What is a stock market or stock exchange? How can you invest?

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If you want to invest in shares, you normally buy shares in companies that are listed on a stock exchange. What exactly is a stock market or stock exchange and how can you buy and sell shares?

Q. What is a stock market or stock exchange?

A. A stock exchange is an exchange that brings together buyers and sellers of shares (otherwise called ‘stocks’ or ‘equities’). In New York, the stock exchange has a physical trading floor where brokers do ‘open outcry’ trading (basically shouting their orders across the floor), although there is also electronic trading.

At the London Stock Exchange, although there’s a stock exchange building in the city, the trading in shares is done via a trading platform and not in the building.

SAVVY TIP: The first stock exchanges in London in the 1770s were in coffee shops.

Q. What is a stock exchange index?

A. An index, such as the FTSE100 index, is designed to measure the performance of the share price of a group of companies. The FTSE 100 index tracks what’s happening to the share price of the 100 biggest companies listed on the London Stock Exchange. The FTSE All-Share index represents around 99% of the market capitalisation of the companies listed on the London Stock Exchange.

Robert Lockie of Bloomsbury Wealth Management says that all indices are weighted, but some are weighted according to the value of the company – which means that a 10% change in the value of a massive company has more impact than a 10% change in the value of a small company. But not all take this approach. “Some indices are price-weighted, so the price of each share has more effect.  This can result in somewhat anomalous outcomes if, for example, a small company has a high share price in cash terms and a large company has a low one, as a 10% change in the high price has more impact than the same change in the lower price. ”

Although the FTSE 100 is made up of 100 companies, according to Russ Mould of AJ Bell, the biggest ten companies make up 50% of the FTSE 100’s market capitalisation. This means that if you invest in a fund that tracks the FTSE 100 index, your fortunes are largely tied to those of a handful of companies.

Q. What does a company have to do in order to have its shares listed on the London Stock Exchange?

A. A company has to meet certain requirements in order to be listed – such as having a certain size (market capitalization). The company must make a certain percentage of its shares public (which means they are available for others to buy) and it must abide by strict rules after it has listed, especially relating to when it has to make announcements that could affect its share price.

SAVVY TIP: Insider trading is the practice of buying or selling shares using information that hasn’t been made public.

Companies have to report their results twice a year – full year results and six monthly or interim results.

Q. Are there other stock markets in London?

A. There are two official London Stock Exchange markets in London – the main stock market and AIM, which is the alternative investment market or ‘junior’ stock market.

If a company wants to list on AIM rather than the full stock exchange in London, the rules aren’t so strict. This means that the AIM is more appealing to smaller and younger companies, in particular. This does mean that companies that are listed on AIM are likely to be riskier if you invest in them. Russ Mould of AJ Bell says you’d have to do more research if you invest in an AIM listed company than if you buy shares in a company listed on the main stock exchange.

Q. Can a company choose where its shares are listed?

A. Companies will often choose to list in a stock exchange where they have their headquarters or where they carry out the majority of their business. But there are exceptions.

Russ Mould explains: ‘Where a company chooses to list may come down in part to the advice that it’s given by its investment bank and broker in the run up to it floating. It may be that the company is based in one company but its assets are elsewhere.”

He says another reason why a company might choose a different exchange is if that market understands the sector it operates in (Nasdaq stock exchange in the United States is a favourite of tech companies, for example), or if one stock market is more likely to give it a higher valuation.

Companies can also choose to list on more than one exchange, if they operate in more than one market, although most companies only list on one.

What is a flotation or IPO?

A. A flotation or IPO (initial public offering) happens when a company first makes its shares available to the public to buy. It issues shares to raise capital (money), which it can use to grow and invest in its future.

Some companies will make their shares available for individual investors and large institutional funds (such as pension funds) or it may make its shares available to institutional investors only.

Q. How can you buy shares in a company?

A. Robert Lockie of Bloomsbury Wealth says that you can’t normally just contact the company direct and say that you want to buy some of its shares. Generally, you have to buy or sell shares via a broker.

There are several different types of broker:

  • Execution-only broker: This broker will carry out the trades that you ask him or her to do. They won’t give you any advice about what you’re about to do. There are lots of brokers that offer an online and/or telephone service on an execution-only basis.

SAVVY TIP: While execution-only brokers can’t give you advice, many of them offer lots of information – normally online but it may be on the phone – to help you.

  • Advisory broker: Here you’ll be given advice about whether you should buy or sell certain shares.

Discretionary broker: This broker will buy and sell shares for you without having to ask your permission each time. You normally need a certain amount to invest to be able to use a discretionary broker.

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