What is the stock market and how does it work?

When we talk about “the stock market”, we could actually be referring to any one of many stock exchanges around the world.

A stock exchange is where shares in companies are issued, bought, and sold.

These exchanges have two main purposes: to enable the companies listed on them to raise money; and for individuals – and institutions – to trade their shares.

There are stock exchanges all around the world, with the oldest having been around for some 300 years. The membership requirements will vary between them.

As far as companies are concerned, potential investors are spoilt for choice. There are now more than 43,000 listed companies, according to data compiled by The World Bank.

 

Why do companies list on a stock exchange?

Companies looking to raise money – without having to take on debt – may decide to sell shares in their business to investors. They may want to fund expansion plans, raise their profile in the industry, or even put themselves in a better financial state by clearing existing debts.

The process starts with an Initial Public Offering (IPO). This refers to the company going from private ownership to public. This is also where the term ‘going private’ originates.

Once listed, a company will be required to follow set rules, disclose information about their businesses, and allow shareholders a say in how it operates.

What are the biggest global stock exchanges?

The New York Stock Exchange (NYSE) is the largest in the world, with a total equity market capitalisation of around $22.1tn*. Its origins date back to the so-called Buttonwood Agreement signed by 24 stockbrokers on 17 May 1792, in response to a financial panic. This set rules for how stocks could be traded.

Other large exchanges include the NASDAQ, which is also based in the US, China’s Shanghai Stock Exchange, and Euronext in Europe.

The London Stock Exchange (LSE), whose origins can be traced back to 1698, is smaller than some of its rivals but is still widely regarded as very important in financial circles. In 2021, it became the largest centre for IPOs globally outside of the US and Greater China, when it welcomed more than 120 additions to its ranks.

*Statistica, Oct 2022

What are stock market indices?

With so many thousands of companies listed on the many exchanges, there needs to be a way to break them down into more manageable lists. That’s where stock market indices come into play. These track the performance of groups of stocks that are defined by categories such as their size or their industry.

There are numerous indices within the various international exchanges, and they all enable prospective investors to focus on particular types of companies. For example, the S&P 500 is a list of the 500 largest companies in the United States.

 

The FTSE 100

The FTSE 100 was founded in 1984 and is an index that’s made up of the 100 largest companies listed on the London Stock Exchange, ranked in order of their market capitalisations.

This ‘market cap’ figure is calculated by multiplying the company’s stock price by the number of shares that it has issued.

People will often refer to this index as ‘the footsie’, with news reporters often using it as a barometer when discussing the health – or otherwise – of UK investing.

Today, however, this index is full of global businesses whose revenue streams are earned around the world. This makes them far less affected by the domestic UK economy.

 

How does the FTSE 100 work?

The FTSE 100 is reviewed four times-a-year – in March, June, September, and December – to ensure only those companies with the highest market caps are included. The process is overseen by FTSE Russell, a global index provider that provides a range of benchmarking, analytics, and data solutions for investors.

“The rules-driven, impartial quarterly reviews ensure the indexes continue to portray an accurate reflection of the market they represent and form an essential component to the management of the indexes,” it has stated. This means that stocks can be demoted to – and promoted from – the FTSE 250 index. As its name suggests, this is an index for the next 250 largest companies.

You may also hear the term ‘FTSE All-Share index’. This is the combination of the FTSE 100, FTSE 250 and FTSE SmallCap indices. This covers almost 99% of the UK equity market’s capitalisation.

The FTSE SmallCap index, meanwhile, are those businesses that are too small to be included as part of the 350 largest quoted stocks.

*Source: Statistica, October 2022


Photo by Kelly Sikkema on Unsplash

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