A Brief History of the Stock market

A Brief History of the Stock Market

When were the markets born?

Much depends on how you define thw stock market. Essentially stock markets can be described as a market where products that are derived from stock, debt or commodities are traded. If you take this broad definition (that doesn't assume the 'stock' part makes it mutually exclusive to equities) then the first such markets can be traced back to the 12th and 13th centuries in France and Belgium where 'courratiers de change' and commodity traders gathered in formal meetings to trade debt and commodities. By coming together to trade in an organised way the notion of todays stock markets were born. From these early roots the idea of setting up formal trading houses spread throughout Belgium and Italy where it wasn't long before government securities were being traded.

It is thought that the Dutch were the first to set up a stock exchange in the modern sense of the word. The Amsterdam Stock Exchange was the first and the biggest for many years after its inception in 1602 which was performed by the Dutch East India Company when it issued it's first stock and bonds. It was the first exchange to formally trade in securities.

Two of the most famous stock markets, based in London and New York were formed in 1773 and 1792 respectively in the City of London and in Wall Street in New York. Prior to the formulation of these exchanges all stock trades were perfomed by asking around friends and associates for buyers or sellers however once the markets were formed anyone could enter and place a bid or offer into a centralised market place.

What is the point of stock markets?

The main reason for a company to list on a stock market is that it is one of the best ways to raise capital to fund either it's current operations or future expansion. Another common way for companies to raise funds is by taking out debt from banks, the downside of which is that they have to pay regular interest payments, irrespective of whether any profit is made which can be expensive. On the other hand when companies raise funds by issuing equity, they are under no obligation to reward the shareholders. This reward will usually only be made once the company becomes profitable when shareholders are rewarded by increased share value (enabling them to sell for a profit - growth) and regular or increased dividend payments (income).

The increasing importance of stockmarkets

In recent years the importance of stock markets in the global financial systems have grown enormously. As the number of financial products available has grown and access to such products has increased, more and more people have gained exposure to the markets. 50 years ago the average person on the street would not have had any relationship with the stock market with any savings being deposited in his or her local banks. However things are very different now with personal pensions, insurance, ISA savings plans, employee share purchase schemes, online stock brokerage accounts etc all now widespread among populations in developed countries. This has resulted in most people having some sort of exposure (either direct or indirect) in the stock markets.

The growth of the markets has prompted governments to introduce more and more regulation of stock markets in an effort to protect the interests of all stakeholders; the listed companies, investors, the exchanges themselves, indirect investors, economies etc). Such regulation usually comes about as a result of crashes or events that have happened in the past.

Stock Market Crashes

Stock Market crashes are unfortunately a well known and repetitive phenomenon. Though stock markets are supposed to be rational and represent the effects and value of all available information in the market, there is a huge psychological element which many often ignore. In certain situations where economic, political and social factors exist, panic can set in and cause a crash in prices. All analysts acknowledge the existence of boom and bust cycles (in other words stock market bubbles and crashes). Much of this is thought to be due to a herd mentality. When prices are rising significantly in a particular sector, everyone want to buy, forcing prices higher. Conversly when the tide turns and prices begin to fall people tend to panic and sell, forcing the prices lower. These effects are a self perpetuating phenomenon.

There have been many famous stock market crashes over the years such as the Wall Street crash of 1929, Black Monday in 1978 and the Dot Com bubble crash of 2000. In all of these cases many were predicting the crash long before it happened, however due to the irrationality of the market they took time to develop and actually happen. It is impossible to tie down the exact causes of a particular crash however in general they almost always result from a sustained period where the market has over priced, or over valued a sector (as in the case of the Dot Com crash) or the market as a whole. As a result stock markets could be described as mean reverting, in that they tend to suffer corrections back to their mean or 'fair value' from time to time.

Derivatives

The markets are no longer limited to simple equity products. As time moves on there are a growing numbers of new products being devised by traders t meet their clients individual needs. Examples of derivatives are Equity Swaps, Options, Futures, Interest Rate Swaps, some of which are traded on official exchanges and the remainder traded on a bespoke over the counter method in a 'virtual market'. All of the derivatives are derived from simple products such as Equity Stocks or Interest Rates, hense there name. Increasingly the derivative markets are gaining more trade volume and are the reason that new markets are created (e.g the credit markets, securitisation etc). For many traders and banks the derivatives markets are seen as the future of the markets and the best way to make profits as margins on more simple products falls.