How Does the Stock Market Work?

The stock market is all about companies and dividends and before investing your money in stocks options you need to understand how does the stock market works.

The birth of a company

At the beginning there are entrepreneurs with an idea and a vision. That is transformed gradually into project, but to materialize it they need capital or assets such as machines. These assets are brought by investors, sometimes the contractors themselves. In exchange for these contributions, each investor was awarded with shares of the newly created company.
Then investors become shareholders each with a percentage of the company determined by their contribution. It is important to remember that an action is nothing more than a share of the company. You therefore become owner of a part of the machines, the stock of cash and everything the company owns. The company is therefore launched and can start its activity.

How does the stock market work?

Image courtesy of [photokanok] / FreeDigitalPhotos.net

The search for new capital on the stock exchange.

After some time the company needs to invest to continue to grow.
There are two options: to borrow money or to issue shares.
When it borrows money from a bank or investors, it works int he same way as it would with you with  your banking institution with regular repayments.
The second option is to offer shares on the stock market. Investors buying these shares bring new capital to the company.
This means that if the total number of shares of the company increases, the share of the company for each share or action decreases.
It is better for the company to have an action from the available 100 which gives right to 1% of the company than 1 action out of 10000 which gives the right to 0.01%. Investors are therefore the new owners of the business.

As long as they keep their shares they receive a part of the distributed dividends and have the right to vote at the general meeting of the company.

In the mean time the stock trade evolves. One day a shareholder decides to sell his shares, he sells them to the market price and gets back more value if the course has mounted since its purchase or a less value otherwise.
As soon as the shares are sold, the rights to the company are obviously lost.

How to buy shares on the stock exchange

There are two markets for the purchase of shares:

The primary market.

When the company goes public and offers directly to investors the shares at a fixed price determined by the company itself.

The secondary market.

It is when investors exchange shares between themselves by buying and selling in the stock market without the intervention of the company.
The price is then determined by a confrontation between supply and demand. Note that companies may decide to buy back some shares which is a sign of good health and good news for shareholders. The stock exchange is a market regulated by the financial markets authority in your country. The companies listed should have the obligation to provide information regularly about:

• Their annual accounts once per year.
• A financial report, an activity report and report of the Auditors.

Many companies have habit to publish quarterly financial and activity reports to inform investors.

Why not all companies are in the stock market

Do you see how does the stock market work? Some times investors are making decisions on the company and certain managers don´t like that. Specially if they don´t own a mayor number of stocks, they´ll have no voice.
Being ruled by investors add pressure on performance and reports but especially this imposes additional pressure on leaders. If the stock price is too low, the company could be acquired by a competitor or by investors who would impose a different management policy.

The leaders of the largest companies have part of their remuneration which consists of actions, they have therefore every interest in the fact that the course rises to make a profit on the future resale. Another advantage of a high stock price is that it facilitates the supply of new capital.

Let´s say that the company needs $ 1000, and its course is € 10 then it will issue 100 shares. If its course is € 1 it will be obliged to issue 1,000 shares.
The more it issues shares and the more the value of each is one 'diluted' or low, which is not interesting for investors.

What is a stock market index

A stock market index is a set of values which reflects the global movement of the companies that make it up.

Some examples in America are:

• Dow Jones
• S&P 500
• NASDAQ

In Europe:

• FTSE 100
• CAC 40
• Swiss Market Index

In Asia:

• Nikkei 225
• Hong Kong Hang Seng Index

Usually the number after the name represents the number of companies that are included in the index. For example, the CAC 40 index is made of 40 companies.

There are many other products that are traded on financial markets besides the stocks, such as bonds, warrants or raw materials. I did not go in the details on this article on how does the stock market work because they are more complex and need to be explained more extensively.
And now, do you understand how does the stock market work?