How does the stock market work?

The stock market brings together buyers and sellers, enabling them to exchange securities, which is the group name for all investment products like shares, bonds, investment trusts and exchange traded funds.

Securities can be listed on a stock exchange, such as the Australian Securities Exchange (ASX) or the New York Stock Exchange (NYSE) in the US.

While the stock exchange used to be full of traders rushing around the trading floor, buying and selling securities from one another, today most of it is done electronically, although the NYSE still has a physical trading floor.

Participants in the stock market range from individuals, known as retail investors, to big institutional investors, such as fund managers, insurance companies, banks and pension funds.

Buying and selling

Like any market, there are buyers and sellers and all buy and sell orders go through traders or brokers, whose job it is to match orders and get the best possible price for buyer and seller.

If you place an order to buy shares in a company, for example, it will be fed into an electronic system that will try to find a match for your offer, i.e. someone willing to sell at the price that you have offered or lower.

The price at which you want to buy the shares is known as the bid price, and the price at which a seller wants to sell the shares is known as the offer price.

There are multiple stock exchanges operating in Australia and brokers will scan those exchanges in order to find you the best available price.

Stock exchanges provide liquidity to investors, because there are lots of market participants so you can generally buy and sell securities relatively quickly.

The importance of stock markets

Stock exchanges enable businesses, governments and organisations to raise capital, in order to invest or grow, from individuals and institutions that are willing to invest money in exchange for securities that could potentially grow in value.

If a company decides it wants to raise money and have its shares traded on a stock exchange, it will sell shares to investors in what is known as an initial public offering (IPO).

This offering is known as the primary market for investors and once the shares are sold they will begin trading publicly on a stock exchange, as the secondary market.