Trading
In general, the shares of a company may be transferred from
shareholders to other parties by sale or other mechanisms, unless
prohibited. Most jurisdictions have established laws and regulations
governing such transfers, particularly if the issuer is a publicly
traded entity.
The desire of stockholders to trade their shares has led to the establishment of stock exchanges, organizations which provide marketplaces for trading shares and other derivatives and financial products. Today, stock traders are usually represented by a stockbroker
who buys and sells shares of a wide range of companies on such
exchanges. A company may list its shares on an exchange by meeting and
maintaining the listing requirements
of a particular stock exchange. In the United States, through the
intermarket trading system, stocks listed on one exchange can often also
be traded on other participating exchanges, including electronic communication networks (ECNs), such as Archipelago or Instinet
Many large non-U.S companies choose to list on a U.S. exchange as
well as an exchange in their home country in order to broaden their
investor base. These companies must maintain a block of shares at a bank
in the US, typically a certain percentage of their capital. On this
basis, the holding bank establishes American depositary shares and
issues an American depositary receipt
(ADR) for each share a trader acquires. Likewise, many large U.S.
companies list their shares at foreign exchanges to raise capital
abroad.
Small companies that do not qualify and cannot meet the listing requirements of the major exchanges may be traded over-the-counter
(OTC) by an off-exchange mechanism in which trading occurs directly
between parties. The major OTC markets in the United States are the
electronic quotation systems OTC Bulletin Board (OTCBB) and OTC Markets Group (formerly known as Pink OTC Markets Inc.) where individual retail investors are also represented by a brokerage firm
and the quotation service's requirements for a company to be listed are
minimal. Shares of companies in bankruptcy proceedings are usually
listed by these quotation services after the stock is delisted from an
exchange.
Buying
There are various methods of buying and financing stocks, the most common being through a stockbroker. Brokerage firms, whether they are a full-service or discount
broker, arrange the transfer of stock from a seller to a buyer. Most
trades are actually done through brokers listed with a stock exchange.
There are many different brokerage firms from which to choose,
such as full service brokers or discount brokers. The full service
brokers usually charge more per trade, but give investment advice or
more personal service; the discount brokers offer little or no
investment advice but charge less for trades. Another type of broker
would be a bank or credit union that may have a deal set up with either a full-service or discount broker.
There are other ways of buying stock besides through a broker.
One way is directly from the company itself. If at least one share is
owned, most companies will allow the purchase of shares directly from
the company through their investor relations
departments. However, the initial share of stock in the company will
have to be obtained through a regular stock broker. Another way to buy
stock in companies is through Direct Public Offerings which are usually
sold by the company itself. A direct public offering is an initial public offering in which the stock is purchased directly from the company, usually without the aid of brokers.
When it comes to financing
a purchase of stocks there are two ways: purchasing stock with money
that is currently in the buyer's ownership, or by buying stock on margin. Buying stock on margin means buying stock with money borrowed against the value of stocks in the same account. These stocks, or collateral, guarantee that the buyer can repay the loan; otherwise, the stockbroker has the right to sell the stock (collateral) to repay the borrowed money. He can sell if the share price drops below the margin requirement,
at least 50% of the value of the stocks in the account. Buying on
margin works the same way as borrowing money to buy a car or a house,
using a car or house as collateral. Moreover, borrowing is not free; the
broker usually charges 8–10% interest.
Selling
Selling stock is procedurally similar to buying stock. Generally, the
investor wants to buy low and sell high, if not in that order (short selling); although a number of reasons may induce an investor to sell at a loss, e.g., to avoid further loss.
As with buying a stock, there is a transaction fee for the
broker's efforts in arranging the transfer of stock from a seller to a
buyer. This fee can be high or low depending on which type of brokerage,
full service or discount, handles the transaction.
After the transaction has been made, the seller is then entitled
to all of the money. An important part of selling is keeping track of
the earnings. Importantly, on selling the stock, in jurisdictions that
have them, capital gains taxes will have to be paid on the additional proceeds, if any, that are in excess of the cost basis.
Stock price fluctuations
The price of a stock fluctuates fundamentally due to the theory of supply and demand.
Like all commodities in the market, the price of a stock is sensitive
to demand. However, there are many factors that influence the demand for
a particular stock. The fields of fundamental analysis and technical analysis
attempt to understand market conditions that lead to price changes, or
even predict future price levels. A recent study shows that customer
satisfaction, as measured by the American Customer Satisfaction Index (ACSI), is significantly correlated to the market value of a stock.
Stock price may be influenced by analysts' business forecast for the
company and outlooks for the company's general market segment. Stocks
can also fluctuate greatly due to pump and dump scams.
At any given moment, an equity's price is strictly a result of supply and demand. The supply, commonly referred to as the float,
is the number of shares offered for sale at any one moment. The demand
is the number of shares investors wish to buy at exactly that same time.
The price of the stock moves in order to achieve and maintain equilibrium. The product of this instantaneous price and the float at any one time is the market capitalization of the entity offering the equity at that point in time.
When prospective buyers outnumber sellers, the price rises.
Eventually, sellers attracted to the high selling price enter the market
and/or buyers leave, achieving equilibrium between buyers and sellers.
When sellers outnumber buyers, the price falls. Eventually buyers enter
and/or sellers leave, again achieving equilibrium.
Thus, the value of a share of a company at any given moment is
determined by all investors voting with their money. If more investors
want a stock and are willing to pay more, the price will go up. If more
investors are selling a stock and there aren't enough buyers, the price
will go down.
- Note: "For Nasdaq-listed stocks, the price quote includes information on the bid and ask prices for the stock."
That does not explain how people decide the maximum price at which
they are willing to buy or the minimum at which they are willing to
sell. In professional investment circles the efficient market hypothesis
(EMH) continues to be popular, although this theory is widely
discredited in academic and professional circles. Briefly, EMH says
that investing is overall (weighted by the standard deviation)
rational; that the price of a stock at any given moment represents a
rational evaluation of the known information that might bear on the
future value of the company; and that share prices of equities are
priced efficiently, which is to say that they represent accurately the expected value
of the stock, as best it can be known at a given moment. In other
words, prices are the result of discounting expected future cash flows.
The EMH model, if true, has at least two interesting consequences. First, because financial risk is presumed to require at least a small premium on expected value, the return on equity
can be expected to be slightly greater than that available from
non-equity investments: if not, the same rational calculations would
lead equity investors to shift to these safer non-equity investments
that could be expected to give the same or better return at lower risk.
Second, because the price of a share at every given moment is an
"efficient" reflection of expected value, then—relative to the curve of
expected return—prices will tend to follow a random walk,
determined by the emergence of information (randomly) over time.
Professional equity investors therefore immerse themselves in the flow
of fundamental information, seeking to gain an advantage over their
competitors (mainly other professional investors) by more intelligently
interpreting the emerging flow of information (news).
The EMH model does not seem to give a complete description of the
process of equity price determination. For example, stock markets are
more volatile than EMH would imply. In recent years it has come to be
accepted that the share markets are not perfectly efficient, perhaps
especially in emerging markets or other markets that are not dominated
by well-informed professional investors.
Another theory of share price determination comes from the field of Behavioral Finance.
According to Behavioral Finance, humans often make irrational
decisions—particularly, related to the buying and selling of
securities—based upon fears and misperceptions of outcomes. The
irrational trading of securities can often create securities prices
which vary from rational, fundamental price valuations. For instance,
during the technology bubble of the late 1990s (which was followed by
the dot-com bust
of 2000–2002), technology companies were often bid beyond any rational
fundamental value because of what is commonly known as the "greater fool theory".
The "greater fool theory" holds that, because the predominant method
of realizing returns in equity is from the sale to another investor, one
should select securities that they believe that someone else will value
at a higher level at some point in the future, without regard to the
basis for that other party's willingness to pay a higher price.
Thus, even a rational investor may bank on others' irrationality.
Arbitrage trading
When companies raise capital by offering stock on more than one
exchange, the potential exists for discrepancies in the valuation of
shares on different exchanges. A keen investor with access to
information about such discrepancies may invest in expectation of their
eventual convergence, known as arbitrage trading. Electronic trading has resulted in extensive price transparency (efficient-market hypothesis) and these discrepancies, if they exist, are short-lived and quickly equilibrated.(Information Courtesy Wikipedia)
