What is a stock market?

1.1. Introduction

In this article we provide an introduction to financial markets. First, we will define them, We will explain its properties and which actors are involved. Then we enter one of the financial markets with more popularity, the stock market, and we will analyze the characteristics of its assets. Finally, we will perform An introduction to the activity known as trading and the different approaches to making profits from it.

1.2. Financial Markets

a market Financial is a set of people or institutions that exchange or trade financial assets. Although it is It is true that the creation and exchange of a financial asset can be carried out outside of them, currently in the Most economies create financial assets that are subsequently traded in some type of market. financial.

The function of financial assets is to transfer funds from those who have surpluses to those who need invest in tangible assets, in such a way that they also redistribute the unavoidable risks associated with the assets tangible between those who provide the funds. In this sense, financial markets have the following properties:

The interactions between buyers and sellers in a financial market determine the price of the asset negotiated. That is, the performance of an asset is set by the supply and demand that exists in a given moment in the market.
Financial markets provide a mechanism for an investor to sell an asset. That is, they allow Investors get rid of the obligation to hold an asset by transferring it to another investor.

1.3. stock market

Stocks, also known as equities, represent property rights over a company. Each share gives its owner the right to participate on any corporate governance matter submitted in a voting format at the meeting of the partnership and a share in the financial profits of the property when the profits are distributed in the form of dividends.

Shares are created by the need of companies to obtain new capital to achieve the growth. Through an initial public offering, or IPO (initial public offering), the company's shares They are sold to institutional and individual investors.

After the IPO, they are freely traded in the market and money circulates among investors. Those investors They must endure the unpredictable nature of the market to price their shares. For an institution or person who owns common shares, the return on obtaining a share comes from two sources:

Dividend payments: Dividends are distributions made by a corporation to its owners, usually in the form of cash or additional shares of stock. The payment of dividends is not mandatory, Normally young companies do not pay them, but as time passes and they mature they begin to do so.
Share Price Changes: While holding a stock, if the price at a future date is greater than the purchase price, there is a capital gain and, if the price is less, there is a capital loss. When a shareholder calculates the return on holding a stock from the date of purchase to a point in time given, you are actually calculating the profit or loss you will get if you sell the stock at that time. moment.

There is an additional very popular way to profit from a stock, known as short selling. This operation has two steps, in the first, the short seller borrows a certain amount of shares and sells them to a third party; Then, in the second step, the short seller buys back the shares from the third party and returns to the fork. If the price of the stock has fallen between the time of the initial sale and the time of the return will be the profit obtained from the investment. If it increases, it generates an investment loss.

The desire of shareholders to trade their shares has led to the establishment of stock exchanges, organizations that provide markets for trading shares and other financial derivative products. those bags They can be physical locations, such as the New York Stock Exchange (NYSE), or digital platforms, such as the NASDAQ. Each stock exchange imposes its own listing requirements on companies that wish to list on that exchange. bag. Such conditions may include the minimum number of shares outstanding, market capitalization minimum and minimum annual income.

Today, stock trading is mostly electronic. This has been possible thanks to the liberalization of markets and technological advances for monitoring markets and the execution of orders, which has also reinforced competitiveness between markets, lowering costs and putting negotiation at available to the general public and institutions.

1.4. Trading

The globalization of the stock market has allowed access for both the individual investor and the institutional investor. When a investor wishes to buy or sell a common share, the price and conditions under which the transaction will be executed order must be communicated to an intermediary (broker), then this agent organizes the operation and charges a commission to the investor. These orders can be of many types:

Market Order: This is a buy or sell order that will be executed at the current market price. An order of A purchase is made at the best price offered and a sell order is made at the best price offered. How can you appreciate, there will be a gap between both prices known as the bid-ask differential.
Conditional Order: Prices can change between the time an order is created and the time it is placed. executes, so investors can also place orders by specifying prices at which they are willing to buy or sell a stock.

All requests are included in the order book, which constitutes a record of buyer interest and sellers in a particular financial instrument, in this case shares. Subsequently, a system of Comparison uses this book to determine which orders can be fully or partially executed. Consequently, The price of a stock fluctuates fundamentally due to the theory of supply and demand.

In addition to supply and demand, there are other factors that influence the value of a particular stock. The Fundamental analysis and technical analysis attempt to understand the market conditions that lead to changes in prices on shares with the aim of making profits on it. These two fields represent two approaches different from the market:

Fundamental analysis: consists of the analysis of underlying factors of a company to determine its value. In this context, the idea of value investing stands out, which supports that Markets may price a stock incorrectly in the short term, but the price will eventually be reached. correct price at some point. Under this assumption, investors can make profits by buying/ selling stocks at incorrect prices and then waiting for the market to change the price of the security to sell/buy it and make a profit on the difference.
Technical analysis: involves using past market data, such as price and volume, to develop forecasts about the direction of prices. It is based largely on techniques of time series analysis, but also exploits more advanced techniques from other fields, such as statistics or signal analysis.

These two approaches were a hot topic for many years, but there is now some consensus that Stock market prices are essentially unpredictable. This is based on the efficient market hypothesis , which states that all available information about an asset is contained in their prices, which makes it impossible to "beat the market" consistently, since these prices will only react to new data not available.

In this context, algorithmic trading appeared, a new system that emerged from the application of ideas provided by fundamental analysis and technical analysis to automate trading strategies using computer programs. These algorithms They can handle more information and faster than a human manager, so, by implementing A set of programmed rules can lead to a high profit margin. Some examples of these trading strategies can be:

Mean reversion: This strategy is based on the concept that the high and low prices of an asset are a temporary phenomenon that returns to its average value periodically. Then, identify and define a price range allows trades to be placed automatically when the price of an asset enters and leaves its range defined.
Trend Following Strategies: Some popular strategies follow trends on moving averages, channel breakouts, price level movements and related technical indicators, so the Operations are carried out based on the appearance of desirable trends. %
Arbitrage Opportunities: Other popular strategies are to, given two markets, buy a stock at a lower price in one market and simultaneously sell it at a higher price in another market to maintain the price differential as a risk-free profit. Implement an algorithm to identify such Pricing spreads and placing orders efficiently allows for profitable opportunities.