You’ve probably heard about the stock market — and all of the investors who have made mind-blowing amounts of money by playing it just right.
But just what is the stock market? What purpose does it serve, how does it work, and how can you use it to ascend the financial ladder?
Here’s a quick and simple stock market primer. Read on and get acquainted with this popular yet poorly-understood economic powerhouse.
What Are Stocks?
First things first: what is a stock, and why should it matter to you?
Essentially, a stock is a business that has chosen to open itself up to outside ownership interests. Investors can purchase shares of the company and become partial owners of it — and the more shares one buys, the greater their ownership stake in the company.
Becoming a stock — also known as “going public” — is a tried-and-true way for a company to gain more capital, which in turn allows it to research new products, repay debts or expand its development.
And for investors, it’s an opportunity to gain partial ownership of an established company… and potentially make money in the future by selling that ownership to other investors.
Stocks are also known as publicly-traded companies or equities.
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What Is the Stock Market?
On an extremely basic level, the stock market is exactly what the name suggests: a marketplace where investors can buy and sell shares of various stocks.
Of course, in practice, it’s a little more complicated than that. There are many players in the game, including exchanges, indexes, brokers and individual investors.
What Are Stock Market Exchanges?
The stock market is made up of smaller sub-markets called exchanges. You may have heard of some of these, such as the New York Stock Exchange (NYSE) and the Nasdaq, but they’re far from the only ones — globally, there are 60 active stock exchanges.
Each exchange has its own roster of stocks, and companies can pick and choose which exchange they want to be sold on — as long as they meet each exchange’s requirements. Higher-profile exchanges attract more investors, but a company must have a high income and net worth to be listed on them.
Think of an exchange like a farmer’s market: many individual vendors collected in one location for a diverse yet well-vetted shopping experience.
What Are Stockbrokers?
Individual investors don’t typically interact directly with exchanges. Instead, they utilize the services of stockbrokers, who know all the ins and outs of dealing with the exchanges and can properly facilitate each transaction.
In the past, a stockbroker was a real person who carried out each investor’s buy and sell requests. If you wanted to make a trade, you’d call your broker, give them the details, and pay them a small commission to do the dirty work on your behalf.
But though there are still many individual stockbrokers today, fully-electronic brokerages such as Fidelity and TD Ameritrade have largely taken over. These e-brokers still take a small cut of each transaction, but they allow investors to instantly make trades from a website or app.
What Are Stock Market Indexes?
Stock market indexes are lists of stocks that serve as gauges to summarize current stock market conditions. Investors can use indexes to quickly get a feel for how various sectors of the market are performing.
The S&P 500, for instance, is made up of the 500 largest publicly-traded companies in the U.S. Representing a wide range of industries, it provides a benchmark for the overall direction of the stock market.
And the Nasdaq index tracks all of the companies sold on the Nasdaq exchange, which focuses mainly on the tech industry. If the Nasdaq index is up, the tech industry as a whole likely is too.
How Are Stock Market Prices Determined?
The stock market operates based on supply and demand: some people want to sell shares of a company (supply) and others want to buy those shares (demand). The ratio of supply to demand determines the value of the stock.
If there are many buyers clamoring to own a particular stock, but few sellers willing to give theirs up, the price of the stock will be higher. The demand is greater than the supply, so sellers can fetch a premium for their shares.
Conversely, if many sellers want to jump ship on a stock, but hardly anyone wants to buy those shares, prices will be low. Sellers must take what they can get for the shares they want to get rid of.
What Determines Supply and Demand?
Company announcements, world events, predictions from experts, and other external factors can all drive supply and demand — and thus influence a stock’s price.
Say your favorite tech company announces an innovative new product that will sell for a hefty sum. The company is primed to bring in a lot of money, which causes demand to increase: every investor wants in on the bounty that’s sure to come.
But then a natural disaster strikes, destroying the factory where these shiny new products are being produced. At the same time, the government announces that it’s investigating the company for sketchy advertising practices.
The company can no longer bring in those anticipated profits, and investors want out before things get any worse. What’s more, few people want to take on the risk of investing in a company that looks to be on the brink of ruin — supply is high, but demand is very low, causing the stock price to plummet.
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How Can You Make Money on the Stock Market?
There’s no surefire way to succeed on the stock market — by definition, it’s risky, as are nearly all investments.
But by following the golden rule of “buy low, sell high”, you can play the stock market to your advantage. Keep an eye on the supply and demand ratios of your chosen stocks, and watch indexes to see how the market is trending as a whole.
Don’t put all your eggs in one basket, either: by investing in many different stocks across industries, you’ll mitigate your risks. Index funds, which allow you to invest in all of an index’s stocks at once, are a highly-diverse, lower-risk option for those who are new to the stock market.