How does the stock market work in simple terms?
Investing could help you grow your money faster than savings accounts and inflation, so let's take a look at how the stock market works. How does it provide opportunities for investors? Well, in order to expand, companies need to pump money back into their businesses. The world’s stock markets give them an opportunity to raise money by selling parts of their businesses as shares. Similar to a slice of cake, a ’share’ is fairly self-exlanatory. If you buy a share in a company, you own a small share of that company and become a shareholder. Hundreds of thousands of deals take place in the UK every day, with people buying and selling several billion pounds worth of shares.
As well as shares, there are many other investment types. For example, funds are a more hands-off investment than shares. They can help you diversify, spread risk and reduce costs by pooling your money with others, which is invested by a Fund Manager for you.
London Stock Exchange
the London Stock Exchange was started in 1698 and is the main market in the UK. It enables investors to easily buy and sell shares in about 3,000 companies. Open from 8.00 to 16.30, Monday to Friday (excluding bank holidays), the London Stock Exchange supervises trading, facilitates transactions and provides information such as company announcements and share prices. There are also a few other smaller markets/trading platforms, with AIM (Alternative Investment Market) being the largest. AIM enables smaller companies to trade their shares.
the FTSE indices (pronounced ’footsie’) were founded by the Financial Times and the London Stock Exchange and give us an indication of how different market segments are performing. The FTSE 100 is the most commonly used and tracks the performance of the 100 most highly capitalised (largest) companies. These account for approximately 81% of the UK equity market. The FTSE 100 started in 1984 at a base level of 1,000 and it moves up and down on a daily basis. It is often mentioned in the news as an indicator of how UK businesses are performing.
How do stocks make money?
Now that we've looked at how the stock market works, how do we make money from investing?! There are two main ways:
Income can come from a few sources, depending on what investment type you choose. For example, many companies retain a portion of their profits to reinvest in their businesses and then pay out the remainder as dividends to shareholders. Such dividend payments are usually quarterly or six-monthly.
Performance, market conditions and the economy drive supply and demand for investments, which causes prices to fluctuate. For example, if you buy shares in a company which goes on to perform well, more investors become interested and its share price is likely to rise. If you then choose to sell your shares, they should be worth more.
Consequently, people invest in the stock market for one of three reasons:
- To receive an income from their investments in the form of dividends.
- To hopefully see a growth in the value of their investments and sell them at a profit.
- A combination of income and growth, known as a balanced strategy.
More about how the stock market works
Hopefully that's given you a good start to understanding how the stock market works. We've got plenty more resources and tools available to you when you start investing with us. Be sure to have a good look around the new to investing section of our website for plenty more invaluable information, tips and guides.