Stock market

The stock market is an organised market which brings together supply and demand according to certain rules. It serves to locally and timely steer trade, and it supervises the pricing. A distinction is made between the cash market and the option market, as well as floor trading and fully-electronic trading. For example, stocks, bonds, foreign currencies and commodities can be traded. The aim is to reduce transaction costs, increase market transparency and create market liquidity.

Classification of the stock market in the capital market

From a functional point of view, the capital market can be divided into the primary market and the secondary market. In the primary market, the rights and obligations associated with the securities are first documented. This is also referred to as the issue market. The secondary market is responsible for the trading which is done after issue trading. It represents a highly organised trading place (stock market) with standardised transaction products and processes, around which securities circulate.

The 3 basic functions of the stock market

1.) Allocation function

The allocation function is the most important task of the stock market. This is achieved when the investors’ capital is directed to the best manner of use, and the investment of the financiers are supplied with the most favourable financing resources. If the capital flows into an investment that involves a higher risk for the same return than another investment, then this would not be the best manner of use. The allocation function is therefore best fulfilled if the investors, with the same amount of risk, always receive the same risk premiums.

2.) Market function

A prerequisite for the fulfilment of the allocation function is the market function. This refers to the combination and coordination of the individual demand and supply wishes at a time and at a place. The place need not necessarily be a physical trading place, but can also be a virtual construct. Because of this function of the stock market it is no longer necessary for the market participants to conduct individual negotiations. This in turn leads to significantly lower transaction costs and a higher liquidity in the market. Furthermore, the problem of divisibility is solved.

A company is therefore not divisible because the assets and liabilities only generate cash flow in combination, which is reflected in the market value. In the stock market, in contrast, one purchases a share of the total. Through the divisibility one obtains additional liquidity and the possibility of diversification, and thus addresses a larger group of investors. The problem of the payback period of an investment is also eliminated because the investors on the stock market evaluate the financial securities based on the future cash flow. An investor could, therefore, get back his invested capital employed via the stock market at any time.

3.) Pricing and evaluation function

The plans of the economic entities are developed based on certain expectations. If all individuals have the same information at the same time, they form homogeneous expectations. These are then reflected in the price. Consequently, the fulfilment of the pricing function depends on the degree of information efficiency. The higher this is, the more likely the price of the securities will correspond to their fair value.

In summary, performance of the stock market consists of the deadline, lot size, risk and spatial transformation.

Is the stock market a perfect market?

In economic theory, a perfect market is often used to explain certain models better. In this way, one can explain very complex contexts. A perfect market is referred to when the following conditions are met:

  • complete transparency for all market participants
  • homogeneous assets
  • rationally active and utility maximizing market participants

This makes it clear that the stock market is also not a perfect market. For example, there cannot be complete transparency, since some market participants always have an advantage concerning information. In addition, information is not available free of charge, thus, differences in information already exist thereby. Furthermore, there are no fully rational market participants. As a result, no market will come close to this ideal concept. But it is the case that a stock market comes relatively close to this model.

Why is the stock market important?

The basic functions of the stock market actually explain the importance of this institution. Without the stock market the economy would not have the dynamic that it has, as there would be less liquidity in the market and companies would not be able to develop accordingly. In addition, investors could find it hard to generate returns and capital would not be used in the most efficient manner. The stock market thus significantly contributes to prosperity in society.

Who invented the stock market?

The stock market institution developed slowly. Initially, traders met to trade goods with one another. Agricultural products were the focus of trade efforts. Spices were later also traded in. In the commodity trade, the first future deals were made when a buyer bought a future harvest from a farmer. However, these trading centres were not called as such, although they actually were trading centres. The first trading centre of this kind was founded in Bruges in 1409 by a merchant family. Subsequently, it was recognised that the issue of payment difficulties came into play hereby. As a result, trading in bills of exchange became more and more important. The first exchange centres of this kind originated from securities. Trading with shares of companies was not yet considered. This did not happen until the 18th century. The merchant family from Bruges can therefore be named as the inventors of the stock market.

Who controls the stock market?

The responsibility of the control of the stock market is held by the Exchange Supervisory Authority. This authority grants admission to official trading, ensures that the trade transactions proceed duly, and that the legal frameworks are complied with.

How can one earn money in the stock market?

The question is quite simple to answer, as it is like all other professions where one can earns money. You should have a reasonable education. Of course, there are also cases where someone has placed the correct securities with a lot of luck. But these are the exceptions. Professional dealers do not leave success up to chance. They try to generate profits through a reproducible strategy. The prospects for success are increased by having a good trading education. We at ATT Trading offer such an education. Best would be to inform yourself about the possibilities right away and register for our free info webinars.

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