Are you thinking about a career in finance, and keen to get on top of those mysterious things called shares? In this article, we take you through the basics – it’s your first step in becoming a stock market expert.
A bright guide to the stock market... Because you’re probably going to be talking about it a lot…
How do shares work?
Imagine a company is just getting started. Maybe it’s a small chain of restaurants. The company is doing well and the owners want to open more branches. To do that they need money to refurbish new premises, equip the kitchens, hire employees and pay all the other startup costs. They could borrow money from a bank but then they would have to pay it back, with interest.
Fortunately there’s another option. The owners could raise money by splitting the company up into shares and selling some of them. Whoever buys a share owns a small part of the company and is (often) entitled to a share of the profits. They’re also entitled to a say in how the company is run.
People choose to buy shares in a company if they think it will do well. They bank on the shares gaining value so they can sell them later at a profit.
Stock markets are places where these shares are bought and sold. In the past, they were actual buildings – you’ve probably seen scenes from films that involve a lot of shouting. Now shares are traded electronically.
Why do you need to understand the stock market?
Understanding the stock market is vital if you want to go into finance. It’s key to a lot of jobs. For example:
- Investment managers choose which stocks to buy and sell in order to make money
- Investment bankers help companies with large financial transactions involving shares – for example, listing the company on the stock exchange for the first time
- Tax advisors will often deal with profits and losses from shares
The stock market will almost certainly come up in your interview for a job or internship, particularly for investment banking or investment management. You might be asked about what specific shares you think will do well or asked to give the current value of a particular stock market index.
There’s a lot to learn about the stock market. Next, we’ll look at five key points in more detail.
1. Why stock values go up and down
It’s important to remember that stocks are, in some sense, imaginary. While some stocks pay out dividends (a share of the company’s profits) - others don’t. They’re only worth something because people are willing to pay for them.
Each company only has a set number of stocks. When things are looking good for the company, more people want the stocks and are willing to pay more – so the price goes up. When things aren’t looking so good, people want to sell their stocks and others will only buy at a low price – so the price goes down. If you can buy stocks when the price is low and sell them later at a higher price, you make money.
Of course, if the price gets really low, some people will buy the shares because they’re so cheap. There’s more demand so the price goes up again.
And what makes things look good for the company? It might be something like
- a year of high profits
- new, attractive products
- a sudden demand for its services
- new clients
- a merger with another company
2. When to buy and sell
We’ve already seen it’s best to buy shares when they’re cheap and sell them when they’re expensive. But this means you have to predict the future. Will the stock go up in value? Or will it lose more value?
You might buy shares in a company whose profits are growing quickly and steadily. If the trend keeps going, the shares are likely to keep gaining value. They might be expensive at the moment but if you’re lucky they will be even more expensive later.
You might also buy shares in a company that seems very unsuccessful when you think the price has hit rock bottom. If you snap up the shares then, even a small improvement could make you money.
3. Appetite for risk
When looking at stock market investments, you might come across the phrase ‘appetite for risk’. Your appetite for risk dictates your investing strategy.
- People with a higher appetite for risk are willing to take a chance on losing money if they might get a large profit. They’re likely to buy shares whose price moves around a lot – often in new companies or unpredictable industries
- People with a low appetite for risk will accept a smaller profit if they feel sure their investment won’t lose money. They invest in more established companies and rely on the fact that, over the long term, the value of the stock market tends to go up
4. The big stock markets
There are different stock markets all over the world. The biggest are:
- New York Stock Exchange (NYSE)
- Tokyo Stock Exchange
- London Stock Exchange
5. Stock market indices
The Dow Jones, the FTSE 100 and the S&P 500 are all examples of stock market indices. They’re useful tools for measuring how well the stock market is doing as a whole. Each index is the weighted average of a different set of stocks. For example, the FTSE 100 looks at the 100 companies with the highest market capitalisation listed on the London Stock Exchange.
Where can you go to swat up on the stock exchange?
These are some good places to start.
- The Wall Street Journal and the FT. These are the papers to read to keep on top of stock market news. Your university almost certainly has a subscription
- Websites. There are a lot of great investment specific websites out there, such as The Motley Fool
- Talks and seminars. Keep an eye out for lectures by economists or representatives from financial companies. These often happen at careers fairs. You might also find out about them from your university economics society
- Your university library. When reading articles about the stock market, non-finance students are likely to come across terms and concepts that are new to them. Borrowing a basic economics textbook can be a big help – as can Google!