What Is Stock Market?

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The market operates via over-the-counter (OTC) or stock exchanges that list the stocks of the companies issuing shares for trade. Some widely preferred exchanges include New York Stock Exchange (NYSE), NASDAQ, National Stock Exchange (NSE), etc. Here, investors can opt for both short-term and long-term investments.

Key Takeaways

  • The stock market works on the basic principle of matching supply and demand through an auction process where investors are willing to pay a certain amount for an asset and sell off something they have at a certain price. Each asset has a value with individual preference and price facilitating the ultimate asset valuation as the market determines.The market works like an anonymous auctioning machine – one person auctions assets and waits for another person to bid the right amount.The stock market encourages active investments rather than passive ones.

Stock Market Basics Explained

A stock market definition is similar to a market for buying and selling goods and services. It is a marketplace where financial instruments are bought and sold in exchange for money. The trade helps companies raise funds to develop and grow their business, making investors earn profits when the firms perform well and incur losses when they do not perform per expectations. 

The emergence of this market can be traced back to the 1600s when the Dutch East India Company sent multiple ships on voyages to trade gold, porcelain, spices, silk, etc., around the world. However, these voyages were quite expensive. Thus, the traders approached citizens to fund the transportation in exchange for a portion of the profits. 

Given the income generated by funding the trips, the individuals invested in the voyages. The process helped businesses fund grand voyages, thereby increasing profit-making scopes. This sale of shares made the Dutch East India Company the originator of the stock market investing idea.

Process

With time, the companies aiming to raise funds to grow their business listed themselves on a stock exchange to make their share available to be bought and sold. They introduce their stocks for investments, and the investors spent on them, sponsoring the company’s initial public offering (IPO), which finally made the stocks of the company public.

The buyers who find the stocks profitable can purchase them in lots. The lot size is the number of stocks offered for sale or asked for at a certain price. If the stock value rises in the long run as expected, given the company’s improved performance, the investors reap profits. On the other hand, if the stock value decreases because of the poor performance of the business, the buyers have to sell the stocks at a lower rate to hedge risks. The investors may also receive profits through dividend payments.

The market, however, does not always go up. There have been multiple instances of a stock market crash, which has been triggered by a sudden steep drop in stock prices within a specific day. The crashes are normally caused by natural disasters, speculations, and investor panic arising from rumors.

The market remains open throughout the year from Monday to Friday from 9:30 a.m. to 4:00 p.m. eastern time except for the yearly trading holidays and decided half-days. The U.S. Securities and Exchange Commission (SEC) regulates and monitors the stocks on the exchanges. 

Factors

A stock market works on multiple parameters that determine the sale, purchase, pricing, and fluctuations occurring in the market.

1. Demand & Supply

It uses demand and supply as the driving force. As good as this is, other derivativesDerivativesDerivatives in finance are financial instruments that derive their value from the value of the underlying asset. The underlying asset can be bonds, stocks, currency, commodities, etc. The four types of derivatives are - Option contracts, Future derivatives contracts, Swaps, Forward derivative contracts. read more depend on stocks, and people can change the supply to move the option prices in the direction they want. The anonymity makes it tough to trace back to the owner.

The line ‘D’ is the demand, and ‘S’ supplies, with a horizontal axis being the quantity (q) and the vertical axis (p) being the price. Here, as price increases, supply increases, and demand decreases. The point of the stock market is to find a midpoint and proceed with the transaction.

2. Pricing

The price labels associated with a company’s stocks differ – market price, bid price, and ask price. 

The market price is the current value of the stocks. It could be of two types – opening price and closing price. While the former is the market price at which stock opens at the beginning of the day, the latter is the last price at which the stock was traded on the previous working day.

When multiple buyers want to buy a stock, they bid for it, and the highest price becomes the bid price. On the other hand, when multiple sellers start selling the stock, they ask for a specific price. The lowest of such prices is the ask priceA Certain Ask PriceThe ask price is the lowest price of the stock at which the prospective seller of the stock is willing to sell the security he holds. In most of the exchanges, the lowest selling prices are quoted for the purpose of the trading. Along with the price, ask quote might stipulate the amount of security which is available for selling at the given stated price.read more. The transaction occurs when the highest bid and the lowest ask prices meet.

Example

Take an example of one of the most traded stocks ever – Apple on NASDAQ. NASDAQ is the exchange that deals with the stocks of the technology giants.

The current trade price for Apple (AAPL) is 204.23, but on June 3rd, it closed at 204.41 and opened at 203.35 the next day. On July 3rd, the stock’s highest price was 204.44, and the lowest was 202.69 – one should consider that these are the traded highs and lows, not the ask and bid highs and lows.

These details are taken from Ameritrade as the broker, and the bid and ask spreads are as follows for a certain point on July 3rd.

Observation

In the above table, 203.84, 203.87, and 203.88 USD are unavailable; no one has specifically bid at that price. Therefore, the bid sizes are the number of stocks asked for at that price. The same is the case with the asking price. If the 203.90 (highest bid price) and 203.97 (lowest ask price) match, the stock market executes the transaction, and the lot sizes are deleted.

So, if the demand is more, the bid prices go up, and as the transactions are conducted, the prices rise, and the transaction occurs at the highest available rate.

The difference between the highest bid and lowest ask prices is called the bid-ask spread, which helps gauge the stock’s liquidity. Since Apple has highly traded stocks, such situations where the bid and ask are about six ticks (each tick in the USA is 0.01USD) are rare.

Stock Market vs Share Market vs Cryptocurrency vs Real Estate

The stock market is synonymously used with the share market. However, the market may differ based on the type of financial instruments and vehicles in which investors transact or deal.

Let us have a quick at the differences between them:

This article has been a guide to what is Stock Market. We explain its basics, factors, an example, & compare it with the share market, real estate, & cryptocurrency. You can learn more about accounting from the following articles –

The global stock market normally remains open Monday through Friday from 9:30 a.m. to 4:00 p.m. eastern time. In addition, the market remains open even before it officially opens from 6:30 a.m. to 9:30 a.m., and the after-hours trading begins at 4:00 p.m. and continues through 8:00 p.m.The market remains closed nine days a year and has scheduled half-days when it closes at 1:00 p.m.

A stock market crash occurs when there is a sudden fall in stock prices. The decrease in the prices of the shares is witnessed when there is an economic event that leads to severe fluctuation in the market, speculation that increases the buying pressure in the market, and investor panics that arise because of fake news or rumors. Some such crash examples include the 1929 Great Depression, the 2001 Dotcom Bubble Burst, the 2008 Financial Crisis, and the recent 2020 COVID-19 pandemic.

The market comes up with multiple options for investors to invest in. They can invest in stocks, mutual funds, bonds, options, annuities, bank products, retirement, ETFs, etc.

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