling them on if the value increases. If a company’s shares are trading at a low price you need to be confident that it is not a true representation of their value, and that they have the potential to be worth a lot more; otherwise you won’t make money on your investment. Remember there is no guarantee that the value of your investment will increase as you wish it to.

You can buy and hold. This is usually a recommended good practice. Do your research into a company that has done well historically, published sound figures, and has strong plans for future growth. Once you understand it and you decide you want to buy a piece in it, you then hold onto that piece for a long time; sometimes even decades. The theory is that over time a strong company will continue to develop and your share value will increase (not to mention that you may receive dividend payments). Again, it’s important to note that there is no guarantee that this will assure you any returns on your capital.

Your capital is at risk, and past performance may not be a reliable  indicator of future results. Oval Money is not permitted to provide  financial advice, and if you have any questions please consult an expert.

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