Understanding Stock Market— Definition, Functions and Importance of Stock Market and How It Works

ByMd. Mizanur Rahaman Mizan Published on 0

Table of contents

What Is the Stock Market?

Stock market refers to a number of exchanges where shares of publicly traded companies are bought and sold. The terms ‘stock market’ and ‘stock exchange’ are frequently used interchangeably. We can say, “The stock market is where investors come together to buy and sell investments, most frequently stocks, which are fractional shares of a publicly traded company.”

In most countries, the stock market serves two vital purposes: As a dedicated market for securities, it ‘ensures liquidity’ and consequently ‘encourages people to channel their money into corporate investment’. As a pricing mechanism, it transfers capital across enterprises by calculating prices that reflect the underlying investment worth of a company’s shares.

The stock market is a network of exchanges where securities such as stocks and bonds are traded. In the United States, the terms “the stock market” and “Wall Street” can refer to the full world of securities trading, including stock exchanges where public company shares are listed for sale and marketplaces where other securities are traded.

Understanding the Stock Market

A stock market or stock exchange makes it possible for stock brokers to trade firm stocks and other securities. Buyers and sellers of securities can meet, interact, and deal in the stock market. Stock markets enable the discovery of corporate share prices and serve as a barometer for the general economy. As market players compete in the open market, buyers and sellers are assured of a fair price, strong liquidity, and transparency. Although it is called a stock market, it also trades other securities such as exchange-traded funds (ETFs).

A stock exchange is a tightly monitored and regulated environment. The Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) are the two main regulators in the United States (FINRA).

The early stock exchanges produced and traded tangible share certificates made of paper. Today’s stock exchanges are run electronically.

How the Stock Market Works?

The stock market assists corporations in raising funds to fund operations by selling stock shares, as well as creating and sustaining wealth for individual investors. Companies raise funds by selling ownership stakes to investors on the stock market; these equity stakes are known as shares of stock Stock markets provide a safe and regulated environment in which market participants can confidently trade shares and other qualified financial instruments with zero to low operational risk. The stock markets function as both primary and secondary markets, according to the guidelines established by the government.

The stock market, as a primary market, enables corporations to issue and sell their shares to the general public for the first time through the process of an initial public offering (IPO). This practice assists businesses in obtaining the funding they require from investors.

A company or a  business farm divides itself into shares and sells parts of those shares to the general public for a price per share.

The stock market facilitates this process by providing a marketplace where these shares can be sold. A publicly traded firm may also offer new, additional shares in the future through further offers, such as rights issues or follow-on offerings. They may even repurchase or delist their shares.

Investors will purchase firm stock in the hope that the share price will rise or that they will get dividend payments, or both. The stock exchange serves as a facilitator for this capital-raising process and is compensated for its services by the company and its financial partners. Investors can use stock exchanges to acquire and sell shares they already possess in the secondary market.

The stock market has a number of market-level and sector-specific indicators, such as the S&P (Standard & Poor’s) 500 index and the Nasdaq 100 index, that provide a way to track the overall market’s performance.

The stock exchange acts as a trading platform for the purchase and sale of existing shares. The secondary market is made up of this. During secondary market activity, the stock exchange earns a fee for each deal that occurs on its platform.

What Are the Functions of a Stock Market?

The stock market ensures price transparency, liquidity, price discovery, and fair dealings in trading activities. It is worth mentioning that the stock market also guarantees all interested market participants have access to data for all buy and sell orders, thereby helping in the fair and transparent pricing of securities.

Stock markets support discovery where the price of any stock is determined collectively by all of its buyers and sellers. Those who are qualified and willing to trade should get instant access to place orders and the market ensures that the orders are executed at a fair price.

Sellers and buyers on a stock market include market makers, investors, traders, speculators, and hedgers. An investor may buy stocks and hold them for the long term, while a trader may enter and exit a position within seconds. A market maker provides necessary liquidity in the market, while a hedger may trade in derivatives.

What Is the Importance of the Stock Market?

The stock market is one of the most popular places for the general population to put their money. Through the issuance of equity shares and the transfer of collected funds to productive sectors that require financial resources to perform and function in an economy, the stock market stimulates the mobilization of domestic savings.

The free market economy includes the stock market. It enables firms to raise funds by issuing stock shares and corporate bonds, and it allows investors to join in the companies’ financial successes, profit from capital gains, and generate income through dividends. The stock market serves as a platform for individuals’ savings and investments to be efficiently directed into productive investment possibilities, thereby contributing to the country’s capital production and economic progress.

Stock markets allow companies to be publicly traded and raise financing. Capital and ownership are transferred in a regulated and safe environment in the stock market. It helps to raise cash and allows firms to grow, expand operations, and generate jobs in the economy.

Stock markets allow investors to invest money in order to potentially profit from the company’s profits (knowing that the risk of losses exists too). Because of the substantial liquidity in most major stock markets, active investors and traders can readily purchase and sell their securities.

Differences between Stock Market and Stock Exchange (Stock Market vs Stock Exchange)

Although the phrases are used interchangeably, a stock market is not the same as a stock exchange.

  1. A stock market is a group of stock exchanges where securities are issued, purchased, and sold; on the other hand, a stock exchange is a meeting place for stockbrokers and traders to purchase and sell stocks.
  2. The stock market has a broader reach because it is made up of several stock exchanges; yet, the stock exchange has a limited scope because it is part of the stock market.
  3. When compared to stock exchanges, the volume of trade in a stock market is often higher. On the contrary, the volume of transactions for a stock exchange is often lower when compared to the whole stock market.
  4. The stock market does not serve as a clearinghouse; instead, the stock exchange does.
  5. The primary function of a stock market is to serve as a meeting place for diverse stock traders to perform trading operations; nonetheless, stock exchanges exist to benefit from investors’ trading activity.
  6. Examples:
    • Some of the examples of stock markets are the India Stock Market, European Stock Market, American Stock Market, Japanese Stock Market, etc.
    • Some of the examples of stock exchanges are National Stock Exchange, New York Stock Exchange, Shanghai Stock Exchange, Bombay Stock Exchange, Bangladesh Stock Exchange, Chattagram Stock Exchange, etc.

Conclusion

A stock market is the gathering of buyers and sellers of stocks (shares) which represent ownership claims on businesses; these may include securities listed on a public stock exchange as well as stock that is only traded privately, such as shares of private companies sold to investors through equity crowdfunding platforms. Investments are typically undertaken with an investment strategy in mind.

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