Stock market

A stock market is a market for the trading of publicly held company stocks or shares and associated financial instruments (including stock options, convertibles and stock index futures). Traditionally such markets were open-outcry where trading occurred on the floor of an exchange. These days increasingly the markets are cyber-markets with buying and selling occurring via online real-time matching of orders placed by buyers and sellers.

Many years ago, worldwide, buyers and sellers were individuals investors and businessmen. These days markets have generally become "institutionalized", that is buyers and sellers are largely institutions whether pension funds, insurance companies, mutual funds or banks. This rise of the institutional investor has brought growing professionalism to all aspects of the markets.

How it works

The movements of the prices in a market or section of a market are captured in price indices called Stock Market Indices, of which there are many e.g. the Standard and Poors Indices and the Financial Times Indices. Such indices are usually market capitalisation weighted.

There are stock markets in most developed economies, with the world's biggest markets being in the USA, Japan, the UK, and Europe. There are global stock market indices that, because they delineate the global universe of stock opportunities, shape the choices and distribution of funds of institutional investors. The character of markets around the world varies, for example with the majority of the shares in the Japanese market being closely-held (by financial companies and industrial corporations) compared with the structures of ownership in the USA or the UK.

Derivative instruments

An option is a contract to buy or sell something at an agreed-upon price during a specified period. A buyer who believes that the price of a stock will rise can enter a contract known as a "call" which gives him the right to buy another's stock at a date three to nine months in the future. He pays a fee to the owner of the stock and will forfeit it if he does not exercise the option. But if the stock price rises enough, he can exercise the option and buy the stock at the fixed price, then re-sell it for a higher price to recover his premium and make a profit.

Someone who thinks that the price of a stock is about to fall can write a "put" contract with someone else who agrees to buy the stock at a fixed price. He does not have to own the stock at the time the contract is made. Again, he pays a premium. But if the stock price does fall, he can buy the stock at a low price on the market and then sell it for agreed-upon higher price.

Option contracts are traded like stocks, often by people who have no intention of exercising them. Although there is a guaranteed loss of the premium when an option is not exercised, there is enormous potential profit from trading the option itself--its price rises or falls with the price of the underlying stock. Someone who has a guaranteed buyer for 10,000 shares of stock at $35 has a contract of enormous value if the price of the stock falls to $10. He may not want to invest $100,000 to fulfill the contract and earn $350,000. But someone will want to buy the contract from him for more than he paid for it.

There are also two sorts of trades involving cash or stock not actually owned, short selling and margin buying. In short selling, someone sells stock that they don't actually own, hoping for the price to fall. They must eventually buy back the stock. In margin buying, someone borrows money to buy the stock and hopes for it to rise. Most industralized countries have requlations which require that if the borrowing is based on collateral from other stocks, then it can be at only a certain percentage of those other stocks value. Other rules include a prohibition of freeriding, that is, putting in an order to buy stocks without paying intially, and then selling them and using part of the proceeds to make the original payment.

Stock Market Regulation

Before 1929, there were few regulations governing trades. This was taken advantage of by the so-called "Robber Barons", to amass the large fortunes for themselves using (today illegal) techniques.

Since then, there have been periodic attempts to solve other perceived business problems with further regulation. As of this writing (in 2002) there is a stock market downturn that is prompting such considerations in the United States.

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