Making Money on the Stock Exchange: How Stock Exchanges Work

The London Stock Exchange is a marketplace for buying and selling shares. There are two groups:

• Stockbrokers, who buy and sell for you. They arrange the deal and receive commission, which might be 1 % with a minimum amount of perhaps £15.



• Market makers, who buy from and sell to you. They get the difference between the buying and selling price the spread (this is usually about 1%).

There is a new trading system, called order driven trading (the old system is called quote driven trading), operating for high value companies SETS (Stock Exchange Electronic Trading System) whereby buyers and sellers are automatically matched. However, deals are still set up by stockbrokers.

Some large companies have set up means to trade in their shares at lower costs than are charged direct by stockbrokers.

In addition to commission, stamp duty of 0.5% is payable on purchases.

Adding these together and you have to achieve a gain of about 2.5% to break even.

The animals

The Stock Exchange is full of nicknames. You have already met stags but there are two more important animals bulls and bears. Bulls are optimistic and believe share prices will rise; bears take the opposite view.

To go with the meat there are chips! Blue chips are shares in big companies thought to be relatively sound, such as BP Amoco and Tesco. Then there are white chips smaller, sound companies.

Share prices

Prices of popular shares are printed in most daily and evening papers and can be found on Ceefax/Teletext and on the Internet.

They are usually grouped into sectors, such as stores, electrical, engineering. Lists of share prices will include some or all of the following:

• Yesterday's closing price: this being the middle market price, halfway between the buying and selling prices.



• Yesterday's increase/decrease, shown as + or the previous day's price.



• Highest and lowest prices in the last 52 weeks.



• Market capitalisation total number of shares times current price, a measure of company size.



• Gross yield last full year's dividend before tax as a percentage of the current price.



• P/E ratio price divided by earnings (profit before tax) per share, i.e. how many years' earnings to recover the share price (theoretically the higher the figure the better the potential growth).

Share price indices

Most people have heard of the 'footsie'. It is the FT/SE (Financial Times/Stock Exchange) 100 index the 100 being the largest 100 companies by market capitalisation.

The other main index is the all share index comprising all the shares quoted on the main exchange. There is also the mid 250, being the next 250 after the top 100, and the recently introduced Techmark index for new technology stocks. There are also indices for the main categories of shares on the London market and for foreign shares Europe, the US, Japan, the Far East.

Settlement

Most transactions are now settled electronically through the Crest system, under which share ownership is registered in the name of a nominee.

The old system using transfer forms and share certificates is still available but may cost more.

Settlement of electronic deals is now made three working days after the transaction date. For certificated dealing it is still ten days.

Alternative investment market

In addition to the main market, there is also AIM, the alternative investment market which deals in shares of companies which are relatively new and small. It is an intermediate step before the main market.

Stock exchange regulations are less onerous than for the main market, but this does not in itself mean more risk for the investor.

Shares quoted on AIM are more volatile, may be difficult to buy and sell due to restricted numbers and are certainly more risky due to the newness and small size of the companies. However, large profits can be made.

OFEX market

This is a market for trading in shares in unquoted companies, that is companies which are not quoted on the main or AIM markets and are therefore much more risky.

Stockbrokers

Some operate on an execution-only basis whereby they just deal in accordance with instructions. If advice is also needed, it will cost more. Deals are usually arranged by telephone or using the Internet.