The stock market is one of the most important institutions in our economy where stocks and shares are traded, and it can have a big impact on everyday people’s lives. But how does it all work? In this blog post, we’ll explore the basics of the stock market and explain how it functions.
How the Stock Market Works
The stock market is a collection of markets where stocks and other securities are traded. The stock market let’s buyers and sellers negotiate prices and make trades.
The most well-known market in the US is the New York Stock Exchange (NYSE). Other major stock exchanges in the US include the NASDAQ (National Association of Securities Dealers Automated Quotations), which began as the world’s first electronic stock market in New York, the American Stock Exchange (AMEX), and the Chicago Board Options Exchange (CBOE).
In order to trade, you must first be a member of the exchange. Members of the New York Stock Exchange must be broker-dealers registered with the Securities and Exchange Commission (SEC).
Once you become a member, you can trade stocks or securities. When stock buying, you are buying shares of ownership in a company. If the company does well, the value of your stock will increase. If the company does poorly, the value of your stock will decrease.
Types of Stocks
There are two main types of stocks: common stock and preferred stock.
A common stock is the most prevalent type of stock and typically entitles the holder to vote on corporate matters and elect the company’s board of directors.
A preferred stock generally does not have voting rights, but may have a preference in dividend payments or liquidation proceeds.
Investing in Stocks
Individuals can invest in a stock through a brokerage account. When you open a brokerage account, you deposit money into the account and then use that money to purchase stocks. You can also set up a brokerage account with financial advisors.
There are a few different ways to make money from stocks:
- Dividends: A distribution of a company’s earnings to shareholders. If you own stock in a company that pays dividends, you will receive periodic payments from the company.
- Capital gains: When you sell a stock for more than you paid for it, you realize a capital gain. Capital gains are taxed at a lower rate than ordinary income.
- Appreciation: If a company’s stock increases in value, you can sell it for a profit. This is known as appreciation.
Risks of Investing in Stocks
The most obvious risk is that the stock price could go down, which would result in a loss and a risk of fraud. Some companies may engage in fraudulent activities in an attempt to artificially inflate their price.
Additionally, the market is subject to a number of other risks including:
- Market risk: This is the risk that the stock market will decline in value.
- Interest rate risk: A risk that interest rates will rise, which could lead to a decline in stock trading prices.
- Liquidity risk: A risk due to the possibility of a stock being difficult to sell at its current price.
Origins of the Stock Market
The first stock exchange was established in Amsterdam in 1602. The Amsterdam Exchange was created in order to fund the Dutch East India Company. The company was founded in order to trade with the East Indies and it quickly became one of the most powerful companies in the world.
The first exchange in the US was established in 1792. The New York Exchange was created in order to finance the American Revolution.
The modern stock markets in Western Europe had humble beginnings. The London Stock Exchange was created in 1801, while the Paris Bourse was not established until 1808.
Other exchanges are Shanghai Stock Exchange, Philadelphia Stock Exchange, Japan Exchange Group, and Hong Kong Exchange. The market has since grown to become a major part of the global economy. As of April 2020, the total market capitalization of the stock markets was around $87 trillion.
Understanding the Stock Market
Stock prices are set by supply and demand. When more people want to buy a stock (demand) rather than sell it (supply), the price of the stock will go up. When more people want to sell individual stocks rather than buy them, the price of the stocks will go down.
The easiest way to start investing is by buying a stock of a large publicly-traded company like Bank of America, Google, American Airlines, or Tesla. Another solid strategy is to invest in low-cost index funds for long-term investment success.
Stock Market Terms You Should Know
We all know that stock market terms can be confusing, especially for beginners, but it’s important to understand how the stock market works before investing.
Below is a quick overview of the useful stock market terms:
Mutual fund: An investment vehicle that allows investors to pool their money together and invest in a variety of securities. Mutual funds are managed by professional money managers.
ETF (Exchange Traded Funds): ETFs are baskets of securities that track a broad market index, such as the S&P 500.
Derivative: A financial instrument whose value is derived from the value of another asset. The most common type of derivative is a futures contract. Futures contracts are agreements to buy or sell stocks at a future date.
Index: A collection of securities that represents a certain market or sector. One of the most popular stock market indices is the S&P 500, which tracks the 500 largest publicly-traded companies in the US.
Stock Market Volatility: Volatility can be caused by a number of factors, including economic news, company earnings, and global events.
Stock Market Trading: A process of buying and selling stocks of companies. The prices of these shares are set by supply and demand in the stock markets.
Stock Exchanges: A market where shares of publicly traded companies are bought and sold.
Stock market index: A statistical measure that tracks the performance of a group of stocks. One of the most well-known stock market indexes in the US is the Dow Jones Industrial Average (DJIA).
Bull market: A market where prices are rising and retail investors are optimistic.
Bear market: A market where prices are falling and other investors are pessimistic.
Market makers: A firm that provides liquidity to the market by buying stocks and selling securities.
Broker: An individual or firm that buys and sells securities on behalf of investors.
How Does the Stock Market Work: Final Thoughts
The stock market is a complex system that can be difficult to understand. However, by breaking it down into its simplest components and understanding how they work together, we can get a better idea of how the stock market works as a whole.