Understanding the stock market
The stock market is complicated – and that’s putting it lightly. There are a lot of concepts to grasp and a lot of terminology to learn, but it’s not beyond anyone’s reach. After all, the stock market is designed to be simple enough to get as many people as possible to make use of it. And by learning the fundamentals of the market, you’ll know more about how to get the most out of it – how to do a better job at investing your money with confidence.
What is a stock?
When you buy a stock, you share the ownership of the underlying company. When companies are initially publicly traded, they offer pieces for sale – in exchange for the money you give the company, they offer you a share in their earnings and assets. The stocks (also known as shares) that you’ve purchased can change in value – generally, the more people are willing to pay for a piece of a company, or the more that company is worth, and assuming a constant number of outstanding shares, the more valuable those pieces become. Furthermore, because shareholders are part-owners of the company, they are usually allowed to vote on some corporate decisions.
What is the stock market?
The stock market provides the opportunity to buy pieces of these publicly held companies – either from the company itself, or from other investors. It’s a marketplace, filled with people buying, selling, and trading stocks. However, it’s a little more intricate than a simple swap meet – there are two main components: the primary market and the secondary market.
The primary market refers to the buying and selling of stocks at a company’s initial public offering (IPO). When a privately-owned company decides to sell shares in order to raise capital and expand, the IPO is when it first offers pieces of itself for sale. Investors at IPOs buy their shares firsthand from the company – they are “primary” investors. IPOs are facilitated by brokerages such as Scotia iTRADE®, who can accept expressions of interest on behalf of investors. However, given the frequently limited supply of shares made available, not all primary market expressions of interest are guaranteed to be fulfilled.
The secondary market is what we normally refer to as the “stock market”. Here, rather than buying directly from the companies themselves, investors buy stocks second-hand, from other investors. All stocks traded on the secondary market were first bought on the primary market, then sold by their buyers on the secondary market.
The secondary market also contains two sub-categories of market: auction markets and dealer markets.
In an auction market, everyone who wants to trade meets and announces the prices at which they’re willing to buy (the “bid price”) and/or sell (the “ask price” or “offer price”) stocks. The New York Stock Exchange (NYSE) and Toronto Stock Exchange (TSX) are well-known examples of auction markets. Brokerage firms like Scotia iTRADE act as agents and enable investors to purchase stocks without having to be on the trading floor themselves.
In a dealer market (sometimes called an over-the-counter (OTC) market), multiple dealers (also called “market makers”) list prices at which they will buy or sell a specific stock. The theory is that the competitiveness between market makers will result in the best possible price for the investor. OTC markets do not require a physical trading floor, and most are managed over computer networks. NASDAQ, the National Association of Securities Dealers Automated Quotations Exchange, is a well-known example.
What happens when a stock is traded?
There are a number of steps in a stock trade. To buy or sell a stock, you place an “order” with a brokerage. The brokerage then places the order with the appropriate exchange or dealer, and upon its completion, delivers the stock or money to you. By law, brokerages are obligated to give each of their investors the best possible order execution.
There are also conditional orders, which will be placed normally, but will not be filled until certain conditions of your choosing are met. For example, with a limit order, the order will not be filled until the stock reaches a certain price (the “limit price”). It’s possible that the condition may never be met, so conditional orders also have a term – a time limit.
It’s possible to cancel orders before they’ve been filled, in case you change your mind. It’s also possible to change orders before they’re filled. This lets you change certain parameters of an order – the limit price, the term, and the number of shares to buy or sell.
There are different ways of buying and selling, but the heart of the stock market is always the same: companies that want money now sell parts of their assets and future profits; investors that want money later buy them; investors trade shares with each other to make changes to their personal portfolios. All steps in the process strive for simplicity, because if they’re too complicated, they’ll drive investors away.
Watch our video to learn more about order types.
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