Considering the massive gains experienced last year in the stock market, many are finally taking a closer look at investing.
So if you are wondering why is the stock market important and how does it work, we are here to answer.
More and more people are investigating the stock market because they want to buy and sell shares as a hobby or are looking for a way to make extra income on the side.
Trading stocks can be a little overwhelming at first — which is natural — but the right guidance can teach you how to properly understand the market before making your first trade.
But before you start trading, you need to know what the stock market is, how it’s used to make investments, and the financial benefits and risks.
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A Brief History of the Stock Market
However, the age of the stock market dates back several centuries.
You’d be surprised to know that the original idea behind stock markets began as far back as the 1300s.
Stock exchange vs stock market
Before we move forward, let’s clarify the difference between the stock exchanges and the stock market — it’s really simple.
Stock exchanges refer to the infrastructure where the trading takes place (think of the physical locations you see investors trading in the movies).
The stock market is the conglomerate of all the publicly traded stocks, shares, and securities that you can buy and sell.
Further, markets are regulated by the Securities and Exchange Commission (SEC), an independent agency of the U.S.ensure that traders are protected from trading abuses or fraud.
The Venetian Market and Its Merchants in the 1300s
In the 1300s, moneylenders would trade debts with one another, and they would also buy government debt issues.
As the markets continued to grow and evolve, the moneylenders would buy and sell the debts to individual investors.
The buying and selling of these debts and investments were the first known trading techniques in history that were specifically associated with the trading of securities from other governments.
Belgium’s Stock Market in the 1500s, Without the Stocks
About 200 years after the money lending and debt trading in Venice, stock markets began to appear in Belgium.
In the 1500s, a stock exchange existed in Antwerp, and it was here that brokers and moneylenders would meet to handle business, government, and individual debts.
This market dealt entirely in promissory notes and bonds, as there were no publicly traded companies at this point in history.
East India Companies and Stock Markets in the 1600s
The East India Companies sparked a need for the more modern version of the stock market that we are familiar with.
With so many companies organized to travel back and forth to East India by ship for the trade of goods, it made sense to allow people to invest in the companies themselves.
Investors quickly learned that this is an exceptionally useful way to make a sizable income.
Individuals were finally able to purchase stock in the companies that would be paid back with interest following the successful completion of their voyages.
An entire market revolved around the investment in these companies, with massive amounts of competition.
The New York Stock Exchange
In the late 1700s, the New York Stock Exchange was founded.
While it arrived after the London Stock Exchange and the Philadelphia Stock Exchange, it quickly became the most powerful.
The NYSE was founded on Wall Street, and its location was the reason behind its power.
Even with all of its ups and downs, the New York Stock Exchange has remained strong.
Why Do Stock Markets Exist?
To put it simply, stock markets exist as a servant of the economy.
It allows traders to invest in companies and make a profit off of their investments when companies do well.
Stock markets also allow for companies to raise capital by letting these individuals invest in them — an initial public offering (IPO) is a good example.
Overall, though, there are 3 main reasons that stock markets exist.
1. Companies Raise Capital Using the Stock Market
One of the most important reasons that stock markets exist is to allow companies to raise capital.
The stock market allows companies to avoid borrowing money from banks by selling their stocks to traders.
In turn, this allows them to avoid unwanted costs, such as interest on loans, which frees up more money when profits are made.
With any publicly-traded company an IPO is conducted.
The IPO allows the company to raise large amounts of money without having to repay it and without the need to pay dividends if any losses are incurred.
Really, any capital raised using the stock market is a helpful tool for companies that are looking to expand operations and create jobs.
This form of investment not only helps the company — but it also helps the overall economy.
When businesses expand, more money is spent, which means higher tax revenues for the government and lower unemployment rates.
2. Personal Wealth is Created When You Buy and Sell on the Stock Market
The stock market allows individual investors to create personal wealth.
By investing in companies that are doing well, investors can share in the profits in the companies that they support through buying their stocks.
The personal wealth of these investors has a larger effect on the economy and markets as well.
When individuals can make money off of profitable companies, they can put that money back into the economy.
Overall financial growth for individuals and companies is the ideal situation for every party involved.
3. The Stock Market Drives a Country’s GDP
Gross Domestic Product, also known as GDP, is an indicator of how well a country is doing.
GDP is the total value of goods and services produced by a country in a single year.
That total value is highly influenced by the investment in companies.
The most prominent way to invest in companies is through the stock market.
When investors put money into companies, it influences how successful they are and increases their overall growth.
As companies grow and produce more, they increase the GDP of the company that they are located in.
It is important to realize that the investors don’t have to be domestic to invest in a company.
For example, individuals from other countries can invest in American companies that are traded on the NYSE, which increases the GDP of the U.S. through a series of compounding effects.
Investing in the stock market is the best way to increase the GDP of a country.
Why Is The Stock Market Important?
The stock market is incredibly important for a couple of different reasons.
Stock markets influence the overall economic well-being of a country, which affects everyone in the economy.
The strength of the stock market also influences the overall strength of the economy.
The Stock Market Affects Everyone in the Economy
Even if someone chooses not to buy and sell stocks from a stock exchange, it still affects them.
Any person with a retirement account or a pension fund is directly affected by how well the stock market is doing.
These accounts are directly tied to the performance of the stock market and how well companies are performing.
If companies start to do poorly, they may have less money to spend on their employee benefits (their pensions).
This can directly affect the retirement age of their employees.
It is also important to realize that a company’s share price influences how much money it is willing to spend.
When share prices go down, so does a company’s spending.
And more often than not, companies will take extreme measures to reduce spending to regain financial equilibrium.
These cutbacks can heavily affect the number of employees as well as how much money current employees can make.
Jobs with hourly positions will cut shift workers down to skeleton crews, using as little labor as possible to keep profits high.
Another way that the stock market and stock trading can affect non-investors is through the overall influence it has on taxes and interest rates.
When the stock market is performing well, more taxes are collected and higher interest rates are given for loans.
When the stock market is doing poorly, the government will typically reduce taxes, and interest rates will plummet, which influences consumers to spend more.
This relationship with the overall economic health of the market affects both investors and non-investors, even though non-investors may not see it at first glance.
Stock Markets Provide a Reflection on the State of the Economy
As described previously, the health of the stock market and the economy are intimately intertwined.
This is the primary reason why stock markets provide a good indication of the overall health of the economy.
Typically, if the stock market is doing well, so is the economy and vice versa.
Looking at it on a larger scale, you can see that anytime the stock market has had dips, the economy and income suffer.
The same can be said about the highs of the stock market.
As stock prices experience growth, this means that buyers have more money to invest in companies, putting them in a higher demand.
When stock prices fall, it means that there are too many sellers, indicating that people are afraid to risk their money by investing in companies.
In a bad market, investors demonstrate that they would rather keep their money out of the market and for themselves, which is a key indicator of hardship.
Stock Markets: Economic Analysis
Economists will analyze large sets of data regarding the stock market as well as the economy.
When undergoing this process, they review the strength of the stock market and the economy side by side and use the information and conclusions they come up with to write economic policies.
By being able to predict what the economy will do concerning the stock market, the entire population can be taken care of through policy writing.
Should Everyone Invest in the Stock Market?
By gaining an understanding of the stock market and the way that it’s related to the economy, you may believe that everyone should invest in the stock market.
Well, you’d be right.
However, you shouldn’t just start dumping your money in shares without following one of the most basic rules.
This leads us to…
Invest Only Within Your Means
Investing is the best way to promote growth in the economy and a fantastic way to turn a profit over time.
When investing, though, it’s important to remember that you need to invest the funds that are well within your means.
This means that you DO NOT invest what you CANNOT afford to lose.
Be Careful When Trading on the Stock Market
While you may read headlines about large-scale investments that turn a massive profit, you must keep in mind that the sensible individuals who invest their money won’t be hurt if they lose it.
If you’re considering becoming an investor, make sure that you understand your limits and know that investing comes with inherent risks attached.
No trade is a sure thing.
Keep educating yourself and become a part of the most important part of the economy, the stock market!