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How Does the Stock Market Work?


As an outsider, it can be easy to feel overwhelmed by the stock market. News coverage of markets is often dramatized with images of brokers hollering across a trading floor, a litany of unfamiliar terms and lingo, and the threat of a catastrophic crash hanging over the proceedings. But despite all of this noise, the stock market is based on a handful of easy-to-understand concepts. The most foundational one can be broken down as follows: Companies sell stock, or partial ownership in the company, to investors in order to raise money. And as those companies increase or decrease in value, the value of your investment will rise and fall.

If you need help picking an investing strategy, a financial advisor can help.

What Is the Stock Market?

The stock market lets companies raise money and investors make money. When a company decides to issue shares to investors, it’s offering partial ownership in the company. Issuing shares helps companies raise money and spread risk. Instead of finding investors one by one, companies who qualify and register offer their shares in a stock exchange. This offering is known as an initial public offering (IPO), also called “going public.” An IPO creates a primary market for the company’s shares.

In the secondary market, investors buy and sell shares on a stock exchange like the New York Stock Exchange (NYSE) or the Nasdaq. Investors in stocks could be large entities like commercial banks, or they could be individuals just like you. Rather than buying the shares from the issuing company, you buy them from someone who already owns them. Most major stock exchanges engage in trading from 9:30 am to 4 pm ET, known as trading hours. While trading does occasionally take place outside these hours, you’ll want to plan on making any sales or purchases during trading hours.

If you want to get in on what the stock market has to offer, you don’t have to travel to New York, put on a blazer and start yelling “buy! sell!” You just need a broker to act as your representative. This could be a person you hire, but more likely you can just open a brokerage account with a large retail broker like Fidelity, TD Ameritrade or Schwab. The internet has made this process much simpler.

You also don’t have to be rich to start investing, but it’s important to look for low-fee options. Fees eat into your gains and can cost you tens of thousands of dollars over the years you invest.

Investing in the stock market is one of the most popular methods to build wealth and save for retirement. While you don’t need to pore over market data for hours every week to succeed, having some fundamental knowledge can help you better understand the risks involved and how to mitigate them as best you can.

How Stock Prices Move

How Does the Stock Market Work?

The price of a stock fluctuates according to supply and demand, investor confidence, world events and information about company profits, among other factors. Since there are only so many shares of a stock on the market at a given time, the price will rise if there are more buyers trying to get it than sellers hawking it. The reverse is also true; if there are more sellers than buyers, sellers will lower their prices to account for that.

Experts caution investors to be careful when trading stocks during moments of big price peaks. As an example, stocks like GameStop Corp. (GME) and AMC Entertainment Holdings Inc. (AMC) rose sharply in January 2021 after individual investors drove up prices on companies that were heavily shorted. This compelled traders with short positions to buy more stock in an effort to mitigate their losses, triggering a frenzy that drove up prices even higher. Now, as those trades lose momentum, experts remind investors that volatile prices are risky.

With all the variables in play, it’s notoriously hard to know which stocks are on the rise. It’s a good idea to be suspicious of any “hot tips” or guarantees of astronomical returns. If it sounds too good to be true, it probably is.

What’s on a Stock Ticker?

A stock ticker shows the price and trading volume of various stocks. It updates throughout the day during trading hours, showing “ticks” (changes) in stock prices and trading volume. Not all of the companies whose shares are traded on a given market appear on the ticker.

Stock tickers list companies by their symbol. Unless you know the symbol of the company you’re interested, you’ll have to look it up before you consult a stock ticker. Then, you’ll see the stock symbol, the number of shares trading and the price. You’ll see a green upward arrow if the price is higher than the day before. You’ll see a red downward arrow if the price is lower. You can also see the difference between the current price and the price at the end of the previous day.

If you’re an average retail investor, you don’t need to spend your day glued to the stock ticker. It’s probably information overload. But now you’ll know what you’re looking at next time you’re watching television and see a stock ticker moving across the bottom of the screen.

Stockholder Equity: Why You Want It

How Does the Stock Market Work?

So why buy stocks when you could just stash cash under the mattress or put it in a CD or savings account? The answer is simple: Over the long term, the stock market generally provides higher returns. On average, the stock market goes up around 8% per year, compared to around 2% for the highest-yield savings accounts.

Stocks do come with some risk, though. If the stocks you own become less valuable, your net worth goes down. If this happens, you’ll need to decide whether to cut your losses and sell, or ride out the volatility and stay the course. If you’re investing for the long term, most experts will tell you to go the latter route. If you panic in a downturn and “sell low,” and then you only “buy high” after stocks have become expensive, you’ll miss out on opportunities to increase your net worth.

The good news is that there is a way to remove the temptation to try to “beat the market” by timing your investments and hand-picking stocks. If you think you’ll be tempted in this way, it’s probably a good idea to steer clear of individual stocks and online stock-trading sites. Instead, consider low-cost index funds that track the market and stay strong in a downturn, knowing that over the long term, the market as a whole will grow.

Bottom Line

If you’re looking to grow your retirement savings, you’d likely be well served to invest in the stock market. Conventional wisdom says that when you’re younger and further from needing to live off your investments, you can afford to have a high percentage of your investments in the stock market. Later, as you approach retirement, you’re more vulnerable to a market downturn that could wipe out your retirement savings right before you need them. That’s why experts typically advise folks who are closer to retirement to decrease their exposure to equity risk by reducing the percentage of their investments in stocks and increasing the percentage in bonds.

If all that rebalancing sounds like too much to take on, there are target date funds that re-balance for you according to the year you intend to retire. You tell them when you want to retire and they chase higher returns (with more risk) while you’re young, preserving those gains with a lower-risk portfolio as you near the end of your career.

Whichever investing strategy you choose, it’s important to go into it with your eyes open. Starting from a place of knowledge will likely improve your returns, and it will make you less vulnerable to fraud. Happy investing!

Investing Tips for Beginners

  • If you’re intimidated by the prospect of navigating the stock market yourself, consider working with a financial advisor who can make an investment plan for you. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • If you’ve decided you want to start investing, the first thing you’ll want to figure out is how much you want to invest, how much risk you can take on and how long your time horizon is. All of this will inform how you allocate your assets. Remember, diversification is key.
  • Don’t forget to pay attention to the taxes that you will owe when investing in the stock market. SmartAsset’s capital gains tax calculator will show you how Uncle Sam impacts your gains.

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