Stock Market

What It Means

Stock market is a term referring to a place where buyers and sellers of stocks come together. It may also be used to refer collectively to all the places in the world, some of which are real buildings and some of which exist mainly in computer networks, where stocks are bought and sold.

A stock is a share of ownership in a company. If you buy one share of stock in Wal-Mart, you literally own one tiny portion of that enormous company. As a shareholder in Wal-Mart, you can expect to profit as the company profits, because your stock will most likely increase in value when the company performs well. But your stock also stands to lose value when Wal-Mart does not perform well. Based on your predictions about how Wal-Mart will perform in the future, you may want to buy more stock in Wal-Mart to make more money or sell your stock in Wal-Mart to avoid losing money. To buy or sell your Wal-Mart stock, you might contact a stockbroker (someone authorized to place orders for the purchase and sale of stocks) by phone, and the broker would then forward your order to someone who would carry out the transaction on the floor of the New York Stock Exchange (NYSE), located on Wall Street in New York City, where stock in the largest American companies is bought and sold.

There are numerous other regional stock exchanges in the United States, but the most prominent domestic stock exchange other than the NYSE is the NASDAQ, a virtual exchange (this means that all trading is done by computer) specializing in smaller U.S. companies. There are, additionally, stock exchanges in all developed countries and in many developing countries. In addition to the NYSE and the NASDAQ, the world’s largest stock exchanges are in the United Kingdom, Japan, France, Germany, and India.

When Did It Begin

The first phenomena resembling stock markets probably arose in thirteenth–fifteenth century Italy, when leading citizens of city-states like Venice, Florence, and Genoa were forced to pay a portion of the debt incurred by local governments and the Catholic Church in their efforts to provide for defense and the maintenance of trade routes. These shares of debt collected interest (a fee paid to someone who loans money to someone else), and because of this, the owners of shares could expect to make a profit. Shares in the public debt therefore acquired value, and the governing authorities allowed people to buy and sell these shares. The government and Church were providing people with a way to make money at the same time that those people were paying the institutions’ debts; thus, an effective way of financing large projects was discovered.

This model was later adopted by businesses who wanted to raise money for expansion and other pricey ventures. In 1602 the Dutch East India Company not only decided to sell stock in its company, it created for that purpose what is generally considered the world’s first continuously operating stock market, the Amsterdam Stock Exchange. Once the value of stocks in the Dutch East India Company became widely recognized, stockholders could use their shares as collateral for loans. (Collateral is any item or items of value that you offer as proof of your ability to repay a loan.) This gave rise to many of the financial intricacies of present-day stock trading, such as options and derivatives, which are essentially complex ways of buying stock, and accordingly to the specialized investors that characterize developed stock markets.

The forerunner to the New York Stock Exchange was created in 1792, when 24 brokers agreed to deal only with one another in the buying and selling of the U.S. government’s debt. The London Stock Exchange came into being in 1801 and became the world’s largest and most important stock market. It was instrumental in raising the capital necessary for England to defeat Napoleon, the French leader who attempted to conquer much of Europe in the early nineteenth century, and many countries attempted to copy the London exchange’s success. Stock markets appeared in most European capitals or other large cities. World War I (1914–17) brought about declines in the European stock markets, while the NYSE expanded in the following years. This growth slowed dramatically in 1929, when a stock market crash signaled the beginning of the Great Depression.

More Detailed Information

The need to raise money to pay for business ventures remains a principle reason for a company to sell stock, and the promise of large increases in the value of a stock is the primary reason for an individual or institution to buy stock. The stock market is a crucial factor in economic growth on a large scale, because it allows businesses to grow more rapidly than they could if they were funded privately, and because it allows investors to make larger amounts of money than they could by placing their money in bank accounts.

For a business to be listed (to have its stock made available for trading) on a stock exchange, it has to meet certain requirements. Each stock exchange establishes its own requirements, usually relating to a business’s financial soundness and the amount of capital (money and other assets) that it has, and when a company meets these requirements, it can choose to go public on one of the world’s stock exchanges. Going public refers to the transition that a business makes from being a privately owned organization to being a business owned by the public, or stockholders. When a company makes its stock available for purchase for the first time, this is called an initial public offering (IPO). Once it has sold all shares of its stock, a business has access to the money raised in this process. The leaders of the company are no longer answerable only to themselves at this point. They must answer to shareholders, the true owners of the company.

In the stock market prices fluctuate according to the law of supply and demand. As demand for a stock increases, its price increases, and vice versa. Demand is created or lessened for a stock, of course, when a company is known to be profitable or known to be struggling. Demand can additionally be affected based on any positive or negative news about a stock. Stock markets are thus vulnerable to human psychology. For instance, when large numbers of people get enthusiastic about a stock and decide to buy it, they can greatly inflate the stock price in a short period of time.

Sometimes the price of a stock rises so high that it loses its correlation to company earnings. This happened on a large scale in the late 1920s and also in the late 1990s. The 1929 stock market crash, like the lesser and more gradual crash that occurred in 2001–02, started when investors widely understood that the inflated value of stock prices could not last. Investors sold off stocks in large numbers, stock prices dropped across the market, and many people who had invested heavily in stocks lost a great deal of money.

While the stock market offers investors the potential to multiply their money more quickly than they might be able to do by other means, it is also inherently risky. Most financial professionals advise investors to resist the temptation to make quick profits. Those who invest with an eye toward long-term profit often balance investment in risky stocks (frequently these are stocks in untested companies, or companies specializing in new technologies) with investment in larger companies less subject to volatility. Since World War II the U.S. stock market has increased in value by an average of 10 percent a year, in spite of dramatic fluctuations from year to year and decade to decade.

People are still able to invest in government debt as well. They do so usually by buying items commonly called government bonds, which are traded not in the stock market but in the bond market. The bond market includes other types of bonds in addition to government bonds and works in a similar way to stock markets. One key difference between stocks and government bonds is that the value of government bonds is largely risk-free, meaning that as long as the issuing country itself continues to exist and is not in a severe financial crisis, the bondholder can expect repayment. Bonds can generally be expected to increase in value at a steady rate, but they are unable to match the explosive growth sometimes offered by stocks.

Recent Trends

A period of sustained stock-price increases is called a bull market. During bull markets, investors make money rapidly. Between 1991 and 2000, the United States experienced the longest and most vigorous bull market in its history.

The performance of the U.S. stock market is most frequently measured according to the Dow Jones Industrial Average, a statistic that conveys the combined stock prices of the 30 top companies in the country. In 1991 the Dow, as it is commonly called, reached the 3000-point mark for the first time in its history. By 1995 the Dow had passed 4000 points, and by 1998 it had surpassed the 9000-point mark. In 2000 the Dow peaked at more than 11,700 points, and many analysts seemed to think that, despite the unprecedented growth of the stock market over the decade, the bull market might go on forever.

However, a number of unforeseen factors, including irrational inflation of stocks in technology companies and unethical accounting practices that made some companies appear to be more profitable than they really were, triggered large-scale declines in the stock market beginning in 2000. The already vulnerable economy received another tremendous blow with the terrorist attacks of September 11, 2001, which forced the New York Stock Exchange to close for six days (the longest closure since the Great Depression) and which further undermined investor confidence in the stock market. These conditions created what is called a bear market, or a period during which stock prices generally decrease. By late 2002 the Dow had returned to pre–1998 levels, bottoming out at 7,286.27. It was not until 2006 that the Dow returned to the level it had reached at its peak in 2000.