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How Do Stock Market Work

By: Tarun Jaswani

A stock market, or (equity market), is a private or public market for the trading of company stock and derivatives of company stock at an agreed price; these are securities listed on a stock exchange as well as those only traded privately. The size of the world stock market is estimated at about $36.6 trillion USD at the beginning of October 2008. The world derivatives market has been estimated at about $480 trillion face or nominal value, 12 times the size of the entire world economy.

It must be noted though that the value of the derivatives market, because it is stated in terms of notional values, and cannot be directly compared to a stock or a fixed income security, which traditionally refers to an actual value. Many such relatively illiquid securities are valued as marked to model, rather than an actual market price.

A stock exchange, share market or bourse is a corporation or mutual organization which provides trading facilities for stock brokers and traders, to trade stocks and other securities. Stock exchanges also provide facilities for the issue and redemption of securities as well as other financial instruments and capital events including the payment of income and dividends. The securities traded on a stock exchange include: shares issued by companies, unit trusts and other pooled investment products and bonds. To be able to trade a security on a certain stock exchange, it has to be listed there.

Usually there is a central location at least for record keeping, but trade is less and less linked to such a physical place, as modern markets are electronic networks, which gives them advantages of speed and cost of transactions. Trade on an exchange is by members only. The initial offering of stocks and bonds to investors is by definition done in the primary market and subsequent trading is done in the secondary market. A stock exchange is often the most important component of a stock market. Supply and demand in stock markets are driven by various factors which, as in all free markets, affect the price of stocks (see stock valuation).

The term has taken on a specific meaning in finance to describe the particular types of people and companies that regularly purchase equity or debt securities for financial gain in exchange for funding an expanding company. Less frequently, the term is applied to parties who purchase real estate, currency, commodity derivatives, personal property, or other assets. The term implies that a party purchases and holds assets in hopes of achieving capital gain, not as a profession or for short-term income.

Stock typically takes the form of shares of either common stock or preferred stock. As a unit of ownership, common stock typically carries voting rights that can be exercised in corporate decisions. Preferred stock differs from common stock in that it typically does not carry voting rights but is legally entitled to receive a certain level of dividend payments before any dividends can be issued to other shareholders.

Convertible preferred stock is preferred stock that includes an option for the holder to convert the preferred shares into a fixed number of common shares, usually anytime after a predetermined date. Shares of such stock are called convertible preferred shares (or convertible preference share in the UK).Participants in the stock market range from small individual stock investors to large hedge fund traders, who can be based anywhere.

Their orders usually end up with a professional at a stock exchange, who executes the order. Some exchanges are physical locations where transactions are carried out on a trading floor, by a method known as open outcry. This type of auction is used in stock exchanges and commodity exchanges where traders may enter verbal bids and offers simultaneously. The other type of stock exchange is a virtual kind, composed of a network of computers where trades are made electronically via traders.

Actual trades are based on an auction market paradigm where a potential buyer bids a specific price for a stock and a potential seller asks a specific price for the stock. (Buying or selling at market means you will accept any ask price or bid price for the stock, respectively.) When the bid and ask prices match, a sale takes place on a first come first served basis if there are multiple bidders or askers at a given price.

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