An Explanation of the Stock Exchange: A Detailed Guide

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Updated: 03 June 2020

One way to make money is to trade on a stock exchange. The appeal for some investors lies in the fact that depending on what kind of trading you are doing, for example trading in futures or shares, you can invest very little money and make a large profit quickly. This is especially true of futures, as you are essentially betting on the prospect of something happening and do not technically need to own what you are betting on. If the very notion of a stock exchange is foreign to you, this explanation will help you understand the following:

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  • What exactly a stock exchange or stock market is
  • How to start trading on one
  • What considerations you need to bear in mind when you first start trading
  • Typical factors that move a stock market “up” or “down”

What is a Stock Exchange?

In a basic explanation of a stock exchange, a stock exchange is a marketplace for stocks. If one were to use an unsophisticated metaphor, a stock market would be the supermarket where manufacturers (traders and those selling their shares) sell their goods. In the same way that a supermarket is only the shelf space for the products consumers come to buy and advertises prices and sets discounts, a stock market does not own any shares. It is only the “house” or market for the shares where stock buyers and sellers meet – whether online or on the phone – to buy and sell stocks.

Stockbrokers make their money by trading based on your instructions. Unless you give a stockbroker a full mandate to trade on your behalf, their role is to listen to your instructions. You instruct them via their trading platform, by email, by phone, by live chat, or any other means of communication they allow, and the broker must execute that instruction. So if your instruction is “Sell 100 of the Red Company shares in my portfolio”, they must do just that. They cannot sell 200 Red Company shares for you simply because they can see you’ll make a bigger profit. The only way they can do that is if you have a relationship with them that allows them to give you direct advice and you in turn accept that advice and agree to it.

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The Basic Risk Involved in Trading Shares on the Stock Exchange

In any stock market deals, investment and trading come with risk. People have made a great deal of money in a short span of time, such as those who invested in Facebook when it was first listed. When a company initially lists, its share price is likely to be low. It is only when the company becomes more valuable that that share price goes up. So, for example, if you bought 10,000 Facebook shares at the pound equivalent of $1, you’d now be wealthy, as one share – or the share price – is now worth many, many times this amount.

However, you could also lose a lot of money overnight. Let’s say you’re a beginner and don’t know how to spread your risk, read company reports or analyse warning signs. You buy many shares in a bank at £20 each. This bank has just released its third quarter report and has signed up thousands of new customers. Its share price goes up. The upward price is fuelled by the bank’s great prospects, the demand – everyone wants these shares, and the supply – there are only a fixed number of shares available for trading.

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How to Get Started Trading Shares as a Novice

At this point in our explanation of a stock exchange you are probably wondering how on earth to begin trading. When you’re very new to trading and investing on the stock exchange, a sensible beginning point is to purchase an exchange traded fund, or ETF. This will give you initial exposure to a number of top UK companies on the London Stock Exchange, although you will have access to international companies on other huge and well-regulated stock markets as well, such as the NYSE.

Purchasing your ETFs through a reputable broker that’s right for you is safest in the beginning. You’ll have access to their educational material, such as their reports, insights and news. They’ll also have share charts that will enable you to see which shares are trading at what price at any time and whether the movement is up or down.

If you’re wondering if you can trade on any stock broker, the short answer is yes – at least in theory. However, remember that, in the beginning, you’ll be trading through a stockbroker, and it depends on which stock exchanges these stock brokers give you access to. They are likely to help you trade shares on the major stock markets of the world, such as the London Stock Exchange, the New York Stock Exchange (NYSE) and the Hong Kong Stock Exchange.

How Should You Choose Your Stock Broker?

Having said that purchasing an EFT through a broker is a good starting point, the next logical question is, how do you identify a good brokerage firm? This is the reason why you should always do a broker comparison before making any final decision.

  • Is the broker reputable and well regulated? What are professional traders saying about them in broker comparisons? The broker website will also tell you by what legislation it is governed.
  • What kind of trading platform do they use and is it user-friendly? Again, consult a broker comparison.
  • What kinds of trading options do you have? Initially you’ll want to trade shares, but as you become more sophisticated, you’ll also want to know what other things, called instruments, you can trade.
  • On which stock exchanges does my broker trade? This will determine the breadth and scope of companies you’ll have access or exposure to. More does not necessarily mean better. What you don’t want, for example, is a broker giving you access to shares on a huge number of lesser known, not very well regulated stock markets. This is why you also need to read a stock exchange guide. You also need to know if there are any restrictions on trading on that stock exchange, for example.

These are some of the criteria you should analyse and compare before making any decisions on what stock broker to use.

Why it’s Important to Have a Strategy as a Beginner Trader

Once you’ve actually started trading you are no longer a novice but a beginner trader. Now is the time to start formulating your trading strategies before you get in too deep.

An important thing to grasp in this explanation of a stock exchange and trading on one is that you need to decide upfront if you’re a trader or an investor. The difference is how long you’re prepared to wait to make a profit. If you’ll be trading shares, it means you will buy and sell often, sometimes daily or hourly, with the aim of making quick profits. This is riskier as you will make decisions based on sentiment rather than fact. In other words, you’ll make decisions based on short-term news and feelings about the company rather than long-term information and projections.

The less risky thing to do is to start as an investor and build up your share portfolio. Take the time to educate yourself over a minimum of 18 months. Notice which stocks work for you and why they are working and then stick with them. Try to see if you can spot curveballs early on that allow you to sell before there’s a problem. See if you can start picking one or two good stocks before everyone else – these are the kinds of skills you should be honing at this point.

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Detaching Emotionally and Making Decisions Purely on Fact is Critical

In developing a strategy it is also vital to detach emotionally from the buying and selling process. In fact, that should be the core of your strategy – being analytical as opposed to emotional and impulsive. In most cases, a good instinct for knowing when to buy is actually founded on years and years of experience of having studied and read the market, no matter the gripping Wolf of Wall Street storylines, which in any case proves our point at the end.

A bad trader, or an inexperienced one, will be euphoric upon the news that the London Stock Exchange has risen by 22% – in other words, that most stocks are trading at 22% higher in price than they were in three or four months before. He or she will immediately want to buy more shares based on the emotional and mostly incorrect assumption that the market will go up. But this is exactly when not to buy because:

  • You don’t want to buy shares when they are expensive
  • There is no guarantee that a market may continue to rise

By the same token, you don’t want to sell every time the market falls or even crashes. You need to know which shares will recover and be patient. You also should keep an eye out for cheap shares to buy during this time.


Which Factors Influence Stock Market Fluctuations?

No explanation of a stock exchange and how it works would be complete without a basic look at what influences a stock market either way. Knowing this can help you anticipate when a market may rise or fall, as we have just discussed.

  • Supply and demand. Supply equals the shares that individuals want to sell and demand equates to the shares that people are looking to buy. If supply and demand or more or less equal, there will be no movement. But the bigger the difference between these two, the greater the movement either way.
  • Economic data. This usually refers to things such as GDP data coming out of a country and similar information. It affects the share prices of companies who do business in that country most of the time.
  • Geopolitical events. These are the big things that shape regions, such as elections and shifts in government policy, as ultimately they impact the economy of a region.
  • Market sentiment. This is the short-term information coming out about a region or company in between actual statistical data being released. It reflects how investors feel about a region or company more than anything else.

It is vital to grasp that there are myriad reasons that could be at play and that the common ones we outline here may in some cases have no bearing on what happens.


Trading on the Stock Exchange Can Yield Big Profits But is Not Without Risk

The allure of trading via the stock exchange versus, say, leaving your money in a fixed deposit at a bank is undoubtedly that you can make thousands by starting with just a few pounds of capital at first. However, trading on the stock exchange is not a game of chance. While it is not difficult to become a good trader, it does require research, patience, and, preferably, risk aversion at first. To that end, it is wise to start trading with only a small amount, to decide on a sector and then to study it.

A sector would be agriculture, technology or retail, for example. If you pick technology stocks it pays to research what kind of technology people would want to tomorrow. Then look at which companies are providing that technology and when they will list and, most importantly of all, monitor the performance of those companies and stay on top of news related to them.

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