"The Stock Market Explained Reveals
The Origins of The London Stock Exchange,
Its Main Functions and How You Can Benefit"

Introduction

The London Stock Exchange Coat of Arms

The Stock Market Explained  suggests that the chances are - you are already a shareholder.

Most probably through your works pension plan (if you're a member of one).

You may have read somewhere that shares have out-performed all other types of asset.  Meaning that, throughout good times and bad, good quality shares have a proven track record as the best way to build financial security.

In this short article, you will discover how the stock market really works and how you can benefit from the terrific tax advantages the U.K. Government gives you in order to encourage you to invest in U.K. Ltd.

You will discover:

• What is the most tax advantageous method of saving for your reetirement
  
  
• What type of share you should ONLY be interested in
  
  
• How to interpret indicators that are used by market professionals - which includes one key ratio that is the most important single factor in your investment decisions
  
  
• How using indices you can compare one investment against another
  
  
• Where you can get all of the information that you will ever need
  
  
• And much, much more
  

Note:  Do take note that early on in the above introduction, it was mentioned that "good quality shares have a proven track record" it is well worth remembering that the emphasis needs to be placed on "good quality shares."  Third rate, or even second rate shares, should not be entertained - no matter how attractive they may look.

"The London Stock Market Explained"

The London Stock Exchange

The London Stock Exchange is situated in central London very close to St. Paul's Cathedral.

It was founded way back in 1571 as The Royal Exchange and opened by Queen Elizabeth I and remained under this name until 1698.

During the 17th. Century stockbrokers were not allowed into The Royal Exchange and instead operated from coffee houses in and around central London, most notably, Jonathon's Coffee House.

The Royal Exchange was destroyed during the Great Fire of London in 1666 and rebuilt in 1669.

Parliament pased an act in 1697 for all brokers to have a license.  The first signs of some kind of regulation.

After the Seven Years' War (1756-1763) trade in Jonathon's Coffee House boomed again and in 1773 Jonathon and another 150 men formed a club and opened a new, and more formal, Stock Exchange in Sweetings Alley.

The first real regulated Exchange was formed was in 1801 and it was this Exchange that raised the enormous amounts of money required to finance the wars against Napoleon.

By the year 1853, the Exchange outgrew itself and a new, much bigger building was required.  And by the late 1800s the telegraph and the ticker tape had been invented.

The old Trading Floor of The London Stock Exchange

The FT 30 Index was always the yardstick for measuring stock performance and it wasn't until 3rd. January 1984 that the FTSE 100 Index made its entrance.  An index comprising of 100 of the largest traded stocks was always going to be more accurate than just the top 30 companies.

The next change didn't take long, in 1986 "Big Bang" as it was called, arrived to the markets and ended the century-old tradition of trading on the floor.

The system of "open outcry" or floor-trading was replaced with the technological system of screen-based trading.

"Big Bang" heralded the de-regulation of financial markets in the U.K.

In 2007, the London Stock Exchange (LSE) merged with the Milan Stock Exchange to form the London Stock Exchange Group.  There have been numerous attempts, by others, to merge with the LSE but they all fell through.

We believe that British Institutions should stay British - but that doesn't always happen.

Who would have though it?  Not four decades later, we as private investors would have the luxury of trading online, from the luxury of our homes, just like the professionals did after "Big Bang."

That's progress!

"Professional Investors Avoid
Small Companies - So Should You"

It has been said many, many times that if you want to succeed at anything then find someone who is ridiculously good at what you want and copy them.

And in the case of investing in the Stock Market there is just one man.

His name - Warren Buffett.

Everybody's heard of him. 

Study him.  His techniques.  Model everything that he does and you will always surface with positive results.  After all he has amassed $90 BILLION (and still counting).

Yet somehow, people are tempted by mythical stories about "killings" made by "dabbling" in small cap shares.  Of course there will always be the odd winner but a very high percentage of them will be damp squids.

Watch the type of companies that Warren Buffett invests in.  They are all high capitalisation shares. 

Definitions:  High Capitalisation shares:  > £1 Billion

Medium Cap shares:  > £300 Million but < £1 Billion

Small Cap shares:  > £50 Million but < £300 Million

Micro Cap shares: < £50 Million

Warren Buffett invests ONLY in high cap shares - therefore, so should the rest of us.  It's not negotiable.

Of course, selecting a share on purely market values is not a good idea, there will always be times when high cap shares are underperforming. 

You want to pick the ones that are already out-performing or are ready to out-perform.

To take this subject further, you need to hop over to the section Fundamental Analysis

"The Stock Market Main Functions Explained"

The Stock Markets of today perform two very different functions:

1.  The Primary Market

When a company joins the stock market the money raised by the issue of shares, less expenses, goes directly into the coffers of the company issuing the shares.

That money may get used to build new factories, develop new products, re-finance debt, or contribute to the company's growth in some other way. 

This is what capitalism is: the raising of capital by sharing risk in return for potential profits.

Think of the analogy of The Primary Market being  a New Car Dealership.  You buy a car and the money you paid goes to the car manufacturer - less the dealer's commissions and expenses.

2. The Secondary Market

The Secondary Market is also referred to as an "after-market." A place where buyers and sellers can easily find each other.

The Secondary Market provides liquidity, or in other words, a way in which assets can be turned into cash.

Think of the analogy of a second hand car dealer.  Noe of the money you give him for one of his cars will go to the car manufacturer.  The dealer buys from one car owner and sell it on to the new owner, and makes his profit by selling the car for more than what he paid for it.

The Secondary (Stock) Market does exactly the same.  Company shares are bought and sold every day. Sometimes for the short term, sometimes for the long term.

Capitalism is often criticised with the claim that the secondary market provides no socially useful role. They cite that none of the profits made there go to the company that originally issued the shares.  But the point is: there would be no primary market if there was no secondary market.

"Why should companies care about their shares in the Secondary Market?"

Any profits made from subsequent sales goes to the investors who bought and sold those shares - not to the company.

But companies do care.  They may want to issue new shares in the futureto finance any expansion.  Or they may want to fend off any predators.

Also, directors, senior manager, and workers may be shareholders - so they all have a vested interest in the performance of their company's shares.

For more information contact: The London Stock Exchange Group PLC

"Why Do Stock Markets Fluctuate?"

We all know that Stock Markets move up and down. 

These moves occur for both rational and irrational reasons.  In the short term and long term.  Such moves provide plenty of chances for profit.

Generally, there are three factors at work causig these price movements:

• Psychological Facors - there is a phenomenom known as herd metality that cause markets to move from extreme optimism to extreme pessimism in a relatviely short time period
  
  
• Fundamental Factors - such as how well a company is managed, are its profits increasing or decreasing? What return does the company make on the money it employs, and many, many other criteria
  
  
• Technical Factors - sectors of industry peak at different times and one share may be more popular than another and demand for its products may be greater than that of a  competitors - consequently, its shares will rise whereas one of its competitors may fall or not rise as fast

It is therefore important to keep a close eye on all three factors that control the movement of shares. 

Markets move on sentiment.Investors are either optimistic or pessimistic.

A contrarian will buy when others are selling. And sell when others are buying. Take for example a market where there are 1,000 participants. And if 750 of them are buyers with 250 of them sellers then sentiment is what the market calls "bullish."  More people think that these particular shares will go up than think that it will go down.

This will result in the shares going up.

Conversely, if there are more sellers than buyers then sentiment is what the market calls "bearish" and the share price will go down.

In the bullish situation, what happens to the share price when the 750 people stop buying?  Will the shares just stop going up, or will they fall?

Think about it!  There is no one left to buy.

Wouldn't it then be logical to know when there is no one left to buy? You can never "know" when the market is about to turn but you can figure out when the buying has dried up.

You can get a "feel" for this market sentiment by closely watching the markets and listening to the news (although we tend to treat this latter with caution). You can, however, look at your charts and decide from the volume figures whether they are buyers or sellers. It takes a little practice but given time, you will be able to read the charts.

Another sentiment indicator could be rising shares versus falling shares.  All the major newspapers publish these figures daily.

Follow the shares you have listed but take note of what Warren Buffett says, and does:

Warren Buffett, our role model, reckons that over a persons lifetime, an investor should only specialise in 30 to 40 companies.  And, at any one time, perhaps only 10 or 12. 

The world's greatest investor believes that there is no substitute for doing research on companies that you place on your watchlist.

All the above factors will be dealt with in detail throughout this website. For more information visit the following:

Stock Market Psychology

Fundamental Analysis

Technical Analysis

"How Companies Raise Money
From The Markets"

Probably the most comon way for compaies to raise money through the Stock Market is to offer new shares to existing shareholders through what are called Rights Issues.

Rights Issues are initially proced below the current market price and then offered to existing shareholders in proportion to the number of shares that they own.  For example: one new share for every existing share, or one new share for every two existing shares.

If existing shareholders do not want to take up their new shares they can be sold in the market - making them a potentially good opportunity to make a profit.

So how does a Rights Issue work?

If you already own shares in a company and they announce a Rights Issue, keeping it simple, the shares are trading at 100p and the rights are issued at 90p.  The "nil paid" rights are not yet paid for but must be bought by a certain date, and in this case would be 10p. 

If the shares in the market go up to, say, 110p that means that the rights will have doubled to 20p.  That is, a rise of only 10% of the market share price results in a rights price increase of 100%.  Conversely, if the share price were to go down, then the value of the rights would be wiped out altogether.

Generally speaking, it is a good idea to take up your rights if on offer.

"How Do You Pick Shares?"

You will read elsewhere on this web site about so-called professional financial advisors.

The fact is, taking advice from these yuppies in fancy suits can be dangerous.  Very dangerous.

The best way to pick shares is to Do It Yourself.  That may seem frightening to you at first glance, but as mentioned elsewhere in this article, you need to model Warren Buffett.  Do that, and you will not only beat the so-called professionals but you will never lose money on a trade.  Never.

If you don't believe the above statement then understand this: most full-time money managers fail to even match, let alone beat, the FTSE 100 Index. 

It has been proven that throwing darts at the financial pages of a newspaper can often do better.  Random theories have been identified many, many times.

You and I have an edge over the professionals.  First of all it's our money that we will be playing with and not someone elses money. And secondly, we (that is you and I) have an intuition of finding opportunities through things that we see every day.

For example: your grandkids are always on their computers playing this new game, online, with all their friends.  And you start to see magazines in shops with this computer game on every front page.  So you decide to make it your business to find out which company invented this game.  Maybe they are into other program developments?

Example 2: Your kids want more spending money because they and all their friends are spending all their money at this one particular high street shop. Or your kids, and their friends, are all suddenly wearing the same kind of trainers. 

Example 3:  It's no secret, Covid has forced a lot of high street retailers to ramp up their online services.  But you notice that one company in particular is doing well both online and offline - what's more - this company is a FTSE 250 constituent

Your friendly investment advisor may well have done considerable research but the companies that he recommends will probably already be fully priced. 

You need to do your own research, a.k.a. the Warren Buffett method. Let's abbreviate that to WBM.

You need to look for "Value" type shares.  Warren Buffett (WB) also likes "Growth" shares but his mantra has been 80% Value, 10% Growth, and 10% cash in reserve.

There is a third type of share that we favour:  Momentum shares.

We amended the WBM (slightly) to one of our own: 70% Value shares, 10% Growth shares, 10% Momentum shares, and 10% cash in reserve.

As a private investor just beginning, you are confronted with an overwhelming choice when it comes to selecting individual shares.  By now, you should get the idea that to 'Do It Yourself' really is the right way to go - but where to start?

You can subscribe to newsletters but they are expensive and do not really have your interests at heart.  Only the publishers get rich.  Besides, they tend to concentrate on the next "ten bagger" - always looking for the spectacular.

Follow the webpages on this website and you will be guided in the direction of the WBM.  And his first rule of investing is: Do not lose money.

The WBM searches for companies with what WB describes as having an "Economic Moat." These are companies with a proven track record, rock solid balance sheets, and highly capitalised (companies valued greater than £1 Billion).

These type of company are sometimes called "Blue Chips"  However, not all "Blue Chips" are a good investment all the time.  Which implies that when to buy could be almost as important as what to buy.

It is mentioned in this website over and over again that you use Fundamental Analysis to find out what to buy and Technical Analysis to find out when to buy (and sell).

But, as mentioned earlier on in this article, there is a third element that you need to consider when picking shares - and this is: yourself.  Psychology plays a very large part in investing as it can play on your mind.  And it doesn't just affect you as an individual, it affects the masses - otherwise collectively known as "the herd."  You do NOT want to part of the herd.

Be your own person.  Be contrarian.

This topic of picking shares is what it is all about and cannot be dealt with here in just a few  short paragraphs. There are numerous places on this website that deal with the topic in much more detail - just follow the links.

"How To Trade Your Chosen Shares"

This is extremely straight-forward.

You open up an account called a Self Invested Personal Pension or SIPP as they are better kown as.

SIPPs are administered by companies that are regulated by the financial authorities.  All SIPP providers have what is called a Stock Trading Platform and the buying and selling of shares is intuitively conducted this way.  It's all done online.  No calling anyone- it couldn't be simpler.

Conclusion

You should by now have grasped the basic concept of how to invest in company shares.

If you can't answer that question, then go back to the beginning of this webpage and read it again.

The concept is this: try to emulate Warren Buffett.

It is utterly surprising that the majority of amateur investors try to "beat the system."  In fact, there is no "system."

Why would anyone not want to emulate the greatest investor the world has ever witnessed?

That is easily answered.  People are always wanting instant gratification.  They read about whiz kids picking this share or that share and it rising ten fold in under six months.

That rarely happens.  And what you don't hear about are the thousands of investors who have tried and gone broke. 

This kind of action can be summed up in one word - impatience.

Warren Buffett invests for the long term - and so should you.

Furthermore, the type of company share to invest in is not one that is new to the marketplace - how can they possibly have any history for research purposes.  All your research and activity needs to be in the Secondary Market a described above.

Nor should you invest in "tiddlers" or low cap shares as they are referred to. You need to invest in long established companies that have a proven track record, brand, market share, and a history of continuous growth.

That's why Warren Buffett says you need only study about 20-30 shares throughout your lifetime - why? Because there are not many of them, that's why.  

Because the companies that you will be investing in are good, solid companies - if a Rights Issueed were to be announced, you should have no hesitation in taking up those rights.

The next article in this series can be found by clicking on the following link:

Under-valued Stocks

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