The stock market is undergoing a renaissance. Presidents often speak about it, some economists use it as a proxy for the economy, and lately, it may seem as if everyone you know has bought a stock or made a crypto investment.
And even when your friends, politicians or news personas aren't talking about it, you may see obscure numbers on websites and TV screens which indicate how stocks are doing.
What do these numbers mean? How do they represent the stock market? If you’re reading this, it may be because you’re curious about what the stock market is, how to get involved, and whether you can participate by investing.
So, before you dive head-first into the stock market, here are basics every investor should know.
The stock market is a general term for all exchanges where stocks are offered to investors. A stock, in the most general sense, reflects a portion of ownership in a company.
The stock market refers to public stock exchanges and over-the-counter markets where stocks are bought and sold and prices for the stocks are determined.
While it is possible to reap rewards by investing in the stock market, it’s important to note that no investments come without risk.
Stocks are typically ownership portions of companies, and are issued as a means to raise funds for the company’s projects, research and development, expansion, and other capital needs. Companies can also choose to “list” their stock on an exchange, which allows the market to value the company as investors buy and sell stock at varying prices over time.
An important distinction to make is between exchanges and indexes. Indexes, like the S&P 500 and Dow Jones Industrial Average (DJIA), are baskets of stocks that are selected by committee. The DJIA consists of 30 prominent stocks in the U.S., and changes from time to time based on a variety of factors like size. The S&P 500 index tracks more than 500 stocks which are also selected by a variety of criteria, including size, trading activity and profitability. The indexes, or baskets, include stocks that are listed on any exchange, as long as the criteria are met. The indexes use different methodologies to calculate the numerical value you will frequently see cited in the press.
In a nutshell, the stock market’s primary purpose is to give businesses access to a large funding pool — the public. Companies typically list stocks on an exchange to provide a market for their shares. Companies can also choose to issue new stock to raise money, with the market price used as a guide for the stock’s value. Brokerages act as facilitators between the stock exchanges and investors.
In the U.S., given the complexity, risk, and potential abuse involved in capital markets, the Securities and Exchange Commission (SEC) is tasked as the regulating authority for public stock exchanges and the stock market in the U.S. It was founded at the height of the Great Depression, and is designed to help protect investors through its oversight of securities laws and push for transparency among those that participate.
The term “stock market” encompasses all stock exchanges where publicly-traded stocks are listed and traded. For the most part, exchanges are businesses that develop a platform and act as an intermediary between buyers and sellers of stock. Exchanges centralize buyers and sellers in an auction-based marketplace. This differs from the over-the-counter (OTC) market, mentioned in the next section, where prices are quoted by dealers and two participants can execute a transaction without others being involved or aware of the price.
The individual exchanges develop the criteria that companies must meet if they want to list their stocks on that particular exchange. For example, in the U.S. the NYSE requires companies to have a pre-tax income of at least $10 million over the previous three years and a minimum share price of $4, among other requirements.
A company’s stock must first be approved to be listed on an exchange before the stock begins trading for the first time. Once a stock is first “opened,” or begins trading on the exchange, investors are allowed to purchase shares via their brokerage or trading platform.
In the U.S., stock markets are open from 9:30 a.m. to 4:00 p.m., when the majority of trading occurs. You will often hear terms like the “opening bell” and “closing bell” to denote the opening and closing times.
In the past, stock markets were generally constrained to their country’s borders, with a few exceptions. However, technology now allows investors and traders with the means to access non-U.S. markets to buy and sell stocks in any country that allows foreign investors to access their exchanges.
There is a distinction when referring to exchanges and the market more broadly. You’ll often hear them used interchangeably, but the stock market is composed of stock exchanges.
The New York Stock Exchange (NYSE) and the NASDAQ are two stock exchanges in the U.S. where publicly-traded stocks are listed. These exchanges are part of the stock market, as are over-the-counter (OTC) markets, and must register with the Securities and Exchange Commission (SEC). In the U.S. there are a total of 13 stock exchanges.
OTC markets are platforms where stocks that do not meet the listing criteria of one of the large exchanges, or have chosen not to list there, are traded. The stocks that are listed OTC have not met or chose not to meet the listing requirements of the larger registered exchanges.
The OTC market, despite serving typically smaller companies, is a material part of the market, hosting more than 11,000 stocks, nearly double that of the NYSE and Nasdaq combined.
One way a private company can gain access to public investors, or “go public,” is to go through an initial public offering, or IPO, as it is usually referenced. In order to complete the steps for a successful IPO, the company must meet criteria set forth by the U.S. Securities and Exchange Commission (SEC).
This registration criteria generally requires company disclosures about its business and finances that ultimately take the form of a prospectus which is disclosed to investors and the public. At times, you may hear references to a “roadshow,” whereby executives will frequently meet with institutional investors ahead of the listing, among other possible steps. Companies must be serious about undertaking this process as it can require substantial time and financial resources.
If the company successfully raises capital, gets approval from the SEC, and meets their chosen exchange’s criteria, they are listed on that exchange, and their stock becomes available to public investors and traders.
Today, there are around 41,000 stocks available worldwide with a combined value of more than $80 trillion.
One of the easiest ways to access the stock market is to use a reputable broker or stock trading platform. Once you’ve chosen a broker or platform, you can set up an account online to buy stocks, mutual funds, exchange traded funds (ETFs), and other investment types.
Purchases and sales of stock vary by stock market participant. Terms such as “investor” or “trader” are frequently used to describe typical actions of those involved. Knowing the distinction can help you decide your role in the stock market if you choose to enter it.
Investors generally research the assets they want to buy to ensure they fit their investing goals. Most investors intend to buy and hold stocks over time. There are different lengths of time an investor may hold a stock before selling it, which can vary from a few weeks to several decades.
On the other hand, traders may look for short-term profits from price movements over narrow periods. For instance, a trader could buy a stock in anticipation of its price rising. If it goes up and the trader can find a buyer for the shares they want to sell, that trader has made a profit. Traders can also seek to profit if a price falls. If the trade goes against a trader, they will determine, based on their own risk tolerance and systems, whether they want to take a loss immediately or expand their time horizon for the trade to be successful.
Day traders look for profits from price changes in even shorter time frames. Sometimes that means within a trading day, over minutes or even seconds. Day trading is usually reserved for experienced professionals who have studied and researched individual stock and market movements, and likely possess the robust tools and resources to help them achieve gains. But, even the finest tools at your disposal do not guarantee trading success.
When you’re investing, it’s crucial to remember the money you invest is not “safe,” like it would be in a federally-insured bank. The Federal Depository Insurance Corporation (FDIC) insures your bank accounts at member banks up to a specific amount. But the money invested in stocks comes with no guaranteed returns. The Securities Investor Protection Corporation (SIPC) does insure your cash and securities up to a certain amount in the case that your brokerage firm goes bankrupt.
But remember, there is a risk you could lose any capital you invest within the stock market.
There are different types of risks associated with investing. Some of the risks you might hear about include the following:
Market risk: Price changes, interest rate changes, and exchange rate changes are all considered market risks. A country’s economic circumstances, like a recession, also falls under this risk category.
Headline risk: The media has an influential role in stock markets. A news story about a publicly-traded company or event can cause significant market volatility. Central bank decisions, economic data and singular stock stories are among the types of headline risk. For example, when BP’s oil platform Deepwater Horizon exploded in 2010, its stock price dropped from $60.48 to $27.02 over two months before rebounding.
Business/company risk: A major influence behind stock prices are earnings and risks associated with a company failing. Factors that impact business risk can include but are not limited to: poor management, new regulations, or increased competition that may dilute a company’s market position.
There are many risks that can affect the money you have invested in the stock market. You’ll need to define the types and how much risk you’re willing to take and can afford.
A smart strategy for investing usually involves only using money you can afford to lose. Then, you’ll want to consider which investments are right for your financial circumstances and goals. A financial advisor can help you decide your risk tolerance and how much you can afford to invest.
To help mitigate investment risk, you may also consider spreading your investments out across multiple assets and sectors — a practice known as diversification. For instance, you could diversify your assets by buying stocks in the technology sector (which tend to be volatile) and consumer staples sectors (which are typically less volatile). This way, the risk of capital losses from extreme swings in tech companies can be somewhat reduced by the relative stability of the companies in the consumer staples sector.
The stock market can create a wide range of opportunities for investors. Some invest to create more wealth, others for additional retirement income, while extremely experienced investors can generate multi-generational fortunes.
If you have funds you won’t need to depend upon in the immediate future, investing may be a beneficial option. For instance, if you have more in your personal banking accounts than required for your necessities and possible emergencies, then you could begin placing the excess in stocks or funds to generate yield or capital appreciation, assuming the risk/reward met your individual needs. Stock markets, partially due to their risk profile, have generally returned more than the interest individuals receive in personal check or savings accounts. Inflation is a risk to low-yielding accounts, as it may exceed any returns you may earn, reducing your account values on an inflation-adjusted basis.
Inflation decreases the purchasing power of your money over time. One dollar today will generally not purchase the same amount of goods the next year because of inflation. Therefore, if you’re not earning enough interest to keep up with or outpace inflation, then it may not be maintaining its purchasing power. Investing, on the other hand, may provide an option to help grow your assets more quickly, when done responsibly.
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