You might hear a news presenter say, “The stock market went up today,” or see a headline that reports billions of dollars were “wiped off the market.”
For those new to investing, those kinds of statements can make the stock market sound like a complicated machine run by professional traders. But the basic idea is much simpler.
So, what is the stock market?
The stock market is a broad network where investors buy and sell ownership shares in publicly traded companies. It offers a means for companies to raise money and for investors to share in the future health or failure of those companies.
When you buy a stock, you are not just speculating on a number going up. You’re buying a small piece of ownership in a real business.
That ownership can result in gains from rising stock prices and dividend payments. But there are no guarantees of profit. A company can underperform, its stock price can decline, and sometimes the company can go bankrupt.
This guide covers how the stock market works, why stock prices change, how trades are made, and how newbies can learn to invest in the stock market without taking on undue risk.
Key Takeaways
| Key point | What it means |
|---|---|
| Stocks are ownership | When you buy shares, you own part of a company. |
| Companies raise capital in markets | Public companies can sell stock to fund growth and other business needs. |
| Prices move all the time | Supply, demand, earnings, economic news, and investor expectations all move prices. |
| Returns are not guaranteed | Investors can earn money, but they can also lose some or all of an investment. |
| Diversification can reduce concentration risk | Holding many investments is generally less risky than depending on one company. |
| Long term thinking matters | Frequent buying and selling and emotional decisions can hurt investment results. |
What Is the Stock Market in Simple Terms?
The stock market is the system through which shares of public companies are issued, bought, and sold. It’s not a place. It’s a collection of stock exchanges, electronic trading networks, brokerage firms, market makers, clearing systems, regulators, public companies and millions of investors.
When you buy a share of stock, you are buying a piece of the company that issued it.
Assume a company has 10 million shares outstanding. If you buy 100 shares, you have a very small ownership stake, but you still own equity in that business.
As a shareholder, you may benefit if:
- The company becomes more profitable.
- Investors are more prepared to pay more for its shares.
- Dividends are paid from a share of the company’s profits.
- The business is acquired by another company at a higher valuation.
You can also lose money if the company does badly or investors decide to cut back the amount they think it will earn in the future.
The Securities and Exchange Commission’s investor education website provides an easy-to-understand explanation of trading venues, market participants and securities trading. Newbies can go to Investor.gov’s explanation of stock markets before opening an investment account.
Why Is There a Stock Market?
The stock market is essentially a means for companies to connect with individuals who want to grow their money.
How Businesses Benefit
To grow, a business needs money. It may need money to:
- Open new locations
- Hire employees
- Develop products
- Purchase equipment
- Expand into new countries
- Buy another business
- Pay off existing debt
- Invest in technology
A company can borrow money, use its existing profits, attract private investors or sell shares to the public.
By issuing stock, the company receives capital without taking out a traditional loan. In exchange, existing owners give up part of their ownership to new shareholders.
How Investors Benefit
Investors receive the opportunity to participate in a company’s growth. They may earn a return in two main ways:
- Capital appreciation: The stock becomes more valuable and is sold for more than the purchase price.
- Dividends: The company pays out some of its profits to shareholders.
Let us say an investor buys 20 shares at $50 each, for a total of $1,000. The stock price increases to $65, and the shares are worth $1,300. The investor has an unrealized gain of $300 before fees and taxes.
If the company pays a dividend of $1 per share, the investor receives $20 in dividend income.
The reverse is also true. If the price falls to $30, the investment is worth only $600.
What Is a Stock?
A stock is a security that represents an ownership interest in a company.
The words “stock” and “share” are used interchangeably, although a share is technically a single unit of stock.
For example:
- “I own stock in the company” describes the investment in general.
- “I own 50 shares” describes the number of ownership units.
Common Stock
Common stock is the type that most individual investors buy.
Common shareholders may receive:
- Voting rights
- Dividend payments
- Potential gains if the share price rises
Dividend payments are not guaranteed. A company may cut, suspend or eliminate its dividend.
Preferred Stock
Preferred stock has characteristics of both stocks and bonds.
Preferred shareholders usually get dividend payments before common shareholders do. However, they may have limited or no voting rights.
Preferred stock can still decline in value and is not the same as a guaranteed savings product.
Public Companies vs. Private Companies
Shares of a public company are generally available for purchase and sale by qualified investors in the open market.
Ownership of a private company is held by the founders, employees, private investors, venture capital firms, or other restricted groups. The shares are not traded freely on a public stock exchange.
| Public company | Private company |
|---|---|
| Shares are traded on public markets | Shares are privately held |
| Must adhere to public disclosure rules | Often has fewer public reporting obligations |
| Easier for regular investors to access | Access is often limited |
| Market value fluctuates during trading | Valuation is determined less often |
Public companies usually release financial statements and material information to investors.
In the United States, you can often review these filings through the SEC’s EDGAR database.
How Does a Company Enter the Stock Market?
A private company can go public through an initial public offering, or IPO.
During an IPO, the company offers shares to public investors for the first time.
Simplified IPO Process
| Stage | What happens |
|---|---|
| Private preparation | The company gets its financial records in order and chooses advisers. |
| Regulatory filing | Required financial and business information is submitted. |
| Pricing | The company and its underwriters estimate an offering price. |
| Public offering | Shares are sold to initial investors. |
| Exchange trading | Shares begin trading between investors. |
The money raised during the IPO can go to the company and, in certain cases, to existing shareholders who sell part of their holdings.
After shares begin normal exchange trading, most transactions take place between investors. If you buy shares from another investor, your money generally goes to that seller rather than directly to the company.
IPOs attract a lot of attention, but a company’s popularity does not mean it is a good investment. New stocks may have little trading history with the general public, high prices or very volatile prices.
How the Stock Market Works
A stock trade begins when one investor wants to buy and another wants to sell.
Most individual investors do not place orders directly with an exchange. They do so through a brokerage firm.
Here’s a simplified process:
- You open a brokerage account.
- You choose an investment.
- You submit a buy or sell order.
- The order is transmitted to a trading venue.
- The matching counterparty is identified.
- The trade is executed.
- The transaction is cleared and settled.
- The shares and cash are reflected in the accounts.
Modern trading happens electronically and can appear almost instant. But there may be many firms and systems working behind the scenes to make the transaction happen.
Stock Market = Continuous Auction
One way to think about the stock market is to think of it as a really big auction.
Some investors announce the highest price they are willing to pay. Others announce the lowest price they are willing to accept.
The highest current buying price is called the bid.
The lowest current selling price is called the ask.
The difference between the two is called the bid-ask spread.
Bid-Ask Example
| Quote | Price |
|---|---|
| Highest bid | $49.95 |
| Lowest ask | $50.05 |
| Bid-ask spread | $0.10 |
Someone submitting a market order to buy may pay about the ask price. Someone submitting a market order to sell may receive about the bid price.
Prices can move fast, especially for a stock that does not trade a lot or in volatile markets.
Stock Exchange: A Beginner’s Guide
Stock exchange is a regulated market where securities are listed and traded.
Examples include:
- New York Stock Exchange
- Nasdaq
- London Stock Exchange
- Toronto Stock Exchange
- Australian Securities Exchange
- National Stock Exchange of India
A stock market is the overall system of many securities and trading venues.
A stock exchange is one particular marketplace within that system.
| Stock market | Stock exchange |
|---|---|
| Broad network of stock trading | A specific regulated marketplace |
| Includes multiple exchanges and venues | Lists and facilitates trading in securities |
| Refers to the overall market | Refers to one organization or platform |
Not every security trades on a major exchange. Some securities trade over the counter through networks of dealers.
Who Participates in the Stock Market?
The market is much bigger than just individual investors.
Individual Investors
These are people investing their own money, through brokerage, retirement, or investment accounts.
Known also as retail investors.
Institutional Investors
Institutions may manage money for thousands or millions of people.
Examples include:
- Pension funds
- Mutual funds
- Insurance companies
- Banks
- Hedge funds
- Endowments
- Sovereign wealth funds
Since the institutions trade large amounts, their decisions can influence demand and short term prices.
Brokerage Firms
Brokerages provide accounts and technology to allow investors to buy and sell investments.
Some provide self-directed accounts; others provide advisory or portfolio-management services.
Market Makers
Market makers continuously quote prices at which they are willing to buy and sell securities. Their activity can help other traders to make trades.
Regulators
Regulators create and enforce rules to promote fair markets, require disclosures, and address misconduct.
Regulation mitigates some risk but cannot prevent losses in the market or guarantee the investment is suitable.
What Makes Stock Prices Move?
Stock prices move because buyers and sellers are always re-evaluating the value of a company.
If the demand to purchase a stock outstrips the available supply at the current price, buyers may bid higher, pushing the price up.
If many investors want to sell and there are not enough buyers at the current price, sellers may accept less, pushing the price down.
Company Earnings
Investors look very closely at revenue, profits, cash flow, debt and future guidance.
If a company says its profits are growing, but the result is not what investors were expecting, the stock can go down.
Markets respond to what has happened, but also to how the result compares with what was expected.
Interest Rates
Higher rates of interest can be costly for consumers and companies that borrow money. They can also make bonds and savings products look more attractive than stocks.
Lower rates can stimulate business activity, but this is dependent on the company and economic conditions.
Economic Conditions
Employment, inflation, consumer spending, economic growth and recession expectations can influence company profits and investor confidence.
Industry Developments
New technology, changing consumer habits, regulation, competition and supply shortages can influence an entire industry.
Investor Sentiment
Markets do not move only on accounting data. Fear, optimism, uncertainty and speculation can cause rapid short term swings.
News and Unexpected Events
Geopolitical conflicts, natural disasters, lawsuits, leadership changes, product failures, government decisions can influence prices.
| Event | Possible market response |
|---|---|
| Earnings beat expectations | Stock may go up |
| Major customer is lost | Stock may go down |
| Successful new product | Stock may go up |
| Regulatory investigation | Stock may go down |
| Changes in interest rates | Different sectors may react differently |
The word “may” is important.
A stock does not always react in the way a beginner expects.
What Does It Mean When “the Market” Goes Up?
When news reports say the market rose or fell, they are usually talking about a stock market index.
An index follows a selection of securities and provides a general idea of market performance.
Commonly discussed indexes include:
- S&P 500
- Dow Jones Industrial Average
- Nasdaq Composite
- FTSE 100
- S&P/TSX Composite
- ASX 200
- Nifty 50
Each index uses its own selection and weighting method. One index may rise while another falls because they contain different companies.
You usually can’t invest directly in an index. But you can buy an index fund or ETF that follows an index.
What Is Market Capitalization?
Market capitalization, or market cap, is the total market value of a publicly traded company.
Calculation
Market capitalization = Share price × Shares outstanding
Let’s say company has 50 million shares and each share is $20.
50 million × $20 = $1 billion market cap
Stocks are often classified as:
- Large-cap
- Mid-cap
- Small-cap
- Micro-cap
Exact definitions can differ from investment firm to investment firm.
A lower price share is not necessarily cheaper in terms of valuation.
A company with a $10 share price might be worth more in total dollars than a company with a $500 share price, depending on how many shares each has outstanding.
How Investors Make Money in Stocks
Rise in Share Price
Capital gain is made when an investor sells his shares for more than he paid.
If, however, the sale price is less, he has a capital loss.
Dividends
Some companies distribute a portion of their profits to shareholders.
Dividend-paying stocks can generate income, but dividends are not guaranteed. A high dividend yield can also be a sign that the share price has fallen because investors are worried about the company.
Compounding
When investment gains begin to generate more gains.
If an investor reinvests dividends, they can buy more shares. These additional shares can eventually produce their own dividends or price appreciation.
Compounding can be powerful over long periods, but stock returns are lumpy. Some years they make money, some years they lose money.
Market Orders vs. Limit Orders
It is important for beginners to understand the two most common order types before you buy a stock.
Market Order
A market order is an order to the broker to execute the transaction at the best price available.
“It’s about execution, not a specific price.”
In a fast-moving market, the final price may not be the same as the quote you saw before placing your order.
Limit Order
A limit order is an order to buy at or below a certain price, or sell at or above a certain price.
It gives you more control over price but it may not be filled.
| Order type | Primary benefit | Primary drawback |
|---|---|---|
| Market order | Likely to execute quickly | Final price not guaranteed |
| Limit order | More control over price | Trade may not execute |
How to Invest in Stocks for Beginners
Step 1: Build a Financial Foundation
Before you start investing, you might want to build an emergency fund and pay off high-interest debt.
Money needed for rent, medical costs, tuition or other short-term needs typically shouldn’t be invested in volatile stocks.
Step 2: Select a Regulated Broker
Compare:
- Fees for accounts
- Trading fees
- Investment choices
- Minimum balances
- Research tools
- Customer service
- Security features
- Tax reporting
- Availability in your country
Tax rules and investment protections vary by jurisdiction.
Step 3: Select the Proper Account
Depending on your country, you can open regular taxable brokerage accounts, retirement accounts, or other tax-advantaged investment accounts.
The account type can have tax implications, contribution limits and withdrawal rules.
Step 4: Fund Your Account
Transfer cash from a linked bank account.
Don’t use money you borrow on a credit card or high-interest personal loan to invest.
Step 5: Do Your Homework
When researching a company, review:
- How it makes money
- Whether revenue is growing
- Whether it is profitable
- Its level of debt
- Its competitive advantages
- Risks within its industry
- The quality of its management
- The valuation of its stock
- Regulatory issues
Even a great company can be a poor investment if its stock price is already factoring in unrealistic growth.
Step 6: Choose Order Type
Decide if a market or limit order is best for you. Before confirming, make sure to double check the share amount, estimated value and ticker symbol.
Step 7: Review Regularly
Long term investors don’t need to react to every daily movement.
Re-evaluate if the investment still fits your objectives, timeframe, risk tolerance and overall portfolio.
Before you buy, investors should know what they’re investing in, including costs, diversification, disclosure documents and the potential risks involved. Its investing basics guide for individual investors is a good place to start comparing stocks, bonds, funds and other securities.
Popular Ways to Invest in the Stock Market
You don’t have to pick individual companies to invest in the stock market.
| Investment type | What it contains | Usual diversification |
|---|---|---|
| Individual stock | Shares in a single company | Low |
| Index fund | Investments that follow a market index | Usually high |
| ETF | A collection of investments traded on an exchange | Varies |
| Mutual fund | A professionally managed collection of investments | Varies |
| Target-date fund | A diversified portfolio that shifts over time | Usually high |
Individual Stocks
Buying individual shares gives you direct exposure to specific companies.
The upside can be attractive, but the downside of picking wrong is greater.
Index Funds
An index fund tries to track a particular market index rather than selecting stocks based on a manager’s predictions.
Broad-market index funds may hold hundreds or thousands of companies.
Exchange-Traded Funds
An ETF holds a collection of investments and trades on an exchange throughout the day.
Not every ETF is broadly diversified.
Some funds are focused on a specific industry, country, commodity, strategy or a small group of companies.
Mutual Funds
Mutual funds are pooled money from different investors which is invested in a portfolio of assets.
They can be actively managed or built to track an index.
Stocks and Bonds
Stocks and bonds are used for different reasons.
A stock is a share in a company.
A bond is usually a loan to a company or a government.
| Stocks | Bonds |
|---|---|
| Ownership in a company | Debt owed by a company or a government |
| Possible return from growth and dividends | Possible return from interest and repayment |
| Usually more volatile | Usually less volatile, but still risky |
| Shareholders are owners | Bondholders are creditors |
| No guaranteed return | Repayment depends on the issuer’s ability to pay |
Diversified portfolios often include both stocks and bonds. The right mix depends on an investor’s goals, time horizon, and risk tolerance.
Risks of Investing in Stocks
Market Risk
A broad market drop can reduce the value of many stocks at the same time.
Company Risk
A company can lose customers, become over leveraged, be sued or not compete.
Risk of Valuation
Even a good company’s stock can fall when investors overpay for expected growth.
Concentration Risk
When you only own one or two companies, your results are highly dependent on those businesses.
Inflation Risk
Stocks don’t always beat inflation, even with their potential for long-term growth.
Currency Risk
International investments can fluctuate in value due to changes in currency exchange rates.
Liquidity Risk
Some securities are hard to sell quickly without accepting a lower price.
Behavioral Risk
Investors may buy after prices have risen because they fear missing out, then sell during a decline because they panic.
The investment itself is not always the only problem. Sometimes the investor’s reaction causes the loss.
Pros and Cons of Stock Market Investing
| Pros | Cons |
|---|---|
| Potential for long-term growth | Prices can decline sharply |
| Access to thousands of companies | Individual companies can fail |
| Dividend income may be available | Dividends can be reduced |
| Easy access through brokerages | Easy trading can encourage overtrading |
| Can help diversify long-term savings | Returns are never guaranteed |
| Some funds have low starting requirements | Fees and taxes may reduce returns |
Common Beginner Mistakes
Trying to Get Rich Quickly
A stock market investing plan built around fast profits can lead to excessive risk and emotional decisions.
Buying a Stock Because It Is Popular
Online excitement does not replace financial research.
By the time a stock becomes widely discussed, much of the expected growth may already be reflected in its price.
Confusing a Low Share Price With a Bargain
A $5 stock is not automatically cheaper than a $500 stock.
Investors must consider the company’s total market value, earnings, debt, and future prospects.
Investing Emergency Money
A market decline may force you to sell at a loss when you urgently need cash.
Beware of Fees and Taxes
Trading fees, fund costs, account fees, currency conversion fees, and taxes can eat into your return.
Keep an Eye on Prices Regularly
Regularly monitoring prices can lead to short-term decision making instead of focusing on your long term goals.
Putting All Your Eggs in One Basket
Even a successful company can face an unforeseen problem. Diversification reduces reliance on a single result.
Taking Unverified Social Media Advice
Fraudsters and promoters can overstate potential returns, hide conflicts of interest or disseminate misleading information.
Always verify who is giving the information and how they might benefit.
Expert Tips for Beginner Investors
Define the Goal First
Know why you are investing.
A retirement goal 30 years away can support a different level of risk than money needed for a house deposit in two years.
Use a Long-Term Time Horizon
Stock prices can be unpredictable over short periods.
A longer holding period gives a diversified portfolio more time to recover from temporary declines, though recovery is never guaranteed.
Diversify
Diversification is spreading money across companies, industries and sometimes countries and asset classes.
It cannot eliminate market losses, but it can reduce the damage caused by one failed investment.
Invest Consistently
Regular contributions can help build discipline and reduce the temptation to guess the perfect time to enter the market.
Understand What You Own
Do not buy a stock, fund, or ETF only because its recent return looks impressive.
Read the investment objective, major holdings, costs, and risk disclosures.
Separate Speculation
If you want to experiment with high-risk stocks, you may decide to limit speculation to a small amount you can afford to lose without affecting major financial objectives.
Real Life Beginner Example
Emma wants to invest for retirement and has a time horizon of more than 25 years.
After building an emergency fund and paying off expensive credit card debt, she decides to invest $150 each month in a diversified broad-market index fund.
During the first few years, the market rises and falls several times. Emma’s account occasionally drops below the amount she contributed.
Instead of selling during a downturn, she reviews her goal and continues making regular contributions.
Her plan does not guarantee a profit. However, it avoids several common mistakes:
- She is not relying on one company.
- She is not investing emergency money.
- She is a frequent contributor.
- She is thinking long-term.
- She recognizes that there may be short-term losses.
The point isn’t to copy Emma’s exact investment. Rather, it’s that a simple, diversified plan may be easier to stick with than always chasing the next hot stock.
FAQs
What Is the Stock Market in Layman’s Terms?
The stock market is an interconnected system in which investors buy and sell ownership units in publicly traded companies. It allows companies to raise capital and gives investors the opportunity to share in their expansion.
How Does the Stock Market Actually Work?
Orders are placed by investors through brokers. Those orders are routed to exchanges or other trading venues where buyers and sellers are matched. The trade is then cleared and settled.
Investors make money if share prices rise or if companies pay dividends.
Neither form of return is guaranteed.
Where Does the Money Go When You Buy a Stock?
In most normal market trades, the money goes to the investor or institution selling the shares. During a new share offering, some or all of the money may go to the company.
Why Do Companies Sell Shares?
Companies sell stock to raise money to invest in their growth, hire employees, buy other companies, develop products, pay down debt and for other business reasons.
Why Does the Price of a Stock Change Every Second?
Prices move as investors submit new buy and sell orders, reacting to company results, economic news, interest rates, expectations and market sentiment.
Is the Stock Market Safe for Beginners?
The stock market is a risky place. Beginners can reduce avoidable risk by using regulated platforms, diversifying, understanding fees, avoiding borrowed money, and investing for suitable long-term goals.
Can You Start Investing With $10?
Some brokers allow you to buy fractional shares or funds with low minimum investment requirements. The availability, fees, and rules of the account will differ depending on the country and the platform.
What Is a Fractional Share?
A fractional share is a fraction of a company or fund that is smaller than a full share. It may allow investors to begin investing with less than the cost of a full share.
What’s the Minimum Investment?
No standard minimum. Some accounts have no minimum and some funds or platforms may require an initial deposit.
Should I Buy an Individual Stock?
Buying one company creates concentration risk. Many beginners prefer a diversified fund which spreads money across multiple holdings. But every investment needs to be reviewed carefully.
What Is an Index Fund?
An index fund is built to track the performance of a chosen market index. It can offer wide diversification, but its value may fall.
Stock vs. ETF: What’s the Difference?
No. A stock is ownership of one company. An ETF is a fund that can hold many stocks, bonds or other investments, and can be bought and sold on an exchange.
What Is the Difference Between Investing and Trading?
Investing is usually more focused on long-term growth and the financial objectives of businesses. Trading is often more about buying and selling more frequently to take advantage of shorter-term price movements.
Is the Stock Market the Same as Gambling?
No, they are not the same. Stock investing is ownership of businesses that produce goods, services, revenue and profits. However, speculative trading without research or risk controls can act very much like gambling.
Can the Stock Price Go Down If a Company Makes Money?
Yes. The shares could fall if the earnings are disappointing, guidance is weak for future quarters, costs are rising or investors feel that the shares were overvalued already.
What Happens If a Stock Drops to Zero?
If a company goes bankrupt and its shares are worthless, common shareholders can lose all their money. When a company is liquidated, shareholders are usually the last to be paid after creditors.
Your maximum loss is generally the amount you invest with a normal cash account. If you borrow using margin, sell short and buy certain complex products, you can lose more than you originally invest.
Should a Beginner Buy Stocks During a Market Crash?
No one can accurately call the bottom of a market slide. Novice investors should follow a plan based on their goals, emergency savings, time horizon and risk tolerance rather than react to scary headlines.
How Often Should I Look at My Investments?
If you’re a long-term investor, a periodic review may be enough. Checking prices several times a day may lead to emotional decisions without improving the underlying investment.
Do Shareholders Get the Profits of the Company?
Profits can be used by companies to grow the company, to pay down debt, to buy back stock or to pay dividends. Just because you own stock doesn’t mean that profits will be passed on directly to shareholders.
Are Dividends a Guarantee?
No. A board of directors can reduce, suspend or cancel dividends.
How Do Stocks Perform in a Recession?
Recessions can lead to lower company profits and less investor confidence, which can create volatile stock prices. But different companies and industries may perform differently.
Is It Possible to Lose All My Money in the Stock Market?
If one company goes under you could lose all the money you invested in that one company. A diversified portfolio is less likely to go completely bust but it can still take a big hit.
Do I Need a Financial Advisor to Buy Stocks?
Not necessarily. Many people use self-directed brokerage accounts. Professional advice can be helpful if your finances are complicated or if you’re unsure about risk, taxes, retirement planning or investment selection.
Conclusion
The first step to making wise investment decisions is knowing what is the stock market.
The stock market is a mechanism for public companies to raise money and for investors to own pieces of real businesses. Prices change because investors are constantly reassessing company performance, economic factors, risk, and future opportunity.
Investing in stocks is a way to build wealth over time, but it’s not a surefire way to make money. Markets go down, companies go bankrupt and emotions can cause you to make bad decisions that lead to losses.
Beginners do not need to predict the next market winner. A stronger starting approach is to define clear goals, build an emergency fund, understand each investment, control costs, diversify, and invest with a long-term perspective.
Educational Disclaimer
This article is for educational and informational purposes only and should not be considered financial, investment, tax, or legal advice. Stock market investing involves risk, including the possible loss of principal. Past performance does not guarantee future results.
Investment products, tax treatment and regulatory protections may differ by country. Please consult with a qualified financial professional before making any investment decision.
