The stock market has been responsible for making countless individuals millionaires and billionaires throughout history. Arguably, it is one of the greatest inventions of mankind.
While the stock market has certainly had its share of ups and downs over the years, it has also been a force for good in the world. From funding life-saving medical research to supporting innovative new technologies, the history of the stock market is a story of hope and progress.
To the inexperienced, the “stock market” may give an image of a fierce field cluttered with jargons, numbers, charts and graphs. Don’t worry! I will take you on this journey while explaining everything in layman's terms.
Let’s begin!
Debt: Farmers needed money!
In the 11th century France, banks hired men to manage and regulate debts given to farmers. These men called courtiers de change also took part in the “trading” of debts and can be said to be the first brokers.
Trading of debts: Exchanging a high-risk, high-interest loan contract with a different loan contract of another person.
In 1409, in the city of Burges (Belgium), commodity traders gave a name to their informal meeting place as “Burgse Beurse” which was a place at a market square containing an inn owned by a family called Van der Beurze. This is often considered the early form of a “stock market exchange”. (Although it will take around two centuries for a “stock” to enter the picture).
The idea of a common place for trading spread all across Europe and many countries started to define the place for stock market exchange: first the Italians (Borsa), but soon also the French (Bourse), the Germans (börse), Russians (birža), Czechs (burza), Swedes (börs), Danes and Norwegians (børs).
In most languages, the word coincides with that for money bag, dating back to the Latin bursa. The word budget evolved from the french word "bougette" meaning a bag or wallet.
Government needed money
In the mid-13th century the government of Venice started raising money from moneylenders through government debts (often called using fancy term Government security) for various projects. Down the line, the moneylenders started trading these government securities with individual traders.
In simplest terms — government security is a type of loan made by an investor to a government, in exchange for a promise to receive the principal amount plus interest at a future maturity date. Investors can sell these securities in the open market, before the maturity date. Similarly, another buyer can purchase such securities from another investor instead of buying from the government. Basic rules of supply and demand, determine the price of such securities.
The idea of trading in government securities soon spread to other cities of Europe and in 1531, Belgium got the first formal stock exchange setup in Antwerp. “Stocks” were still not in the picture.
First Joint Company
In the 1600s, sea voyages from Europe to East Indies (countries in South East Asia, Philippines, Malaysia, Thailand etc.) were common. Every successful round trip brought lots of wealth to the ship owners.
But, the sea voyages were very risky affairs.
Attacks by pirates, bad weather, poor navigation, and outbreak of a disease were some of the common risks associated with the ship’s journey. Ship owners used to seek investors who would finance their voyages in exchange for a share of the profits if the journey was successful, in order to reduce the risk of losing a ship and their fortunes.
This practice, which involved outfitting the ship and crew, created early forms of limited liability companies that typically lasted for one voyage only. After each trip, the company would be dissolved, and a new one would be established for the next voyage.
The formation of East India Companies (EICs) changed this one-ship-investment method forever. These companies issued stock — a certificate of proof for a small a fraction of ownership, that would pay dividends — fraction of profits on all the proceeds from all the voyages the companies undertook, rather than going voyage by voyage. These were the first modern joint-stock companies.
First Public Company & First Stock Exchange
The British East India Company was formed in 1600 and the Dutch East India Company was formed two years later, in 1602. Not only this, in the same year the Dutch EIC also got its stock publicly traded with the formation of the first stock exchange — the Amsterdam Stock Exchange. The Dutch EIC dominated the industry and quickly became a monopoly in the spice trade.
Elsewhere in the Europe many smaller EICs were coming up, all with their own issue of shares. In London, it was common for traders and investors to meet at coffee shops for buying/selling of shares. Very soon the demand for a common place for such activity led to the formation of stock exchanges in different places. Paris Bourse came up in 1724, London Stock Exchange in 1773.
The word and idea spread to different continents and the first stock exchange in the United States, Philadelphia Stock Exchange was founded in 1790 followed by the New York Stock Exchange (NYSE) in 1817 which soon became the largest stock exchange in the world by market capitalization.
Futures & Options
Any discussion on the history of the stock market would be incomplete without touching Futures and Options. Let’s first quickly understand what these are and then we will dive into the history. (You can skip directly to the history part, if you are well versed with these).
Simple Explanation of Futures
A farmer grows cotton and sells it to a garment manufacturer. The time between the start of farming and selling to the manufacturer takes 6 months. In a regular scheme of things, the farmer has to do an initial investment in a hope that after 6 months he will be able to sell the product at a profitable price. The manufacturer on the other hand, also “expects” to be able to purchase the raw material cotton at a price just enough to make a profit on his final product — garments.
But in a 6-month period, anything can happen. The market price of cotton can fall (leading to a loss for the farmer) or it can increase (leading to loss for the manufacturer). To mitigate this “risk”, both farmer and manufacturer enter into a contract before the start of the farming. They decide on a price that will be good for both and sign the contract — before the farming begins. So, irrespective of what happens in the market in the future, the farmer will sell (and the manufacturer will buy) the cotton at the decided price in the future. This is called a “Forward contract”.
“Futures” are just formalized “Forward contracts” which can be traded by one farmer or manufacturer to another.
History of Futures
The first recorded instance of forward contracts can be traced back to ancient Mesopotamia (modern-day Iraq) in the 3rd millennium BCE. Merchants used contracts to secure the delivery of goods at a future date and price, providing a way to manage the risk of price fluctuations.
Trading was conducted on the roads around Dojima Rice Exchange. Water was scattered to drive off people who stayed after official trading had ended for the day.
The first futures market in the modern sense was established in Osaka, Japan at the Dōjima Rice Exchange, in 1697. It was created to allow farmers to hedge against the risk of crop failures and price fluctuations by selling contracts for future delivery of rice. The first futures market in the United States was established in the 19th century in Chicago, which became a center for agricultural futures trading.
Simple Explanation of Options
Example 1: Let’s say you are looking to purchase a flat. You ask a flat owner to reserve the flat for you for $100,000 to be paid after 6 months. And for this reservation, you give a token amount of $1000 to the flat owner.
So, if after 6 months the market price of the flat rises to $120,000, you will be able to purchase it at $100,000. But if the market price falls to $90,000 you can choose not to buy it (as you can buy it from the market at a lower price). In this case you will have to bear the loss of the token amount.
This is an example of a call option. It gives you, the buyer the right, but not the obligation, to purchase an asset at a predetermined price within a certain time frame expiration date. This helps you decrease the risk of a “price increase” of an asset.
Example 2: Now let’s say you are a happy owner of the flat. You now decide to pay a premium amount of $1000 to an insurance company who will pay you $80,000 in case something bad happens to your flat in the next 6 months period.
This is a rough example of a put option. It gives you the buyer the right, but not the obligation, to sell a specific underlying asset at a predetermined price within a certain time frame. This helps you decrease the risk of a “price decrease” of an asset.
History of Options
Options have a long history that can be traced back to ancient Greece, where philosopher Thales of Miletus is said to have made a fortune by using options to predict the harvest of olives. Thales reportedly paid a premium to farmers for the right to use their olive presses during the harvest season and then rented out the presses at a higher price to others once the harvest proved to be successful.
In the 17th century, options began to take a more modern form with the development of the tulip trade in the Netherlands. Tulip growers would sell options on the right to buy their bulbs at a future date, allowing buyers to speculate on the price of tulips without having to take physical possession of them.
In the 19th century, options trading became more formalized with the establishment of organized exchanges in the United States. The first organized options market was the Chicago Board Options Exchange (CBOE), which was founded in 1973 and initially traded call options on a limited number of stocks.
Open Outcry
Open outcry is a traditional method of conducting financial markets, which involves traders shouting and using hand gestures to communicate buy and sell orders on a trading floor. It is also known as "pit trading" because traders typically stand in a circular or rectangular pit, surrounded by a larger group of spectators who watch the activity.
This is what you would have seen in movies like Wall Street (1987) or TV series like Scam 1992.
Traders use hand signals to quickly communicate whether they wish to sell or buy. While different exchanges have different hand signals, the basics are quite similar.
To sell, traders show signals with palms facing out and hands away from the body, while to buy, they face their palms in and hold their hands up. One to five is gestured using one hand, and six to ten are gestured in the same way but held sideways at a 90-degree angle.
For instance, the index finger out sideways indicates six, two fingers indicate seven, and so on. Gesturing numbers from the forehead represent blocks of ten, and blocks of hundreds and thousands can also be displayed. Besides numbers, traders use hand signals to indicate months, specific trade or option combinations, or other market information.
It was also common for the broker to wear a “Trading Jacket” — a blazer brightly colored and distinctive so individual traders and the financial firm they work for can be easily identified.
As of 2023, very few stock exchanges carry out this method of trading. Most of them have switched to electronic forms.
There are many sub-topics related to Stock markets that have an interesting history behind them. Bubbles and market crashes, short-selling, mutual funds, stock market indices, and stock regulations.
Let me know in the below poll if you would be interested in an article covering these.
Feel free to ask any questions or share your thoughts on this article or any feedback you have. This publication is for made for you!