The stock market is where investors connect to buy and sell investments — most commonly, stocks, which are shares of ownership in a public company.

What is the stock market?

The stock market, also known as the equity market, is not a physical place, but instead the gathering of brokers, investors, and traders, who buy and sell shares of publicly-listed companies. Due to advancements in computer technology, the stock market is now primarily a virtual place of exchange. The buyers and sellers of stocks often include banks, insurance companies, funds (mutual, pension, hedge, index, exchange-traded, etc.) and even individuals all over the world. Previously, it was necessary for an individual to use a stockbroker, but these days anyone with an online brokerage account can just sit at home in front of their personal computer or use an app on their smart phone to buy or sell stocks. If you are an individual investor with a limited amount of money to invest, then you are in luck, it has never been easier or cheaper to buy or sell stocks on the stock market than it is today.

Important Stock Markets

There are many stock markets around the world and they play an important part in the world’s economy.

United States Stock Markets

New York Stock Exchange (NYSE) is a hybrid exchange, where orders can be placed both physically on the trading floor and also electronically. The NYSE’s busy trading floor is often featured on television when stock market news is reported. In contrast, NASDAQ is a virtual exchange where all of the activity takes places over a network.

International Stock Markets

Outside of the US, other important official stock exchanges around the world include the Tokyo Stock Exchange, the London Stock Exchange, and the Shanghai Stock Exchange. Although some international companies may list their shares on several different stock markets around the world, most domestic companies are only bought and sold on a single, often local exchange. Therefore, it is important to know which exchange a stock is listed on before buying shares.

Establishment of Stock Markets

The stock market has actually been around for more than four hundred years. The oldest stock exchange in the United States is the New York Stock Exchange, which was founded in 1792. The NASDAQ, is a newer exchange, having been founded in 1971. However, the Amsterdam Stock Market, now known as Euronext Amsterdam, is generally considered to the be oldest in the world, having been started by the Dutch East India Company way back in 1602.

Why We Need the Stock Market?

Most small companies are private, but when a private company wants to grow they often need money to expand their facilities, like when making a new factory or opening more branch offices. As costs rise, private companies often don’t have enough money to expand and rather than borrow money, they may choose to go public. When a private company becomes a public company, the ownership of the company is divided into many small parts, and each part is referred to as a share of the company. While the ownership of a private company is limited to one, or perhaps a few people, a public company offers its shares on the stock market where anyone can buy or sell shares of the company.

Financing

If a company borrows money, then it will have to pay back the loan with interest. This is known as debt financing. However, by issuing stock instead, a company can raise money to money to grow their business on stock market by offering investors partial ownership in their company, which entitles the shareholders to a portion of the earnings and assets of the company. This is referred to as equity financing. With equity financing, unlike a loan, the company does not need pay the money back and it also avoid paying interest. However, the shareholders also assume part of the risk of ownership of the company.

Following The Market

The stock market, when tracked by an index, is regularly used as a barometer to help measure the health of a country’s economy. When stock prices rise, it is seen as an indicator that a country’s economy is improving. Likewise, when stock prices fall, it is considered to be a negative indicator and that the economy is doing poorly.

Standard & Poor’s 500

If you are interested in checking on the performance of the stock market in the United States, then Standard & Poor’s 500 (S&P 500) stock index is one of the most commonly referenced. This index is made up of 500 of the most widely traded companies in the US which makes up about 70% of the total value of the US stock market.

Dow Jones Industrial Average

Another commonly mentioned index is the Dow Jones Industrial Average (DJIA). The DJIA is sometimes also called the Dow Jones Industrial, the Industrial Average, the Dow Jones, the Dow 30, or even just the Dow. Although it is one of the oldest and most well-known indexes, the DJIA actually only includes 30 largest companies in the United States. It is also a price-weighted index, meaning that the higher the price of a company’s stock, the more influence it has over the total index. Due to its limited scope and price weighting, the Dow Jones is probably not the best barometer of the U.S. economy, although it is still widely referenced. Gaining a better understanding of the stock market, where stocks are bought and sold, is necessary for making better investment decisions and reaching your financial goals.

Key Takeaways

Stocks are bought and sold on the stock market, most of which is done virtually. With an online brokerage account anyone can buy and sell stocks from the comfort of their own home. It is important to know which exchange a stock is traded on before purchasing shares. The S&P 500 is probably the better index to follow as an indicator of the overall US economy.

How does the stock market work?

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The concept behind how the stock market works is pretty simple. Operating much like an auction house, the stock market enables buyers and sellers to negotiate prices and make trades. The stock market works through a network of exchanges — you may have heard of the New York Stock Exchange or the Nasdaq. Companies list shares of their stock on an exchange through a process called an initial public offering, or IPO. Investors purchase those shares, which allows the company to raise money to grow its business. Investors can then buy and sell these stocks among themselves, and the exchange tracks the supply and demand of each listed stock. That supply and demand help determine the price for each security, or the levels at which stock market participants — investors and traders — are willing to buy or sell. Computer algorithms generally do most of those calculations. Buyers offer a “bid,” or the highest amount they’re willing to pay, which is usually lower than the amount sellers “ask” for in exchange. This difference is called the bid-ask spread. For a trade to occur, a buyer needs to increase his price or a seller needs to decrease hers. Historically, stock trades likely took place in a physical marketplace. These days, the stock market works electronically, through the internet and online stockbrokers. Each trade happens on a stock-by-stock basis, but overall stock prices often move in tandem because of news, political events, economic reports and other factors.

How do you invest in the stock market?

If you have a 401(k) through your workplace, you may already be invested in the stock market. Mutual funds, which are often composed of stocks from many different companies, are common in 401(k)s. You can purchase individual stocks through a brokerage account or an individual retirement account like an IRA. Both accounts can be opened at an online broker, through which you can buy and sell investments. The broker acts as the middleman between you and the stock exchanges. With any investment, there are risks. But stocks carry more risk — and more potential for reward — than some other securities. While the market’s history of gains suggests that a diversified stock portfolio will increase in value over time, stocks also experience sudden dips. To build a diversified portfolio without purchasing many individual stocks, you can invest in a type of mutual fund called an index fund or an exchange-traded fund. These funds aim to passively mirror the performance of an index by holding all of the stocks or investments in that index. For example, you can invest in both the DJIA and the S&P 500 — as well as other market indexes — through index funds and ETFs.
You can invest in many stocks at once through index funds and exchange-traded funds.
Stocks and stock mutual funds are ideal for a long time horizon — like retirement — but unsuitable for a short-term investment (generally defined as money you need for an expense within five years). With a short-term investment and a hard deadline, there’s a greater chance you’ll need that money back before the market has had time to recover losses.
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