Why Have a Stock Market?

Stock markets determine price and volume.
Stock markets determine price and volume. (Image: Jupiterimages/Photos.com/Getty Images)

Stock markets are public exchanges where individuals and companies under voluntary agreement trade shares of corporate entities. Markets exist to provide a wide range of buyers and sellers so capital investment can move between strong and weak companies. Stock markets exist to create equity investment under uniform rules that have the effect of law. These regulations and the enforcement of fair rules between anonymous parties is crucial to free trade throughout the world.

The Need for Clarity

As national economies have become complex and integrated, it has also become more important for different countries and regions to establish a means of trading that's more efficient than bartering with one another. Countries may trade commodities and products and ideas. Exposing new products and ideas, particularly among different cultures that have a variety of needs and wants, requires capital to be expended to create and introduce new products. The ability of a company to expand its operations domestically and internationally means the company must have capital. Raising risk capital is among the most important reasons for having a stock market. Willing buyers and sellers may all seek to profit from the expansion of trade in new products and ideas.

Price Discovery

Many companies offer products that rapidly become extinct due to newer and better products that are more efficient or cheaper to produce. A company's value is determined by the product line it produces and sells as reflected on the balance sheet. Consequently, an active stock market allows the investor to easily compare the current value of one stock to another. If stocks were only sold in individual private auctions with each sale subject to different rules and accounting principles, neither management nor investors would have a basis for making price and value comparisons.

Investment Efficiency

Stock markets are composed of many investors and issuers. Investors seeking capital appreciation or diversification of investments can quickly and easily buy equity issues on a major exchange. The alternative, investors seeking investments or starting their own companies in many different markets, is impractical. Stock markets provide investors with more transparency of financial data, trading rules and limits for brokers and investment possibilities than could exist otherwise.

Market Liquidity

Stocks can be bought and sold on any trading day to the highest bidder among many investors. Cash for purchases and sales can be exchanged within days of the stock sale. Private markets can offer no such liquidity, or the ability to exchange an asset for cash quickly, without a steep discount to value. In addition, stock exchanges have substantial capital backing and insurance, giving investors worldwide accessibility and high assurance that transactions can be handled efficiently and properly.

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