Why is Trading on the Stock Market a Risky Thing to Do?
A stock market, stock exchange, or share exchange is an agreement where different entities collectively own a stock in a company. A firm holds a majority of shares with the company and is represented by its stockholders. Stocks can be purchased from a company at a pre-determined price by a buyer known as a shareholder. There are also brokerages that buy and sell stocks.
Stock market participants then bid for or buy securities, which are listed in a trading system and traded on a futures exchange. The price is determined by supply and demand in a market driven by supply and demand factors. These factors may be related to general economic conditions, market perceptions concerning a company’s growth or future earnings, and changes in general economic conditions due to the federal government. It is imperative that all parties to a transaction meet the requirements of applicable laws.
There are currently four major exchanges in the US. These are the New York Stock Exchange (NYSE) – considered to be the exchange for New York City listing all New York Stock Exchange listed and traded stocks; NASDAQ (national association of securities dealers or NASD) – which is a Chicago-based exchange for securities in Nasdaq Market; the American Stock Exchange (ASX) – which is an English-based exchange for all shares traded in England. In Canada, there is only one exchange that is considered to be of interest to Canadian investors. This is the Toronto Stock Exchange (TSE).
When an investor purchases stock through an exchange, this transaction then becomes a security and is reported to the Securities and Exchange Commission (SEC). Reporting requirements vary from state to state. For example, in Texas all stock sales must be registered in the state. Similarly, in Canada all sales of securities must be registered in the Canadian market. All investors must register in order to trade in securities in either the US or Canadian stock markets.
The various exchanges for securities in the US and Canadian markets include the New York Stock Exchange (NYSE), the NASDAQ and the Toronto Stock Exchange (TSE). All of these exchanges allow for trading of all types of securities including common stock, preferred stock shares, foreign securities, corporate bonds, debt securities and mortgage backed securities. Stocks are sold on the exchanges by corporations, individuals and hedge funds. When a company issues new securities through a initial public offering ( IPO ) to raise funds, these securities will be listed on the stock market. When the company later decides to delist its stock from the stock exchanges, the stock will be sold by a broker to the buyer. Thereafter, all interested parties can buy the sold shares at current market prices.
The major reason why investors partake in share transactions is to gain profits. However, the process of buying shares on the stock markets comes with a number of risks that need to be considered. The major risk related to trading on the exchange includes improper price discovery. In simple terms, incorrect price discovery means that investors may buy shares with the hopes of deriving higher returns than the actual cost of the shares. As a result of incorrect price discovery, a shareholder could lose a substantial portion of his investment.