Module 1: Investing Foundations
How Stock Markets Work
A stock market can look like a screen of flashing numbers that only professionals understand. In reality it is a simple idea: a regulated meeting place where people who own pieces of companies sell them to people who want to own them. Once you understand who takes part and why prices move, you can invest calmly instead of guessing. This lesson gives you that foundation.
Why companies sell shares
A company that wants to grow needs money. It can borrow from a bank, which it must repay with interest, or it can sell part ownership of itself to investors. Each unit of ownership is called a share (or stock). When a company first sells shares to the public, the event is called an initial public offering (IPO). After the IPO, the company is listed on a stock exchange, and its shares can be bought and sold between investors.
This gives us two markets:
- The primary market, where the company sells new shares and receives the money (an IPO or a later rights issue).
- The secondary market, where investors trade existing shares with each other. The company does not receive money from these trades. Almost all daily trading happens here.
Why would anyone buy a share? Because owning part of a profitable business entitles you to a share of its future: profits paid out as dividends, and growth in the value of the business, which shows up as a higher share price over time.
Who takes part
A working stock market has several players, each with a clear role:
| Participant | Role | Example in Kenya |
|---|---|---|
| Exchange | Runs the trading platform and sets listing rules | Nairobi Securities Exchange (NSE) |
| Regulator | Licenses market players and protects investors | Capital Markets Authority (CMA) |
| Stockbroker or investment bank | Places buy and sell orders on your behalf | CMA-licensed brokers and trading participants |
| Central depository | Holds shares electronically in investor accounts and settles trades | Central Depository and Settlement Corporation (CDSC) |
| Listed companies | Issue shares and publish financial reports | Banks, telecoms, manufacturers and others listed on the NSE |
| Investors | Individuals, pension funds, insurers, fund managers | You |
Other countries have the same structure with different names, such as the New York Stock Exchange with the Securities and Exchange Commission as regulator, or the Johannesburg Stock Exchange. Before using any broker or app, confirm it is licensed by your country's regulator. In Kenya, the CMA publishes the list of licensed market intermediaries on its website.
How prices are set
A share price is simply the most recent price at which a buyer and a seller agreed to trade. The exchange keeps an order book: a list of buyers stating the highest price they will pay (bids) and sellers stating the lowest price they will accept (offers or asks). When a bid meets an ask, a trade happens.
Prices move because the balance between buyers and sellers changes. That balance is driven by information and expectations: a company reports higher profits, interest rates change, a new competitor appears, or investors simply become more fearful or more optimistic. In the short term, mood and news dominate. Over many years, prices tend to follow the company's actual earnings and cash generation. This difference between the short and long term is the most important idea in this course.
Worked example: from saving to owning
Wanjiru, a teacher in Nakuru, has KES 50,000 she will not need for at least seven years. She opens a CDS account through a CMA-licensed broker. She places an order to buy shares in a listed bank at a hypothetical price of KES 40 per share. A seller has offered shares at KES 40, so her order is matched: she buys 1,200 shares for KES 48,000, and the remaining money covers brokerage and statutory fees. A few days later the trade settles and the shares appear in her CDS account in her own name.
Over the next year, the bank pays a hypothetical dividend of KES 3 per share, so Wanjiru receives KES 3,600 before withholding tax. The share price moves between KES 34 and KES 46 during the year. Wanjiru's real return depends on the dividends and on the price when she eventually sells, not on the daily movements she sees in between.
Common mistakes to avoid
- Thinking a share is a lottery ticket. It is part ownership of a business. If you would not want to own the business, do not buy the share.
- Using an unlicensed platform. Many online scams promise access to global stocks with guaranteed returns. Check the licence with the regulator first.
- Investing money you will soon need. Share prices can fall sharply for long periods. Money for rent, school fees or emergencies belongs elsewhere.
- Confusing price with value. A KES 5 share is not cheaper than a KES 200 share. What matters is how much business you get for the price, which you will learn to judge in Module 2.
With this picture of how the market works, you are ready to look more closely at shares, indices and exchanges.
Exercise
Visit the website of your country's stock exchange (for Kenya, the Nairobi Securities Exchange) and the regulator (for Kenya, the Capital Markets Authority). From the regulator's site, write down the names of three licensed stockbrokers or trading participants. From the exchange site, list five listed companies and the sector each belongs to.
Key points
- A share is part ownership of a business, giving you a claim on its dividends and growth.
- Companies raise money in the primary market; investors trade with each other in the secondary market.
- Prices are set by the balance of buyers and sellers, driven by news short term and by earnings long term.
- Always use a broker licensed by the regulator, such as the CMA in Kenya.