The stock market
As many of the investments you are likely to make via your investment strategy and plan will be in stocks and shares, funds or market indexes, it is useful to have an overview of what the stock market is, and what it does.
Firstly, there are many stock markets in operation around the world, and so the phrase “the stock market” isn’t quite correct. The UK has the FTSE 100 where the largest companies are listed, and also the FTSE 250, where the next largest 250 companies are listed. The UK also has stock markets for tech companies, smaller companies, and many other categories.
World stock markets
The USA has the Dow Jones Index, NASDAQ and S&P 500, Germany has the DAX and France has the CAC.
Italy, Spain, Japan, China, Australia and nearly every other developed country in the world also have their own stock markets, so if we do refer to “the stock market” we are really talking about a worldwide market, in which many individual stock markets operate.
FACT: There are currently well over 100 different stock markets around the world.
Stock markets (much like any market), are where buyers and sellers connect, in order to buy and sell things. In this case, stocks and shares, which are essentially shares of ownership in public companies.
As it would be very difficult to track every single stock in any particular market or country, indexes such as the FTSE 100 include a particular selection of stocks from the overall market, and then the index’s performance is viewed as generally representative of the whole market.
For example, if the FTSE 100 went up today by 50 points, it gives a broad overview that the stocks and shares within that market generally rose. In reality, some will have risen, some will have fallen, and some will have remained the same.
The FTSE 100 index started at 1000 points back in 1984. Over the years, there have been three significant market pullbacks, including the latest Covid-19 event in 2020. Even so, you can still see a strong upward trend over the long term.
Buy buy buy!
Access to stock markets is now usually done online, although some people do still prefer to use the phone and trade via a brokerage account or stockbroker. There is certainly no need to physically go to the stock market, and wave your hands about like crazy as often shown in films!
Stocks are traded (bought and sold), via an ongoing negotiation between buyers and sellers who wish to trade. Supply and demand is basically the main driver of a shares price. If there is high demand, the price will go up, and you will have to pay more to own each share. If demand is low, then the price will go down, and you can either buy the share at a lower price, or you may have to sell the share at the lower price if you already own it.
There are many other reasons for shares to rise and fall, such as company news and results, political events, economic reports etc., but supply and demand is a good basic starting point to understand.
Buying an individual stock, a fund or an index is very easy once you have set up an account, or joined a platform, as all the “negotiation” is effectively done behind the scenes with modern-day technology.
We will discuss “platforms” here, but for now, it is enough to understand that if you wish to buy a stock, fund or index, you will be given a buy price (or bid price), and if you want to sell, you will be given a sell (or ask) price.
These prices will usually be slightly different as there is a “spread” between them, which is a trading cost, usually retained by the broker or market maker.
If the share price of Vodafone was £1.00, a buyer may see a buy price of £1.005, and a seller may see a sell price of £0.995, the difference between the two is the spread.
It is worth knowing that spreads can be quite large on less frequently traded stocks such as small caps, so do keep an eye out for this.
Ultimately, if you don’t like the buy or sell price offered, you don’t have to take any action, you can just wait until you are happy with the price and then complete your trade.
FACT: The phrase blue-chip stocks, which means the big, reliable, good quality and profitable companies of an index, are named after the highest value chip in a poker game, namely the blue chip.
Stock market volatility
As mentioned in an earlier page, investing in the stock markets does come with risks, and part of your investment plan is to understand your risk appetite, and then manage those risks as well as possible.
One way of managing this risk is to invest in the stock market for the long term, as this strategy has proven to reduce the risk of loss, and also be an excellent way to grow wealth over time.
The longer you invest for, the higher the probability will be of a positive outcome. Investing for the short term is very unpredictable due to something known as market volatility.
A good example of market volatility can be demonstrated using the American market the S&P 500. This market has a long term historical annual average return of about 10% per year.
However, in practice, it would very rarely if ever produce a return of 10%.
Some years the S&P 500 could go down by 10% - 20%, and other years it could go up by the same amount or even more. These large swings are due to market volatility and must be expected from time to time.
The graph shows the S&P 500 over ten years. Although there is a long term upward trend, you could have lost money over the short term on many occasions.
Trying to time the market with short term investing is near impossible, that’s why a long term “stay invested” approach is recommended by most financial experts.