The term stock market refers to several exchanges where shares of publicly traded companies can be bought and sold. Such financial activities are carried out through formal exchanges and over-the-counter (OTC) marketplaces that follow a set of rules.
The terms “stock exchange” and “stock market” are frequently used interchangeably. Stock market traders buy and sell shares on one or more of the stock exchanges that comprise the overall stock market.
The New York Stock Exchange (NYSE) and the Nasdaq are the two most important stock exchanges in the United States.
What Are the Functions of a Stock Market?
The stock exchange ensures price transparency, liquidity, price discovery, and fair trading practices.
The stock market ensures that all market participants interested in buying and selling securities have access to data for all buy and sell orders, assisting in the fair and transparent pricing of securities. The market also ensures that appropriate buy and sell orders are efficiently matched.
Stock markets must facilitate price discovery, in which the price of any stock is determined collectively by all of its buyers and sellers. Those who are qualified and willing to trade should have immediate access to place orders, and the market should ensure that the orders are executed at a reasonable price.
Market makers, investors, traders, speculators, and hedgers are all types of stock market traders. For example, a long-term investor may buy stocks and hold them, whereas a trader may enter and exit a position in seconds. In addition, a market maker provides market liquidity, whereas a hedger may trade in derivatives.
Functions of Stock Exchange
The following are some of the most important functions of the stock exchange:
- Economic Barometer: The stock exchange acts as an economic barometer, indicating the state of the economy. It tracks all major and minor changes in share prices. It is rightly described as the economy’s pulse, reflecting the state of the economy.
- Securities Valuation: The stock market aids in securities valuation based on supply and demand factors. Securities issued by profitable and growing companies tend to be more valuable. Securities valuation assists creditors, investors, and the government in carrying out their respective functions.
- Contributor to Economic Growth: The stock exchange provides a trading platform for various companies’ securities. This trading process involves continuous disinvestment and reinvestment, which provides opportunities for capital formation and, as a result, economic growth.
- Making the public aware of equity investment: The stock exchange provides information about investing in equity markets and encourages people to invest in securities by issuing new issues.
- Transactional Safety: Transactional safety is ensured because securities traded on the stock exchange are listed, and securities are listed after the company’s position has been verified. All companies listed must follow the rules and regulations established by the governing body.
- Encourages savings and investment: The stock market is an important source of investment in various securities that offer higher returns. Investing in stocks is a better investment option than gold and silver.
- Improved Capital Allocation: Profitable companies will have their shares actively traded, allowing them to raise new capital from the equity market. The stock market assists investors in better allocating capital so that they can profit the most.
- Allows for healthy speculation: The stock exchange ensures demand and supply of securities and liquidity by allowing for healthy speculation on traded securities.
- Liquidity is made easier: The stock exchange’s most important role is to provide a ready platform for selling and purchasing securities. This gives investors confidence that their existing investments can be converted into cash; in other words, the stock exchange provides investment liquidity.
How the Stock Market Works
Stock markets provide a safe and regulated environment in which market participants can confidently trade shares and other eligible financial instruments with zero to low operational risk. The stock markets function as both primary and secondary markets, according to the rules established by the regulator.
As a primary market, the stock market enables companies to issue and sell their shares to the general public for the first time through an initial public offering (IPO). This activity assists businesses in obtaining the capital they require from investors.
A corporation divides itself into shares and sells some of those shares to the general public at a price per share. To facilitate this process, a company requires a marketplace where these shares can be sold, which the stock market provides. A publicly traded company may also issue new, additional shares in the future through other means, such as rights issues or follow-on offerings. They may even repurchase or delist their stock.
Investors will purchase company stock in the hope that the value of the stock will rise. They will receive dividend payments or both. The stock exchange is a facilitator for this capital-raising process and compensates the company and its financial partners for its services. Investors can also use stock exchanges to buy and sell securities they already own in the secondary market.
The stock market or exchange maintains a number of market-level and sector-specific indicators, such as the S&P (Standard & Poor’s) 500 index and the Nasdaq 100 index, which provide a measure of the overall market’s movement.
What Is the Significance of the Stock Market?
A free-market economy includes the stock market. It enables companies to raise funds by selling stock shares and corporate bonds, allowing investors to share in the companies’ financial successes, profit from capital gains, and earn income from dividends. In addition, the stock market serves as a platform for individuals’ savings and investments to be efficiently channelled into productive investment opportunities that contribute to the country’s capital formation and economic growth.
Exchanges, in addition to encouraging management efficiency, also facilitate economic efficiency through capital allocation. Individuals can use stock exchanges to invest their money rather than simply save it. This means that capital that would otherwise be unused is put to good use, resulting in a more efficient economy.
Furthermore, exchanges provide liquidity because it is relatively easy to sell one’s holdings. The stock exchange encourages an efficient market by allowing investors to actively decide the value of companies through supply and demand by providing liquidity and real-time price information on company shares.
Companies that are publicly traded on a stock exchange must follow reporting guidelines established by regulatory bodies. This includes having to report their financial statements and earnings to their shareholders regularly and publicly.
The actions of a company’s management are constantly scrutinised by the public and directly impact the company’s value. Public reporting helps to ensure that management makes decisions that benefit the company’s and its shareholders’ goals, thereby acting efficiently.
Companies can raise capital to fund operations and expansion projects through initial public offerings (IPOs) or the issuance of new shares. This provides opportunities for companies to expand.
The global financial system revolves around stock markets. Businesses rely on stock exchanges to raise capital. Individuals, charitable foundations, pension funds, and other institutional investors use the markets to buy and sell stocks in these companies. Regulators protect investors from abusive trading practices and maintain the financial system’s integrity.