Investing in equities Understanding the stock market

Stock markets explained

Companies list on stock exchanges to raise capital from investors

To make it simple for potential investors to buy their shares, companies opt to have them listed on a stock exchange, such as the London Stock Exchange (LSE). 

To be listed on the LSE, a company needs to have been trading for at least three years and have a market capitalisation (the number or ordinary shares in circulation multiplied by the current share-price) of at least £700,000. 

According to the LSE, there are over 1,400 companies from 60 different countries trading on the main market of the Exchange.

Smaller companies are often unlisted, but some are traded on the Alternative Investment Market (AIM) or the PLUS-quoted market. They are generally seen to be more risky investments than those companies listed on the main market – their share prices are likely to be more volatile and they are more likely to go bust. And smaller companies typically don't pay dividends – they might not be making much, if any, profit yet.

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Stock market indices

A stock market index is used as a way to measure the performance of shares in a particular country, region or type of industry. In the UK, the flagship stock market index is the FTSE 100. The 'footsie' measures the performance of the 100 largest companies listed in the UK. The larger FTSE All Share measures the performance of all listed companies in the UK.

There are hundreds of different indices measuring the performance of shares (and bonds, property and other assets) all over the world. They can be useful as a barometer or benchmark to judge the performance of your investment.

What does the stock market index show?

When you see a stock market index, such as the FTSE 100, it's often referred to in points. When the FTSE 100 launched in 1984, it was started at a base level of 1,000 points. The increases and decreases represent the average change in the share price of the companies that make up the index.

The FTSE has soared much higher since then - it broke through 7,000 points in April 2015, for example. When the index was launched, the total market capitalisation of the companies in the index was just over £100bn. Now it is over £1.5trn – over 15 times larger.

Tracking a stock market index

A simple way to get access to the stock market is to invest in equity funds. Some funds buy shares from all the companies in an index, or a representative proportion thereof, to track its performance. These are known as passive 'tracker' funds. They come with lower annual management charges and are relatively simple investments to own, but will always slightly underperform the stock market index because of the cost of investing in them. 

Active funds, run by professional fund managers, aim to deliver returns that beat a stock market index. For this service, you pay higher annual charges, but in theory the manager will produce superior returns to make up for it. There is, however, no guarantee that active funds will beat the stock market index – indeed, few active managers are able to beat the market on a consistent basis.

Find out more: Active vs passive investment – understand the two approaches

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Last updated:

February 2016

Updated by:

Michael Trudeau

 

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