The stock exchange
In the financial realm, a share is a security representing a share of ownership of a joint stock company. The person holding it is called a shareholder, while all of the shares of the company are referred to as the share capital.
This is, for all intents and purposes, a form of investment by the shareholder and a financial instrument subject to assessment by the rating agencies, generally with unguaranteed capital.
The stock exchange
The stock exchange is a regulated financial market where securities and foreign currencies are traded.
It is a secondary market because financial instruments already outstanding are exchanged there. Its job is to receive purchase and sale orders from operators and execute the trade in accordance with the law of supply and demand.
The work of traders is called trading because cash money is traded for financial instruments. In the Milan stock exchange, for example, equity securities are traded in a market called the MTA (“Mercato telematico azionario”).
Keeping with the Milan stock exchange example, we can see how it is divided into segments on the basis of the instruments traded. Some of the segments are:
- SEDEX, for the purchase and sale of covered warrants and certificates;
- MOT: where bonds are traded, further divided into the DomesticMot and EuroMot;
- After hours: where it is possible to trade after the stock exchange has closed, but only shares, covered warrants and certificates;
- ETFplus, the market of ETFs and securitized derivative financial instruments;
- IDEM, where futures contracts and option contracts with indexes and individual equity securities as the underlying asset are traded.
Other segments are identified on the basis of the capitalization of the listed companies. The capitalization of a company (or a security) is equal to its price times the number of shares the company has issued. In this case, also in the Milan Stock Exchange, we have the following segments:
- Blue Chip, which includes companies with a capitalization exceeding 1 billion euros;
- Star, dedicated to medium-sized companies with capitalization between 40 million and 1 billion euros, fulfilling requirements of excellence;
- Standard Segment, dedicated to other companies with capitalization between 40 million and 1 billion euros.
Initial public offer
A joint stock company enters the stock market through what is called an “initial public offer” (IPO). There are three types of IPOs:
- Public subscription offer: investors may subscribe newly issued shares.
- Public sale offer: investors may subscribe shares already held by current shareholders.
- Public offer of sale and subscription: encompasses both of the prior types.
The public sale offer is the instrument whereby a company offers investors all or part of its shares with voting rights, with the purpose of expanding or in any event modifying its shareholding structure; privatization operations are also carried out through a public sale offer.
The public subscription offer is instead the instrument whereby a company offers investors newly issued shares arising following a share capital increase transaction.
How to purchase and sell shares
Both individual savers and investors, as well as professional companies like banks, private bankers and financial advisors, may operate in the stock market. For those who are not sector experts, it is best to rely on professionals.
Otherwise, those who decide to invest alone may do so through online trading or by sending purchase or sale orders to their bank.
What stock exchange indexes are
A stock index is the result of the weighted average of a set of securities. It is a concept used by investors to have an immediate idea of the performance of a specific stock market. In this sense, the stock exchange index is considered representative of the performance of a market.
Some famous examples are:
- Dow Jones Industrial Average, which includes the 30 companies with the highest capitalization in the New York Stock Exchange.
- the S&P 500, which tracks the top 500 companies by capitalization.
The main indexes of the Milan stock exchange are:
- FTSE Italia All Share, which includes all securities of the FTSE MIB, FTSE Italia Mid Cap and FTSE Italia Small Cap indexes;
- FTSE MIB, which includes the 40 most liquid and capitalized Italian securities listed on the MTA and MIV markets;
- FTSE Mid Cap, consisting of the top 60 most liquid and capitalised shares listed on the MTA and MIV markets not included in the FTSE MIB index;
- FTSE Italia Small Cap, which includes the shares of small companies outside the FTSE MIB index and the FTSE Italia Mid Cap index;
- FTSE Italia Star, which includes the shares of the MTA market’s STAR segment;
- FTSE AIM Italia, which includes all shares traded in the AIM Italia market.
Online trading is a useful way to purchase and sell shares – as well as bonds, futures, government bonds and other financial instruments – via the web and on your own.
It is useful for investors who trade without relying on companies of professionals because it is a low-cost instrument and makes it possible to access prices, graphs, news and technical and fundamental analysis tools. However, significant knowledge is required in order to be able to invest autonomously while minimizing risks. Therefore, if the investor does not have in-depth knowledge of the sector, it is always advisable to rely on professional traders.
The return of a share depends on the growth (or negative growth) of the value of the share in a given period, in addition to any dividends.
If P1 is the sale value of a share, P0 is the purchase price (P1 means the price at time 1 and P0 the price at time 0) and D is the total dividend paid by the share between time 0 and time 1, the percentage return may be calculated as:
It should not be taken for granted that an investor will be interested in a positive return. On the basis of this variable, shareholders are divided into two groups:
- buy and hold investors, who tend to hold shares for long periods of time without selling them, generally because they are interested in the administrative rights.
- speculators, who tend to maintain shares for short periods of time, expecting that their price will rise enough to allow for them to achieve a capital gain or selling first to then repurchase the same security at a lower cost.
The price of an equity security is always determined by supply and demand: if demand is higher than supply, then the security price will rise until the two forces have struck a balance. If, on the other hand, there are more sellers than buyers, the price will fall until enough other buyers have entered into play that a balance point can be reached.
It is difficult to define what exactly causes supply and demand, but what we observe every day in the stock exchanges all over the world is that share prices fluctuate constantly and the balance point is very unstable.
Many different elements can influence security performance, such as:
- changes in the economic outlooks of the company, or the segment in which it operates,
- more general political and economic trends,
- rumors concerning events that could significantly influence the future of the company.
How to read listings
The price of equity securities is contained in stock listings, or the tables that contain data and information that the market manager provides to investors to enable them to monitor its performance.
The following information is typically found in the listings:
- last price, or the current price at which the security in question is being traded;
- closing, or the last price at which the security was traded the previous day;
- opening, or the price of the security in the first transaction of the day;
- bid, or the highest price that someone is currently willing to pay for the security;
- ask, or the lowest price at which someone is willing to sell the security;
- daily variation, or the difference between the current price and the closing price on the previous day;
- minimum and maximum, or the lowest and highest price at which the security was traded on the current day;
- 52-week minimum and maximum, or the lowest and highest price at which the security was traded in the last year;
- volume, or the number of securities traded on the current trading day;
- average volume, or the average volume of shares traded. makes it possible to understand if today’s volume is unusually high or low;
- Market Cap, or the total value of shares outstanding;
- P/E ratio, or the ratio between the current price of the shares and the expected earnings per share;
- EPS, or the earnings per share of the company;
- dividend, or the annual dividend expressed in absolute value;
- dividend yield, or the ratio between the unit dividend of a security and the current price of the security;
- annual performance, or the difference between the current price and the closing price on the last day of the previous year.
A careful investor pays attention not only to the performance of the stock exchange or market returns, but also to the risks that may be run when taking part in trading. However, forecasting the financial risk of an investment in shares is extremely difficult, almost impossible, due to the very high margin of error.
It is very complicated because nowadays investing in the Stock Exchange means not only considering financial risks, but also managing to predict which geopolitical event could influence market performance in the near future.
According to analysts, the risks for those investing in the Stock Exchange are mostly due to volatility, which indeed could be caused by geopolitical tensions. For example, an increase in geopolitical tension could have an effect on the price of commodities.
Editor’s note: This article describes the stock exchange with particular focus on the Italian regulation. Although there are common EU laws, regulation may vary from country to country. For further information visit your Country’s Central Bank and Conduct Authority websites, or contact your bank or investment banker.