What Is the Stock Market?

Before You Invest in the Stock Market, Make Sure You Know What It Is

what is the stock market
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The stock market is where you can buy, sell, and trade stocks any business day. It's also called a stock exchange. 

Stocks allow you to own a share of a public corporation. The stock price is based on the corporation's earnings. If the company does well, or even if everyone thinks the company is going to do well, the stock price goes up. Stocks also rise when the economy does well. Many companies also give a dividend payment each year to the stockholders, which provides extra value.

Why Companies Sell Stocks

Companies sell stocks to get the funds to grow larger. When people want to start a business, they often pay for it with personal loans or even their credit cards. Once they grow the company enough, they can get bank loans. They can also sell bonds to individual investors.

Eventually, they'll need a lot of money to take the business to the next phase. At that time, they will sell the first stocks, called an initial public offering. Once that happens, no single person owns the company because they have sold it to the stockholders. Since the U.S. stock market is so sophisticated, it is easier in this country than in many others to take a company public. It helps the economy expand since it provides a boost up to companies wishing to grow very large.

The need for companies to raise money, and investors to profit from them, is what keeps the stock market going.

Why Invest in the Stock Market

Stock market investing is the best way to achieve returns that beat inflation over time. There are four other benefits of investing.

  1. Stock ownership takes advantage of a growing economy.
  2. Unlike real estate, it's easy to buy stocks and just as easy to sell.
  3. Best of all, you can make money in two ways. Some investors prefer to let their stock appreciate in value over time.
  4. Others prefer stocks that pay dividends to provide a steady income stream.

There are seven ways for you to invest in the stock market. The quickest and least expensive is to buy them online. If you need more guidance at a reasonable price, join an investment club. A full-service broker will cost more but could be worth the price. He or she will give you professional recommendations. A money manager charges the most but will do all the work for you.

Instead of buying individual stocks, you could buy them as part of an index fund or mutual fund. An index fund follows an index, such as the MSCI emerging market index. A mutual fund has a manager that buys the stocks for you. The riskiest is a hedge fund. They also invest in derivatives, which could increase the return but will also increase the risk.

Investing Risks

The most significant downside is that you can lose your entire investment if the stock price falls to zero. If the company goes bankrupt, stock investors are paid after bondholders. For that reason, stock investing can be an emotional rollercoaster. If you need guaranteed returns, stick to bonds. But if you are in it for the long-term, stocks are a better way to go.

When stock market prices decline less than 10%, that's known as a stock market correction. When prices fall that much or more in one day, it's known as a stock market crash. When prices fall 20% or more, it's known as a bear market. These usually last 18 months. The opposite is a bull market, and they last two to five years. 

The U.S. Stock Market Is the World's Financial Capital

The United States is the location of the two largest exchanges in the world. The New York Stock Exchange lists 2,400 companies. They're worth around $21 trillion in market capitalization. That's the value of all its shares. The NYSE is located on Wall Street. The Nasdaq has 3,800 companies with a market cap of $11 trillion. It's located in Times Square. Both are in Manhattan, New York.

The stock market works by matching buyers and sellers. The two major exchanges do it differently from each other. The NYSE is a true auction house. It matches the highest bid for the lowest sales price. There is a market maker for each stock who will fill in the gap to make sure trades go smoothly. At the Nasdaq, buyers and sellers trade with a dealer instead of each other. It's done electronically, so trades happen in split seconds.

The United States is the world's financial capital because its financial markets are so sophisticated. As a result, information on companies is easy to obtain. This transparency increases the trust of investors from around the world. As a result, the U.S. stock market attracts more investors. That makes it even easier for a U.S. company to go public.

The performance of the general U.S. stock market is tracked by its three principal indices: the Dow Jones Industrial Average, the S&P 500, and the Nasdaq. Different components of the markets are also followed. For example, the MSCI Index tracks the performance of stocks in emerging market countries such as China, India, and Brazil.

Major World Stock Markets

Every major country has a stock exchange. Here are the top 10, ranked by total market capitalization. They are listed with the most quoted indices that are closest to measuring their performances:

  1. New York Stock Exchange - NYSE
  2. Nasdaq - The exchange also has an index by the same name.
  3. Tokyo Stock Exchange - Nikkei 225.
  4. London Stock Exchange - FTSE 100
  5. Euronext - Euronext 100. Other European indices are the AEX (Amsterdam), BEL (Brussels), CAC (Paris), DAX (Germany), and PSI (Lisbon).
  6. Shanghai Stock Exchange - Shanghai Stock Exchange
  7. Hong Kong Stock Exchange - Hang Seng.
  8. Toronto Stock Exchange - SPTSX.
  9. Bombay Stock Exchange - SENSEX.
  10. National Stock Exchange of India - NSE Nifty.
  11. BM&F Bovespa (Brazil) - The index is also called BOVESPA. 

Other Financial Markets

The stock market is just one type of financial market. Before you invest, make sure you are familiar with them all:

  • Commodities are usually traded in futures options, which makes them more complicated. They include grains, oil, and the strangely-named pork bellies.
  • Foreign exchange is where people buy and sell currencies. It's a very high risk because the values can change dramatically for no apparent reason very quickly.
  • Derivatives are very complicated securities that derive their value from the underlying asset, such as subprime mortgages. Individual investors should stay away. Even though they can offer huge returns, they can also deplete your entire life savings in a day.