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How does the stock market work?

Most people know that shares are traded on the stock market. But typically their financial education ends there. This is surprising, given that the functionalities of the stock market can be quickly explained.

 

How does the stock market work?

Stock exchange, Wall Street and Dax – terms that we have all heard of. But not that many people know what actually lies behind them. A lack of knowledge and a feeling of insecurity when it comes to financial matters mean that not many people invest their money in shares. Yet, in the long-term, they are missing out on some lucrative opportunities.

The stock exchange is a kind of marketplace. A place where buyers and sellers come together to trade in securities. It's rather like a weekly market except that you will find shares and bonds on the shopping list. Nowadays, you don't even have to leave the house to participate – with the help of electronic trading platforms such as Xetra, the calculation of share prices, communication and purchase transactions take place online in a very straightforward process.1 

With the purchase of a share, you can earn money in two ways – either you wait until the share price rises and then sell it to make a profit, or you hang on to the share and earn a dividend payment from the company in question. Aside from the right to a dividend payment, shareholders who have bought so-called ordinary shares also have the right to a say at the company’s Annual General Meeting. 

Why do share prices rise and fall?

Inexperienced investors often have the feeling that there is no logic to movements on the stock exchange. They feel bewildered when faced with share prices and ask themselves why some shares rise in value and others fall. And yet the matter can be explained quite simply – prices always rise when there are more buyers than sellers. This principle is nothing new and can be transferred to almost any other product. In a very hot summer, for example, a lot of people will want to buy air-conditioning systems. The supply of this equipment is limited, however. Because of the high demand, it will then become significantly more expensive. Air-conditioning systems in summer make sense, but why is it that a lot of people want to purchase a certain share? It has little to do with the weather and much more to do with the prospects of the company in question. For example, if Apple issues a new iPhone, then it is likely that significant profits will be made. If you own an Apple share, then you can reckon with getting a higher dividend payment. Many people will now want to purchase one of these shares of course – and the price will increase. Things look different when it comes to company crises. If a company is threatened with high losses, as happened to VW after the emissions scandal, then investors are afraid that the value of their shares is going to fall. They would therefore rather get rid of them. However, the demand for such shares is not particularly high. There are more sellers than buyers – and the share price falls. In any trading market for shares, there are generally always both optimists who hope that the company will become successful and that share prices will rise and pessimists who expect precisely the opposite.2

How does stock exchange trading function?

Private investors have no direct access to the stock exchange and for this reason all purchases and sales are handled by a bank or a broker. The broker is in this case appointed to purchase shares in the name of the private investor. Therefore you should always be aware that, with every purchase or sale, a proportionate fee will also be charged. Further to this, there are also so-called transaction fees that are fortunately relatively low because all transactions are regulated and processed in a standardised manner. As the prices on the stock exchange are essentially governed by supply and demand, they are also very transparent and comprehensible. In order to guarantee the smooth running of trading, the stock exchange is overseen by state-run supervisory bodies and trade monitoring units. 

Once you have found the right broker for you, the next step is to set up a securities account. This is in principle an account which allows you to manage your various securities. Before you get started and buy your stocks, it's important to do some thorough research into the company behind the shares in question. This is quite time-consuming and requires background knowledge. Investment in so-called funds is somewhat simpler. This involves several investors putting money together to buy a collection of different shares and bonds. If the price of one share drops, the rising price of another share can in some circumstances balance out the loss.3

1 xetra.com

2 aktien-handeln.info

3 brokervergleich.de

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