Do You Know the Basics of the Stock Market?

Take This Quiz to Find out Whether You're Ready to Start Investing.

wall street

To people who don’t invest, or to even new investors, the stock market may look and feel more like a gamble than an investment. The market’s constant ups and downs can make every turn seem like it will bring large financial gains or damaging losses.

While the world of investing can seem confusing, the more you understand about stocks and other investments, the better you can manage your money in the market. Although it is always possible to lose money, investing in the stock market can be a great way to grow your wealth, given enough time and proper planning. Here's what you need to know about smart stock market investing.

Key Takeaways

  • The stock market represents the forum in which securities (e.g., stocks and mutual funds) are bought and sold.
  • Securities are bought and sold on exchanges.
  • Investing in the stock market can offer higher returns than saving money in a bank account, but it can also entail more risk.
  • Economic and political factors can affect stock market movements.

What Exactly Is the Stock Market?

The stock market is a center in which people can buy shares of publicly owned companies to participate in the financial achievements of the companies whose shares they hold. Stocks, mutual funds, and other securities are bought and sold on an exchange, such as the New York Stock Exchange.

Investors can make money through dividends earned on stocks, mutual funds, real estate investment trusts (REITs), and other income investments. They can also reap capital gains by selling stocks they've purchased after a profit. However, if the investor holds stocks in companies that are losing money, the price and value of those stocks generally decrease, which would result in a loss of profit if the investor were to sell.

Important

Stock market performance is often measured using benchmarks, such as the Nasdaq or the Dow Jones Industrial Average. Each benchmark measures a different aspect of the stock market, but in general these indicators can tell investors which way the overall market is moving on any given day.

There are several different factors that can affect stock prices, such as interest rates, inflation, labor strikes, world events like natural disasters, and changes in oil prices. Political and economic events in the U.S. or in other countries, such as a trade war, can also affect the stock market.

What Are Bear and Bull Markets?

To symbolize the constant ups and downs of the stock market, Wall Street has developed its own terminology. In a bull market, plenty in the economy is going well. Stock prices are rising, unemployment is low, and the economy is growing. As stock prices rise, there tend to be more buyers than sellers in the market. A bull market can last for a few weeks, months, or even years. The market moves in cycles, however, so a bull market has an eventual end point.

When stocks are falling, and the economy is not doing well, this is called a "bear market." A bear market also does not last for a set term as it can go on for years. During such a period, investors have a hard time picking profitable stocks. Some investors use a trading strategy called "short-selling" to make a profit when stocks are declining. This is done when an investor sells securities that they have borrowed and are prepared to buy back later at a lower price.

A bear market can be associated with a stock market correction. A correction happens when a major stock market index, such as the S&P 500, declines in price by 10% or more from its most recent peak. A correction doesn't necessarily mean that a bear market will occur, but it can pre-empt a bear market.

How Many Types of Stocks Are There?

There are two main types of stocks that investors can own: common stock and preferred stock. When people talk about stocks they are usually referring to common stocks. Both of these categories represent ownership in a company, but preferred shares normally come with a fixed dividend, unlike the common stock, which has variable dividends. People may choose preferred stocks because, in the event of liquidation, preferred shareholders are paid off before the common shareholders are.

Note

One key difference is that while common stock gives voting rights to its shareholders, preferred stock does not.

What Are Blue Chip Stocks?

Blue-chip stocks are stocks from the big guys in the market; huge, well-established companies with dependable earnings such as Walt Disney, General Electric, and Intel. For a stock to be considered a blue-chip, it must be consistently profitable with a dividend payment.

Many blue-chip stocks are also categorized as "dividend aristocrats." These are stocks that have consistently increased their dividend payouts to investors for 25 consecutive years or longer.

What Does It Mean if an Investment Is Well Hedged?

An investment is well-hedged if an investor limits losses on a certain stock by establishing an opposite position in the same stock and is protected against losses. Certain types of investments can also be considered natural hedge against volatility.

Real estate, for example, is an investment that's historically been good for hedging, because it doesn't correlate to stock market movements as closely as other investments do. In theory, even if stocks begin to slide, real estate values should continue to hold strong.

How to Start Investing in the Stock Market

Investing in the stock market for the first time isn't as difficult as you might think. The easiest way to get started is to open a trading account with an online brokerage. From there, you can begin investing by purchasing shares of stocks, mutual funds, exchange-traded funds, and other investments. Some online brokerages limit you to purchasing full shares, while others allow you to invest using fractional shares. Fractional share investing means you can purchase just a part of a share in a stock, such as one with a price that is otherwise out of your range.

When purchasing individual stocks, mutual funds, bonds, or other investments, pay attention to the cost you'll pay to invest as well as the investment's historical performance. While past performance is not a certain indicator of how well a stock will do in the future, it can be a helpful guideline for making investment decisions.

The Bottom Line

Keep in mind that investing is a long-term activity. People who find success with their investments have developed a sound strategy that they still stick with even when the market swings.

Resisting the urge to react to short-term events could make all the difference in your portfolio and help you achieve your long-term goals. Remember that it's all about time in the market, not timing the market that makes for successful investing. Consult with a financial advisor to learn more and set up an investment portfolio that’s right for you.

Disclosure: This information is provided to you as a resource for informational purposes only. It is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal. This information is not intended to, and should not, form a primary basis for any investment decision that you may make. Always consult your own legal, tax, or investment advisor before making any investment, tax, estate, or financial planning considerations or decisions.