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How Does the Stock Market Work?

Maybe you’ve been hearing terms like IPO and secondary market and you’re wondering if it’s too late to ask: How exactly does the stock market work? Well, it’s not too late to ask, and you’ve come to the right place to get some answers. Let us break down how stock exchanges work and how investing in stocks can help you meet financial goals like preparing for retirement.

What Is the Stock Market?

How Does the Stock Market Work?

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 in exchange for investor dollars. 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, also known as a stock market. 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 or the Nasdaq. Investors in stocks could be large entities like commercial banks, or they could be retail investors (a.k.a regular individuals just like you). You don’t buy the shares from the issuing company, you buy them from someone who already owns them.

The prices of the shares on a stock market fluctuate according to supply and demand, investor confidence, world events and information about company profits, among other factors. 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.

Understanding the Stock Market: How to Invest

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 funny-looking blazer and start yelling “buy! sell!” You just need a broker to act as your representative. This could be a person you hire or a big brokerage firm that sells mutual funds. The internet has made this process much simpler. You 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.

Related Article: What Are Futures?

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.

How Does the Stock Market Work?

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-facing arrow if the price is higher than the day before, or a red downward-facing arrow if the price is lower. You’ll also see the difference between the current price and the price at the end of the previous trading day. If you’re an average retail investor just looking for some low-cost index funds, 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.

Related Article: Investing for Beginners

Stockholder’s Equity: Why You Want It

So why buy stocks when you could just stash cash under the mattress, buy CDs and bonds or keep your savings in jewelry and fine art? I’m glad you asked. Investing in the stock market generally provides higher returns than investing in bonds or CDs. And you don’t have to figure out how to store and insure stocks, like you would with jewelry or art.

Stocks do come with some risk, though. If the stocks you own become less valuable, your net worth goes down. Bummer, right? It sounds counter-intuitive, but experts advise the way to ride out the ups and downs of the stock market is to buy low and sell high, or buy and hold. 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. Experts agree: offloading your shares when times get tough is not a winning strategy.

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!

Next Steps

  • 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.
  • Talk to a financial advisor. Especially if you’re focused on meeting a goal like getting retirement ready, a financial advisor can help you make the right financial decisions to get there.  A matching tool like SmartAsset’s can help you find an advisor to work with who meets your needs. First you’ll answer a series of questions about your situation and goals. Then the program will narrow down your options from thousands of advisors to up to three registered investment advisors who suit your needs. You can then read their profiles to learn more about them, interview them on the phone or in person and choose who to work with in the future. This allows you to find a good fit while the program does much of the hard work for you.

Photo credit: ©iStock.com/GlobalStock, ©iStock.com/Maciej Bledowski, ©iStock.com/grafficx

Amelia Josephson Amelia Josephson is a writer passionate about covering financial literacy topics. Her areas of expertise include retirement and home buying. Amelia's work has appeared across the web, including on AOL, CBS News and The Simple Dollar. She holds degrees from Columbia and Oxford. Originally from Alaska, Amelia now calls Brooklyn home.
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