What Are Equities Markets and How Do They Work?

Equities markets provide a platform where ownership shares of companies are bought and sold. They allow companies to raise capital for growth and operations, and offer investors opportunities for wealth creation. These markets facilitate the flow of capital from investors to companies, essential for economic development and price discovery.

Understanding Equities

Equities, also known as stocks, represent fractional ownership in a company. When an investor buys a company’s stock, they become a part-owner, gaining rights and potential benefits.

There are two primary types of equities: common stock and preferred stock. Common stock grants voting rights, allowing shareholders to elect the board of directors and vote on major corporate policies. Holders of common stock also have a residual claim on the company’s assets and earnings, receiving profits through dividends or assets upon liquidation, but only after creditors and preferred stockholders are paid.

Preferred stock usually does not carry voting rights. However, preferred stockholders have a priority claim over common stockholders regarding dividend payments and asset distribution in the event of liquidation. Dividends for preferred stock are fixed and must be paid before any dividends are distributed to common shareholders.

Companies issue equities to raise capital for various purposes, such as funding expansion, developing new products, or paying off debt. This method of financing allows companies to secure funds without incurring additional debt obligations. Investors purchase equities seeking capital appreciation (stock price increase) or dividend payments (distributions of earnings).

How Equities Markets Operate

Equities markets function through a structured process that facilitates the buying and selling of shares, involving distinct stages. The issuance and trading of shares occur in primary and secondary markets.

The primary market is where new shares are initially issued by a company to raise capital, often through an Initial Public Offering (IPO). In an IPO, a company sells stock to the public for the first time, with proceeds going directly to the issuing company.

Once shares have been issued in the primary market, they are traded among investors in the secondary market. The company itself is not directly involved in these subsequent trades; ownership simply transfers from one investor to another.

Stock exchanges, such as the New York Stock Exchange (NYSE) and Nasdaq, serve as organized marketplaces within the secondary market. These exchanges provide a regulated and transparent environment for trading securities. They offer platforms where buyers and sellers can connect to execute trades.

Brokers facilitate these transactions by acting as intermediaries between investors and the exchanges. They execute buy and sell orders on behalf of individual and institutional clients. Orders are placed and matched in the market.

The matching of orders relies on bid and ask prices. A bid price is the highest price a buyer will pay, while the ask price is the lowest a seller will accept. A trade executes when these prices match.

Major Market Participants

Equities markets involve diverse participants, each playing a specific role. These participants collectively contribute to the market’s liquidity, efficiency, and regulatory oversight.

Investors are divided into individual (retail) and institutional categories. Individual investors are everyday people who invest personal funds, often through brokerage accounts. Institutional investors are large organizations that invest on behalf of clients or members, including mutual funds, pension funds, hedge funds, and insurance companies.

Companies are the issuers of equities, offering shares to the public to raise capital for operations, expansion, and other business needs. Issuing stock provides non-repayable financing, allowing companies to fund growth and develop new products.

Brokers and dealers act as intermediaries. Brokers execute trades on behalf of their clients, earning commissions. Dealers trade securities for their own accounts, buying and selling from their inventory and profiting from the bid-ask spread. Many firms act as both brokers and dealers.

Market makers are dealers providing liquidity by continuously quoting bid and ask prices. They stand ready to buy or sell, ensuring investors can find a counterparty. This maintains orderly markets and facilitates smooth transactions.

Regulators are governmental or self-regulatory bodies that oversee the equities markets to ensure fairness, transparency, and investor protection. In the United States, the Securities and Exchange Commission (SEC) is a primary regulator responsible for enforcing securities laws and maintaining fair and orderly markets.

Market Performance Measures

The performance of equities markets is measured using stock market indices. An index is a statistical measure tracking the performance of a specific financial market segment, such as a group of stocks. These indices serve as benchmarks, providing a snapshot of market sentiment and economic health.

Popular U.S. stock market indices include the Dow Jones Industrial Average (DJIA), the S&P 500, and the Nasdaq Composite. Each index is constructed differently, representing a distinct market segment or characteristic.

The S&P 500 tracks the performance of approximately 500 of the largest publicly traded companies in the U.S. It is a market-capitalization-weighted index, meaning larger companies have a greater impact on the index’s value.

The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 large, well-known U.S. companies. Its value is determined by summing component stock prices and dividing by a divisor, meaning higher-priced stocks have greater influence.

The Nasdaq Composite Index includes almost all stocks listed on the Nasdaq stock exchange, encompassing a broad range of companies, especially in technology. It is also a market-capitalization-weighted index. These indices are widely used by investors, analysts, and the media to gauge market trends, evaluate investment performance, and understand the broader economic landscape.