What is the stock market, how does it work and how can I invest?


If your only knowledge of the stock market comes from watching the news and seeing where the FTSE 100 index ended the day, you may have just a vague idea of what it is and how it works.

Or perhaps you have invested in shares, either directly or via a fund or a pension, having done so without really understanding what stock markets are for.

If you are in either category – and you will be very far from alone if you are – it’s a good idea to start from the beginning to understand what the stock market is, what it achieves and how it works. This solid foundation can help you go on to make your money grow.

We’ll also explain the role of the various professionals and organisations connected with the stock market – such as stockbrokers, the stock exchange itself and fund managers – and what terms such as “index fund” and “stock market bubble” actually mean.

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Any market exists to bring together buyers and sellers. In the case of the stock market, the goods on offer are shares (or sometimes other financial assets, such as bonds).

“Share” is perhaps, like the stock market itself, a term that is more often heard than fully understood.

It is a certificate, real or electronic, that represents part-ownership of a business. Collectively, it is the shareholders who own a business, not the managers or directors.

Shareholders are the ultimate decision makers about what the business does and they have the right to all the profits that the company produces.

Your share certificate is proof of your right to a say in those decisions, and to the appropriate share of the profits (the company also maintains a central register of all shareholders).

If you want to buy shares, in most cases you will need to buy them on the stock market. The exceptions are private companies, whose shares are not traded on the stock market – sometimes people own shares in a family shop or other business, for example.

There is, however, one key difference between a stock market and a market that sells, let’s say, fruit and vegetables. This is that there are two circumstances in which an investor, private or professional, can buy shares in a particular company.

The first is when the company invites investment as a means to raise money from those investors. This takes place when the shares are first admitted to the stock exchange (the terms “stock exchange” and “stock market” are broadly synonymous).

In this case, the investor’s money goes to the company concerned, which issues shares to the investor in exchange. Here, the market is bringing together those who have capital (the investors) and those who need capital (the company). Hence the stock market is a particular example of what are called the “capital markets”.

The term given to the raising of money via the stock market is variously a “flotation”, “float”, “listing” or “IPO” (initial public offering).

The second circumstance relates to the trading of shares. Once the shares in a particular company have become available on the stock market, they can be traded there.

The difference between this type of trading and the initial raising of money just discussed is that one investor is selling to another – the company itself is not involved and does not receive the money raised by the sale of the shares; that money goes instead to the investor who is selling.

To distinguish between the two activities, the initial raising of money from investors by the company takes place on what is called the “primary market” and the subsequent trading of shares between one investor and another on the “secondary market”.