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What Is the Stock Market and How Does It Work?

Investors buy and sell stock and other investments through the stock market.
Oct. 30, 2018
Investing, Investments
What Is the Stock Market
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The stock market is where investors connect to buy and sell financial investments — most commonly, stocks, which are shares of ownership in a company.

The term “stock market” often refers to one of the major stock market indexes — such as the Dow Jones Industrial Average or the S&P 500. Because it is hard to track every single stock, these indexes include a section of the stock market and their performance is viewed as representative of the entire market.

What is the stock market?

The stock market is made up of exchanges — you may have heard of the New York Stock Exchange or the Nasdaq. Companies list shares of their stock on an exchange — often to raise money to grow their business — and investors purchase those shares. Investors 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.

How does the stock market work?

While stock trading has many complexities, 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.

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.

» Learn more about how to invest in stocks

Historically, stock trades likely took place in a physical marketplace. These days, they happen electronically, through the internet and an online stockbroker. 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.

You might see a news headline that says the stock market has moved lower, or that the stock market closed up or down for the day. Most often, this means stock market indexes have moved up or down, meaning the stocks within the index have either gained or lost value as a whole. Investors who buy and sell stocks hope to turn a profit through this movement in stock prices.

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.

» No brokerage account? Learn how to open one

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.

Looking for a broker? Here are our top picks for beginner investors:

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» See more top-rated stock brokers: The best online brokers for beginners

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