What is the Stock Market?

Stock Market NewspaperWhat is the (purpose of the) stock market?

By the time a person reaches adulthood, it is a pretty good bet that he or she will have at least a passing familiarity with the stock market. But if you’re interested in putting your money into stocks, it’s probably a better idea to have more than a “passing familiarity”, don’t you think? This post is an overview of the purpose and structure of the stock market in Canada.

Two types of capital markets

Most fundamentally, you must know that the stock market is a Capital Market. Simply put, capital markets provide a standardized way for money to flow from those who have it (savers) to those who use it (companies and governments).

In addition to the stock market, money can flow from savers to users in the bond market. These two markets are similar in that they provide a means for money to flow between two parties, but different in that, in the bond market, the lender is just that: a lender. This party has no ownership stake. The arrangement comes down to lending money, on the condition that the money, along with an agreed-upon amount of interest, will be paid back by an agreed-upon time. There are many ways that these deals are commonly structured, but that is beyond the scope of this post. (Although the stock market receives much more news coverage, based on volume of trading on the dealer market, the bond market is actually much larger than the stock market.)

Buying stocks is different in that the investor is not lending his money to anybody. Rather, he is buying part of the company. This entitles the investor to share in the profits of a well-run company, or to lose money if the company falls out of favour. Money can be earned from either buying low and selling high, or, the approach I strongly prefer, through collecting regular dividends. Losing money is the result of doing the opposite: buying high and selling low. It is worth noting that the most an investor can lose is the amount of money that has been invested; investors are not personally on the hook if the company ends up going out of business while still owing money to creditors. Another important point to consider is that people who buy stocks are becoming part owners of a company, and have a say in how the company is run. This fact has been brought to the fore in the past months by the very public fight between Bill Ackman of Pershing Square, and Canadian Pacific, whose Board of Directors has been essentially been taken over by Ackman and his clan. Pershing Square, as a group that owned a high percentage of CP shares, made clear its views that the company should be run better, and proceeded to do something about it. As part owners of CP, this was certainly within their rights.

The recent evolution of the stock market in Canada

The stock market came about as a way of standardizing the way and place that investors could buy and sell their interests in companies. As technology has evolved, so too has the way in which shares are traded. At one point in time, it was necessary for people to be in the same place at the same time to trade shares. Not so anymore. The Toronto Stock Exchange (TSX), Canada’s largest exchange, closed its trading floor in 1997, and now uses a “floorless” or “virtual” trading environment.

The TSX is an “auction market”, where bid prices (what a buyer is willing to pay) and ask prices (what a seller is willing to accept) are channelled through a single, controlled market. The single market allows for efficiency and convenience. The TSX is the largest and best-known stock market in Canada, but there are others. The TSX Venture Exchange for smaller and/or newer (“junior”) companies. You may also have heard of the Montreal Exchange, but that is a derivatives market. The products are (much) more complicated that the stocks bought and sold on the TSX, but they ultimately get (“derive”) their value from stocks. All three of these markets are owned by the TMX Group, which is itself a publicly traded company. Its ticker symbol on the TSX is “X”.

CNSX (Canadian National Stock Exchange) is, according to their website, “an innovative new stock exchange for trading the securities of public companies”. I have to admit that I’m not familiar with this exchange, but I’m OK with that.

ICE Futures Canada is for futures contracts, which, frankly, are probably far beyond what you are looking at investing in if you’re reading this article.

So there you have it. In a nutshell, the stock market is the vehicle that allows savers to use their money, though standardized trading conventions and vehicles, to earn a return.  It makes the investor part owner of the company, entitled to a piece of the pie if the company is able to turn a profit, but also subject to losing money if the value of the shares goes down.

 

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