Equities · E1 · 8 min
How equity markets work
Read the prices people are bidding and offering, work out what a quick purchase really costs, and turn one company’s move into the index’s move.
In the news: “The FTSE 100 fell 0.8%, dragged down by banks”: how a few big companies move a whole index.
The essentials
- Bid, offer and spread
- The bid is the most a buyer will pay; the offer is the least a seller will accept. Buying at once costs the offer and selling at once gets the bid. The gap, 1p on a 412p–413p quote, is the .
- Market and limit orders
- A market order trades now against the , taking worse prices as it grows: 300 shares at 100p and 500 at 101p fill 800 at 100.625p. A sets your worst price and may never fill.
- Cap-weighted indices
- Most indices, including the FTSE 100 and the S&P 500, weight each company by its market value. A company worth 5% of the index that rises 4% adds about 0.2%, so a few big names can drive a day’s move.
- Price-weighted indices
- indices, such as the Dow and the Nikkei 225, count each company by its share price, not its size. A $500 share moves the Dow ten times as much as a $50 share for the same % move.
- Settlement
- Shares and cash swap a set number of business days after the trade date (T): the . US shares settle on T+1; UK and EU shares settle on T+2 and move to T+1 on 11 October 2027.
An index move from its members
Index % move ≈ Σ weight × the company’s % move
- weight
- the company’s share of the index, by free-float market value
- Σ
- add up over every company that moved
How it works
1. A share is a slice of a company
A share is a small slice of a company. If a company has 100 million shares and each one trades at £5, the market values the whole company at £500 million. That figure is its market value. The share price itself is set all day by people buying and selling on an exchange, such as the London Stock Exchange.
2. Bids and offers
Buyers say what they will pay: that is a bid. Sellers say what they will accept: that is an offer. If the best bid is 412p and the best offer is 413p, you can buy straight away at 413p or sell straight away at 412p. The 1p gap between them is the spread, and it is the first cost of trading.
3. Market orders and limit orders
A market order says “trade now at the best price available”. It fills at once, at whatever the sellers are asking. A says “trade only at this price or better”. It protects you from paying too much, but it waits, and it may never fill.
4. Big orders walk the book
All the waiting bids and offers form the , best prices first. Say 300 shares are offered at 100p and 500 more at 101p. A market order for 800 shares buys 300 at 100p, then 500 at 101p: an average of 100.625p. The bigger your order compared with what is on offer, the further the price moves against you.
5. An index weights companies by size
The FTSE 100 tracks the 100 largest UK-listed companies. Each counts in proportion to its market value, using only the shares that are free to trade (the ). So if one company is 5% of the index and its shares rise 4%, it adds 0.2% to the index on its own. A few big companies can explain most of a day’s move.
6. Points and percentages
Headlines quote index moves in points. To turn points into a %, divide by yesterday’s close. An index that closed at 9,000 and falls 90 points has fallen 1%. The same 90 points would be only 0.3% of an index at 30,000, so always compare in %.
7. Some indices weight by share price
A few old indices, such as the Dow in the US and the Nikkei 225 in Japan, are : each company counts by its share price, not its size. A $500 share moves the Dow ten times as much as a $50 share for the same % move, even if the $50 company is far bigger.
8. Settlement: when shares and cash swap
When you buy, the price is agreed straight away, on the trade date (T). The shares and the cash swap a set number of business days later: the . US shares have settled on T+1 since 28 May 2024. UK and EU shares settle on T+2 and move to T+1 on 11 October 2027. Weekends and public holidays don’t count.
Worked example
Suppose the FTSE 100 closed at 9,000. Today a bank worth 6% of the index falls 4%, an oil company worth 8% rises 1.5%, and every other company is flat. How far does the index move, in % and in points?
- Bank: 6% × −4% = −0.24%.
- Oil company: 8% × +1.5% = +0.12%.
- Add them: −0.24% + 0.12% = −0.12%.
- In points: −0.12% × 9,000 = −10.8 points.
The index falls about 0.12%, or 11 points: two companies explain the whole move.
Check yourself
8 quick questions on the explanation above.
Practice
New numbers every set. Misses and guesses go into your review deck.
In the interview
Answer out loud in under a minute, then compare.
How do the FTSE 100 and the Dow differ in construction?
You need to buy a large block of a thinly traded stock. How do you go about it?
Remember
Index % ≈ Σ weight × move
An index weighted by size moves with its biggest companies, so a few large stocks can explain most of the day’s move.
Sources
- US Securities and Exchange Commission — New “T+1” settlement cycle – what investors need to know: investor bulletin
- Financial Conduct Authority — About T+1 settlement
- European Securities and Markets Authority — One year to go for T+1 settlement
Definitions and maths are standard textbook material; dated facts link to the sources above. Worked numbers are illustrative.