What is shares trading?
Find out what shares trading is and how it works
Trading shares – The basics
When a privately owned company wants to raise capital in order to expand, this can be done by getting listed on the stock market. The process includes an IPO, also known as initial public offering, and what it means in practice is that investors get units of ownership, called shares, in exchange for capital.
Companies who want to go public prefer major exchanges such the Nasdaq or the London Stock Exchange (LSE), but in order to get accepted they need to meet certain requirements. Once a company becomes listed, their shares are available on a stock exchange for trading.
The earliest stock exchanges started operating in the 16th and 17th century in trading hubs such as London and Amsterdam. The very first stock exchange, the way we know it today, was the Philadelphia Stock Exchange, which continues to exist up to this day. However, it wasn’t until late in the 18th century, when the New York Stock Exchange was founded, that shares started being widely traded.
Before 1792, brokers and merchants had the unofficial agreement to meet under a buttonwood tree on Wall Street in order to arrange the buying and selling of shares. What became known as the Buttonwood agreement is the beginning of modern financial trading. As the markets started getting regulated and technology advanced, shares trading became available to an ever-increasing number of traders, making the market both more liquid and more efficient.
Who trades shares?
The advent of derivative trading allowed investors to participate in the stock market without the need for an exchange, as anybody with access to the internet can speculate on the price of individual shares through an account with an online broker. With billions of transactions taking place in the stock markets on a daily basis, let’s take a closer look at the participants of this market:
- Private traders
This category refers to individuals who buy and sell shares around the world based on their own evaluation of the price and with the sole intention of profit. Private investors account for the largest part of global shares trading and this can include employees who buy shares of the company they work for or fans who buy shares of their favourite sporting club as a way of expressing their support, to name a few.
- Hedge funds
Hedge funds are also heavily engaged in the trading of shares, usually by buying shares across a varied spectrum of companies in order to protect their portfolio from risk and increase their performance.
A lesser known category of participants in the shares markets are competitors who may attempt to gain influence over another company by buying their shares.
What affects the prices of shares?
A share price is essentially a representation of a company’s earnings as well as the dividends paid to the shareholders. In today’s globalised world, a company’s ability to make profits, and therefore its share price, cannot be attributed to simply one factor. The reality is that a large number of variables are interacting, with the net effect shaping the prices of shares worldwide. Let’s take a closer look at the major influencers and how they affect different industries:
- Exchange rates
Currencies fluctuate in value against each other 24 hours a day. As a rule of thumb, companies who import benefit when the currency of their country rises as their purchasing power rises too.
- Oil prices
Companies who are dependent on oil for the conduction of their business, such as airlines, are the first to be affected by significant or unexpected changes in the price of oil.
- New legislation
Let’s take tax policy for example. Should a country change its laws on corporate tax, this will have a direct effect on the profitability of the companies based in the territory.
- Interest rates
Interest rates are determined by the central banks and reflect the cost of capital. A cut in interest rates, for example, can give stock markets a significant boost.
- Expectations & rumours
Sometimes an event, such as an interest rate cut, might not even take place, but the stock markets can move significantly just because of the expectation. Should the event not materialize, the markets return to their usual trading levels. That’s exactly where the saying ‘buy the rumour, sell the fact” stems from.
- Unpredictable events
In this category fall terror attacks and natural disasters. The September 2011 attacks caused the stock markets to plummet, with the Dow Jones losing as much as 7% on the day following the tragic event.
Although the above factors and their effect is quite straight forward, it is worth noting that at times share prices may rise simply because the sentiment for a particular sector is positive. That’s why it is important for traders to keep an eye on the current trends. A classic example is the meteoric rise of internet shares during the dot.com era. During the same period, more traditional sectors such as mining shares were experiencing a bearish phase.
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Losses can exceed deposits.