Most individual investors cannot trade on the stock market and the best way to access the world’s largest exchanges such as the New York and the London Stock Exchange is through a reputable and experienced stockbroker. Stockbrokers (or stock brokers) are professionals or firms that execute buy and sell orders on behalf of their clients, allowing them to invest in company stocks and other financial securities that would be otherwise impossible to invest in.
There are many stock brokers registered on the stock exchanges and while some of them are individual brokers, the majority of them are professional firms that act as intermediaries between retail investors and the stock exchange. The best way to invest in the stock market is through respectable online brokerage firms that offer low pricing and access to a wide range of trading instruments and derivatives.
What Is the Stock Market?
The stock market is a collective term that describes all public markets and exchanges where the daily activities of buying and selling of shares take place. This is where publicly-held companies issue shares and where most of the trade that influences the global economy occurs. The market could be institutionalized formal stock exchanges such as the New York Stock Exchange or the Nasdaq in the United States. Buying and selling could also be conducted through over-the-counter (OTC) marketplaces – OTC trades are conducted between two parties without the supervision of an exchange.
There are various definitions of the stock market and there are even more ways to explain how it works. It operates under rules and conditions defined by the particular local regulator, which gives all participants a guarantee that all trades are legal, secure, and transparent and the risk is very low. In the most general terms, the stock market works as both a primary and a secondary market.
The primary market allows companies to issue and sell shares to the public in a process called initial public offering or IPO. Through this process, privately-held companies become public, i.e. investors can see their financial results, quarterly or annual strategies, etc. In essence, stocks are shares of ownership of a company and they allow retail investors to make a profit through trading and dividend payments.
The IPO process is underwritten or guaranteed by an investment bank and it is usually associated with huge costs but at the end of the day, IPOs can be used for raising capital for the company. This IPO market where shares are issued is referred to as a primary market, while the next phase of the process – when shares are actually offered to the public, is called a secondary market.
The secondary market is where almost all the trade takes place – where securities are sold from one investor to another. Typically, secondary markets are liquid and the more investors and traders there are, the more liquid the market would be. This means that securities such as company stock, bonds, or commodities can easily be sold and bought without causing huge fluctuation in their price.
National exchanges such as the New York Stock Exchange (NYSE) or the London Stock Exchange are all secondary markets where the trade occurs between buyers and sellers rather than between buyers and the entity that issued the securities. Each trade that occurs here drives the price of the stock, bond, or commodity towards its actual value. There are two prices in each trade – the “bid” price, offered by buyers, and the “ask” price, announced by sellers. Usually, the bid is lower than the ask price and the difference between them is called a bid-ask spread or simply spread.
Stock Market Participants
Once we know how the stock market works in general, we can recognize the main participants in it. There are various players, each with a specific role, but these roles are connected and depend on each other. The first participants are investment banks, which handle the IPOs by researching each company that wishes to go public and facilitates the issuing of shares on the market. Investment banks guarantee that the company will receive the pre-determined minimum price per share. Of course, they do this in return for a certain fee, which is usually quite substantial.
The company shares offered initially through IPOs are typically purchased by large institutional investors such as pension funds, credit unions, banks, hedge funds, REITs, and many more. Then they re-sell them to stock brokers, institutional and retail investors in the secondary market. A retail investor is a term that refers to individuals who want to trade or invest in the stock market. This could include short-term trades closing within a day or long-term investments that are associated with a lower risk.
To buy and sell stocks or other securities, investors need to have access to the stock market. However, only members of a certain exchange – the NYSE, for instance, can trade there. Members of the exchanges or more often, member firms, are licensed as brokers or broker-dealers, depending on the regulation in each country. With the rise of the Internet, the role of stock brokers and brokerage firms changed.
In the past, the stock market was accessible only to those who owned huge capital and could afford to pay their broker hundreds of dollars per trade. Nowadays, discount online brokers dominate the market, making a profit from the huge number of trades they execute rather than the cost of each individual trade. Of course, the market is now fully automated and trades are executed within less than a second by computers and sophisticated software programs.
Instead of offering their clients full-service access to the market, complete with predictions, financial advice, and wealth management, today, stock brokers provide them with useful tools for creating and customizing a trading strategy, using bots, and many more.
What Do We Trade on the Stock Market?
The stock market is also known as the equity market although it is mostly used for buying and selling company stocks, it also facilitates the trade of many other types of securities and financial instruments. This includes corporate bonds, exchange-traded funds (ETFs), as well as derivatives based on underlying assets such as stocks, commodities, currencies, and bonds.
It is possible to buy stocks through mutual funds – to do that, investors purchase shares in companies called mutual funds. The mutual fund buys a collection of different stocks and by owning shares in it, traders are able to invest in different companies without actually owning the underlying stock. This type of investment can be used for diversifying one’s portfolio and hedging against risk.
Of course, investors can also purchase shares of individual companies through an online stock broker. Brokers offer clients different accounts – regular trading accounts, individual retirement accounts (IRA), and many more. By registering a brokerage account, retail investors have access to the global markets, to thousands of financial instruments, and to the professional expertise of the broker.
Overall, stocks, as well as stock mutual funds are great for a long-term investment. However, they are not suitable for short-term investing or trading. This is where investors need to decide how they wish to use their capital – for investing in the stock market or for trading. Trading, of course, involves more frequent transactions and is associated with higher returns and higher risk. Traders would seek to make a 10% monthly return, whereas serious, long-term investments would bring a 10% to 15% return annually.
Bull and Bear Markets
There are two basic terms every investor should be familiar with when starting to trade on the stock market. The first one is a bull market and it refers to a market where the price of stocks is rising. Most investors would prosper in such a market. Bear markets, on the other hand, are stock markets where the price of stocks is on the decline. Since prices constantly fluctuate, rising and falling all the time, these two terms are usually used for an extended period of time during which the particular trend continues.
The bull and bear markets are basic aspects of the stock market and they refer to the overall investor sentiment. Bull markets are associated with optimism and investor confidence and they often occur in line with strong GDP performance, drop in unemployment and other positive economic signs. Bear markets are pessimistic and coincide with falling stock prices, rise in unemployment rates, stagnation, etc. It is easy to recognize a bear market once we spot a 20% decline or more in at least a two-month period.
Interestingly, bull and bear markets usually coincide with the economic cycles. Although most investors fear prolonged bear markets since they usually lose money, there are also ways to make a profit even during pessimistic times like this. Investors can make money through put options, inverse ETFs, and short selling. This is why they should look for a stock broker that offers all these alternatives.
Short selling is a good option for many traders – they can borrow shares from the stock broker if they believe the price will fall in a bear market. For instance, they borrow 100 shares at a current price of $20 per share using the so-called margin deposit. Then, they sell these shares for $2,000. After some time, the price falls to $10 per share and the investor buys another 100 shares to return them to the broker – this time, this will cost $1,000, leaving the investor with a $1,000 profit.
How to Choose a Stock Broker
There are many online stock brokers but not all of them are trustworthy, reliable and offering cost-effective services. To make sure they make good investments, retail investors should look for a suitable stock broker and there are a handful of things that must be considered.
To gain access to the stock market, investors need to use the services of a licensed and fully regulated stock broker – a brokerage firm, a dealer-broker, a large bank, etc. Stock brokers may be registered as representatives, dealer-brokers, financial advisors, or simply stock brokers, depending on the local legislation. They comply with a range of rules and regulations, designed to protect all participants in the trade and regulate the entire process. Trading through leveraged positions, for instance, is illegal in some countries – such as in the USA where CFDs are not available.
There are multiple regulatory bodies that issue licenses, approve brokers, and enforce the rules that govern all financial and stock markets. In the US, the stock markets are overseen by the Securities and Exchange Commission, which is an independent federal agency. In the UK, the sector is regulated by the Financial Conduct Authority (FCA). Although each country within the European Union has its national regulator, there is also an EU regulatory body called the European Securities and Markets Authority or ESMA.
Commissions and Fees
Discount brokers are the most popular stock brokers online – through automated execution of trades and the use of modern software solutions, they can charge their clients small fees and make good profits at the same time. Some brokers have no fees for the trades themselves but gain in other ways – monthly fees, inactivity fees, deposit and withdrawal fees, etc.
Depending on the particular financial instrument, the fees could be fixed – $4 to $6 or $8 per order execution or they could come in the form of a spread. When trading CFDs, for instance, brokers gain from the spread – i.e. the difference between the bid and ask prices.
Leverage and Margin
Another important thing to consider when looking for on online broker is whether firms offer their clients leveraged trading. Leverage is mostly used in the derivatives markets and with it, investors can afford to open positions that are much larger than the capital they own. For instance, if they are offered a 1:20 leverage and they have a capital of $1,000, they can open a $20,000 position. As you can see, this could benefit investors a lot since it increases the potential profits. However, it is also much riskier because investors can lose more than they actually own.
Margin requirements are used in the same context – investors are required to own a certain amount of money to be able to trade. When they are short selling stocks, it is also useful to be able to take advantage of deposit margins and borrow stocks from the stock broker.
There are different trading platforms offered by online stock brokers and while most of them operate in web versions, some platforms must be downloaded and installed on the user’s laptop or desktop computer. Depending on the design and the technology used, certain platforms are very user-friendly and intuitive. Investors, especially novices, should look for a software platform suitable for beginners – one with educational videos, lots of information, analytics, and statistics.
Moreover, less experienced investors should opt for brokers who offer stock market simulators or demo accounts. This is sometimes referred to as paper trading or virtual stock trading. Such simulators are computer programs that allow investors to buy and sell stocks, earn or lose imaginary money, or simply test new investment strategies. No actual risk is involved since no real money is invested. Stock market games using such demo accounts are also very popular for educational purposes.
Last, but not least, the customer support service is essential for every investor who wants to access the stock market through an online broker. The largest stock brokers offer multi-lingual support 24 hours a day, 7 days a week, even though markets are open from Monday through Friday. Of course, every exchange operates within a different time zone and those who want to trade on more than one market would need 24/7 support.