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Stock market

A stock market is a market (in the wider sense of the word) for the trading of company stocks or shares. Trading of shares in larger companies generally takes place as part of a stock exchange. The state of a particular stock market (the trade of particular types of shares) is often summarised by means of a Stock market index.

Since the crash of 1929, brokers on American exchanges have had the obligation to assure an orderly and fair market by intervening when the price of a stock seems to be rising or falling too fast. See Economics - Efficient Markets Theory for a more theoretical discussion of how prices may rise and fall. Each of the 3000 or so stocks traded on the NYSE is handled by a specialist--all buys and sells are directed to him, and he matches buyers and sellers. Even before the crash, this was a necessary function because of the conditions that are frequently attached to transactions--someone may want to pay $40 per share but only for round lots (blocks of 100 shares), another person may want to sell only with early settlement. Since then, though, specialists have the authority and the obligation to prevent the market from running wild. A specialist may halt the fall of a stock price by using his own company's funds to buy shares, which can later be sold gradually. He has a reserve of the stock which can release for sale if a shortage is driving the price up too rapidly. Trading can be suspended altogether.

An option is a contract to buy or sell something at an agreed-upon price during a specified period. A buyer who believes that the price of a stock will rise can enter a contract known as a "call" which gives him the right to buy another's stock at a date three to nine months in the future. He pays a fee to the owner of the stock and will forfeit it if he does not exercise the option. But if the stock price rises enough, he can exercise the option and buy the stock at the fixed price, then re-sell it for a higher price to recover his premium and make a profit.

Someone who thinks that the price of a stock is about to fall can write a "put" contract with someone else who agrees to buy the stock at a fixed price. He does not have to own the stock at the time the contract is made. Again, he pays a premium. But if the stock price does fall, he can buy the stock at a low price on the market and then sell it for agreed-upon higher price.

Option contracts are traded like stocks, often by people who have no intention of exercising them. Although there is a guaranteed loss of the premium when an option is not exercised, there is enormous potential profit from trading the option itself--its price rises or falls with the price of the underlying stock. Someone who has a guaranteed buyer for 10,000 shares of stock at $35 has a contract of enormous value if the price of the stock falls to $10. He may not want to invest $100,000 to fulfill the contract and earn $350,000. But someone will want to buy the contract from him for more than he paid for it.

There are also two sorts of trades involving cash or stock not actually owned, short selling and margin buying[?]. In short selling, someone sells stock that they don't actually own, hoping for the price to fall. They must eventually buy back the stock. In margin buying, someone borrows money to buy the stock and hopes for it to rise. Most industralized countries have requlations that recquire collateral for the above two trade types to prevent large losses to brokers.

Before 1929, there were few regulations governing trades. This was taken advantage of by the so-called "Robber Barons", to amass the large fortunes for themselves using (today illegal) techniques.

Since then, there have been periodic attempts to solve other perceived business problems with further regulation. As of this writing (in 2002) there is a stock market downturn that is prompting such considerations in the United States.

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