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How Does The Stock Market Work?

How Does The Stock Market Work?

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The stock market is a constellation of exchanges where securities like stocks and bonds are bought and sold. In the United States, “the stock market” and “Wall Street” can refer to the entire world of securities trading—including stock exchanges where the shares of public companies are listed for sale and markets where other securities are traded.

How Does the Stock Market Work?

The stock market helps companies raise money to fund operations by selling shares of stock, and it creates and sustains wealth for individual investors.

Companies raise money on the stock market by selling ownership stakes to investors. These equity stakes are known as shares of stock. By listing shares for sale on the stock exchanges that make up the stock market, companies get access to the capital they need to operate and expand their businesses without having to take on debt. In exchange for the privilege of selling stock to the public, companies are required to disclose information and give shareholders a say in how their businesses are run.

Investors benefit by exchanging their money for shares on the stock market. As companies put that money to work growing and expanding their businesses, investors reap the benefits as their shares of stock become more valuable over time, leading to capital gains. In addition, companies pay dividends to their shareholders as their profits grow.

The performances of individual stocks vary widely over time, but taken as a whole the stock market has historically rewarded investors with average annual returns of around 10%, making it one of the most reliable ways of growing your money.

Stock Market vs Stock Exchange

Although the terms are used interchangeably, the stock market is not the same as a stock exchange. Think of a stock exchange as a part of a whole—the stock market comprises many stock exchanges, such as the Nasdaq or New York Stock Exchange (NYSE) in the U.S.

When people talk about how the stock market is performing, they mean the thousands of public companies listed on multiple stock exchanges. And more generally, the stock market can be thought of as encompassing a very broad universe of bonds, mutual funds, exchange-traded funds (ETFs) and other securities beyond just stocks.

What Is a Stock Market Index?

A stock market index tracks the performance of a group of stocks that represents a particular industry or segment of the stock market, like the technology, energy and transportation sectors. Often, one of three large indexes is used as shorthand to describe the performance of the U.S. stock market as a whole:

  • Dow Jones Industrial Average (DJIA). The DJIA is made up of 30 blue-chip stocks of U.S. industrial companies.
  • NYSE Composite Index. The NYSE Composite Index tracks the price movements of all common stocks listed on the New York Stock Exchange.
  • S&P 500. The S&P 500 represents 500 of the largest companies in the U.S. economy.

Other Types of Markets

The stock market generally refers to markets and exchanges where equity shares and related securities are traded. Other types of financial assets have their own markets.

  • Over-the-Counter (OTC) Markets. OTC describes securities trading that takes place outside of major stock exchanges. OTC trades are primarily made directly between sellers and buyers, and prices may or may not be publicly available. Most bonds are traded OTC, and many stocks—including penny stocks—are also traded over-the-counter.
  • Commodities Markets. Raw materials like steel, coal and oil are traded on commodities markets. There are around 50 major commodity markets worldwide that facilitate trade in a wide range of commodities.
  • Derivatives. Derivatives are financial contracts like options whose value is tied to an underlying asset. These are essentially contractual bets about whether individual securities’ values will rise or fall. For experienced investors, derivatives can be extremely lucrative ways to hedge their bets when investing, and they can be incredibly risky for beginners.
  • Foreign Exchange Markets. Forex trading is a borderless, international market for exchanging currencies. Forex traders take advantage of the constantly fluctuating value of different currencies to make profits, and help provide liquidity for international trade.
  • Cryptocurrency. Bitcoin and Ethereum are cryptocurrencies, or decentralized digital assets based on blockchain technology. Cryptocurrencies are traded on specialized crypto exchanges.

How to Invest in the Stock Market

If you want to invest in the stock market, the process to get started is easier than you think:

  1. Decide what kind of account you want to open. From retirement savings to college savings, from short-term goals to long, there really is an investment account for everything.
  2. Open a brokerage account. Once you’ve decided what kind of account you want, you’re ready to open an account at a provider called a brokerage. When choosing a company, consider their fees and available investment options.
  3. Deposit money. To get started, you need to make an initial deposit. You can also set up recurring deposits to automate your investments going forward.
  4. Choose your investments. Once your account is open, you can buy and sell securities. You can opt for individual stocks and bonds or mutual funds, index funds and exchange-traded funds (ETFs) that contain hundreds of individual securities. Many experts recommend a diversified, fund-based approach to minimize the risk any one bad investment loses you money.
  5. Purchase your investments. Once you’ve settled on what you want to buy, simply enter the ticker symbol in the buy field and indicate how many shares you want to buy.

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