When you hear people speak about trading or investing, most likely they’ll be talking about share trading. It’s one of the most popular – and most traditional – ways to trade the financial markets. Particularly among individual investors.
As we saw in the previous lesson, if you’ve got a pension plan, the chances are you’re already investing in shares in some capacity. But what are shares? And how do they work?
A share is a unit of ownership in a company.
So, if a particular company is worth £10,000 and has issued 2000 shares, each share would be worth £5 (10,000 ÷ 2000).
As the share price fluctuates, so does the value of the company. Investors who buy shares in a company are hoping it will grow in value, enabling them to sell the shares at a higher price.
Why do companies offer shares?
To raise money
By allowing investors to buy part of the company, the management are able to raise capital to put back into the business. For example, they may need extra cash to expand into other territories, or launch a new line of products.
If the funds are used wisely and the company becomes more profitable as a result, the value of the share price – and therefore the business – should rise.
This means the company and its shareholders are heavily reliant on each other. The company needs shareholders to raise funds, and the shareholders hope the company will use their investment to grow the business – so they can make a profit.
Why do share prices move?
Share prices can stay fairly stable for months, or move rapidly. The amount a share fluctuates is known as its volatility.
Whether a share price moves up or down is based fundamentally on the laws of supply and demand. Essentially, if more people want to buy a share than sell it, the price will rise because the share is more sought-after (the ‘demand’ outstrips the ‘supply’). Conversely, if supply is greater than demand then the price will fall.
How levels of supply and demand move prices
Supply and demand can be influenced by many factors, but the main two are:
Earnings
These are the profits a business makes. If the earnings are better than expected, the share price generally rises. If the earnings disappoint, the share price is likely to fall. Companies tend to release earnings announcements for a specific time period, usually a quarter, half or full year. The firm’s share price can be particularly volatile immediately before and after the announcement, especially if the figures are significantly better or worse than anticipated.
You can use an economic calendar to see when certain companies are releasing earnings results.
Sentiment
This is perhaps the most complex and important factor in a share price. Share prices tend to react strongly to expectations of the company’s future performance. These expectations are built on any number of factors, such as upcoming industry legislation, public faith in the company’s management team, or the general health of the economy.
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