Investing 101 How the Stock Market works

Read this to understand how the Stock Market works.

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How the Stock Market works play

How the Stock Market works

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For new investors or people who do not really understand how the stock market works, it may seem like a big “kalokalo” joint but it is an organized place that handles trillions of naira worth of people’s money in a complex way with different people having different motives for “investing” there.

I will try to briefly explain how the stock market works  just to shed some light on its activities.

To understand how the stock market works, we would need to have a basic understanding of:

  1. What a stock is

  2. What a stock market is

  3. Who the stock market participants are and what service do they provide

  4. How the stock market really functions

What is a stock?

A stock (popularly called shares) as far as the stock market is concerned is a means of identifying ownership in a company. So a stockholder (or shareholder) is an individual or institution that has a claim on part of a company’s assets – so if you have 1 share (or stock) in Okomu Oil PLC for instance, you are part of the company’s owners! So you own part of the buildings, machines, even the profits of the company! Isn’t that interesting?

What is a stock market?

When we want to buy or sell food (I like food a lot), we go to the market e.g. Oshodi (if you reside in Lagos) or Garki Market (if you are in Abuja). The same goes for stocks – we go to the stock market to buy and/ or sell stocks. Simple! It is important to note that stocks are not the only things traded in the stock market (also called stock exchange) but we can also buy bonds, exchange traded funds (ETFs) and other items (also known as securities).

The stock market is divided into 2 key segments as it relates to you and me (retail investors) known as the primary and secondary markets. The primary market is where companies setup their stocks (shares) for sale. This is done by an initial public offering (or IPO). So if a private company wants to sell stocks for the first time, they go to the primary market.

The secondary market, however, is where already created stocks are traded (bought and sold) by investors. So if you want to buy a stock that already exists and is being traded, you can buy it on the secondary market.

These are the key segments of the Nigerian Stock Market.

Who are the stock market participants and what service do they provide?

There are various participants in the stock market and they include:

1. Securities and Exchange Commission (SEC):

The SEC is the main capital market regulator and is answerable to the Ministry of Finance. It also maintains investigative powers over the NSE in order to ensure that issues like insider trading are monitored and prevented to protect the capital market and maintain its integrity.

2. The Nigerian Stock Exchange (NSE):

This serves as the marketplace where these trades occur. It operates an automated trading system (or ATS which is essentially a computer program). So that when we want to buy or sell stocks, the trading platform handles it efficiently, easily and quicker than a manual process. The SEC is a key participant in the whole process and was established in 1960.

 Central Securities Clearing System Limited (CSCS):

CSCS is a subsidiary of the NSE and is in charge of clearing, settlement, and delivery of transactions on the NSE – remember the ATS I mentioned before? Everyone who owns a stock is recorded by the CSCS. In short, all the details of the stock market and stock market participants are stored by the CSCS.

3. Stockbrokers:

There are over 250 stockbrokers registered with the NSE and their job is to be the middlemen between the exchange and us. These are the guys that we would need to tell when we want to sell or buy a stock or security.

4. Issuing Houses:

If a company wants to sell shares to the public (float a stock) or the first time, they usually go to issuing houses to register the IPO with the SEC and make arrangements to underwrite it. They are usually banks or other financial institutions and they register, distribute and sell the IPO on the primary market on behalf of the company.

How the stock market really functions

So how does this all fit? Let us use Tunji – as an example case, for someone who wants to begin to invest in the stock market.

How the Stock Market works play

How the Stock Market works

 

Once as part of the process of registering with the brokerage firm, Tunji will have to bring in some additional documents like valid ID, utility bills etc. – essentially the same things that you will need to open a bank account. He may be asked to make a deposit into his brokerage account which will serve as the source of his trading funds. So if he receives or makes a payment for stock market transactions, the proceeds go into or leave this account.

How the Stock Market works play

How the Stock Market works

 

After “proper analysis”, Tunji may then decide to buy (or sell) some stocks. The diagram above gives an indication of the potential flow of events.

This was just a brief description of what happens and how the stock market works. Different brokerage firms handle things differently but we have tried to describe how a new investor can setup and begin using his/ her brokerage account for investment purposes.

Finally, remember to only invest money that you are willing to lose in the stock market (especially if you are going for growth stocks ).

Keep investing,

Your Investment Analyst

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