How Do Stocks Work? The Basics of Understanding the Stock Market

Table of Contents:

  1. What Is The Stock Market?
  2. What Are Stocks?
  3. How Are Stock Prices Set?
  4. How Does Trading Work?
  5. Why Invest In Stocks?
  6. The Bottom Line

We’ve all heard that investing is a way to get ahead and offers the opportunity to retire in style.

However, if you’re new to investing, you may wonder—how does investing in stocks work? Believe us; you wouldn’t be the first.

Like any new venture, you want to learn before jumping in, and that’s especially true when it comes to money. You work hard and want to make smart decisions, so the fact that you want to learn how to understand stocks and the basics of investing already sets you ahead.

Key Takeaways:

  • Learn how the stock market works and the differences between the stock market, a stock exchange, and stock index.
  • Although there are several types of stocks, knowing just a few of them can help you begin your investing journey.
  • Knowing how to make sound investment decisions can take the stress out of investing so you can focus on your long-term goals.

What is The Stock Market?

The stock market consists of exchanges, such as the New York Stock Exchange (NYSE) and the NASDAQ, where stocks are listed. Buyers and sellers come to the stock market to buy and sell shares of stock in companies facilitated through the market.

In general, when you buy stock, you’re predicting that the stock will go up, showing a profit, and when you sell, you’re expecting the stock to fall. So, if investing sounds unpredictable, you’d be right.

The stock market fluctuates daily and is based on supply and demand. If more investors are buying the stock than selling it, the demand for that stock goes up. The great thing is, even as a small investor, you have the opportunity to buy stock in some of the biggest companies with track records that have shown profitable results over time.

You’ll need a brokerage account to get started in investing, and those are very simple to set up. These days, our phones have become the way we do everything—from searching Google for the best restaurants, to shopping at our favorite stores—and investing is no different.

Although you have a lot of options when it comes to investing, the Public app makes investing simple. How? The app provides users with the tools they need to learn, invest, and keep track of their investments right from the app on their phone.

Stock Exchanges, Stock Indexes, and the Stock Market, Explained

When it comes to investing, the most challenging part is learning the basics of the stock market and understanding the different terminologies. Although they sound similar, they mean different things.

  • Stock Exchange — An exchange is the middleman that connects buyers and sellers who want to trade stocks, bonds and other investing securities. A well-known example is the New York Stock Exchange (NYSE).
  • Stock Market — The market refers to a collection of exchanges where investors can buy and sell stocks among each other and stock is issued to buyers. It is where companies list shares of stock for sale.
  • Stock Index — An index gathers data from a variety of industries and helps investors to calculate performance. Some indexes even look at specific industries. For example, if you want to research the technology sector, you’d look at NASDAQ.

How Does the Stock Market Work?

Although there are endless movies that show a stock exchange filled with people yelling about buying and selling, today, it is all done electronically, from the comfort of wherever you are via your phone or computer.

The basics of the stock market work much like a highly regulated mall, where you have a variety of companies all selling stock in their business. Companies list their stock on what’s called an exchange, and investors buy and sell to each other through a brokerage firm.

When you hear someone referring to the stock exchange in the U.S., they’re most likely referring to the NYSE, NASDAQ, or the indexes such as the S&P 500 or the Dow Jones Industrial Average (Dow). However, there are actually 60 stock exchanges across the world.

What Are Stocks?

Stocks (aka shares or equities) are a type of financial security that investors can buy. Once an investor buys stock, they have partial ownership of that company, which means they’re eligible to earn a portion of the company’s profits. The amount that an investor is able to earn is based on the number of shares they own.

Types of Stocks

When learning the basics of the stock market, you’ll want to understand the different stocks available to you. Two primary types of stock are issued when you buy stocks: common stocks and preferred stocks.

  • Common Stocks As the name suggests, common stocks are the most popular type of stocks individual investors buy. Owning it allows you to share in the company’s profits, have voting rights and possibly earn dividends. It also has the potential for higher long-term returns but is also more volatile due to market ups and downs.
  • Preferred stocks — These types of stocks differ in terms of giving preferred stockholders special treatment when paying dividends (aka distribution of profits). They are paid before common stockholders and earn higher dividends that are fixed and guaranteed. The returns can often be lower, even over the long term, and are less volatile in day-to-day dips and spikes.

Other stocks available include a variety of different classifications and categories that include mutual funds, small-cap, mid-cap, and large-cap stocks, international and domestic stocks, growth and value stocks, as well as several others that you’ll learn about as your investing journey continues.

How Are Stock Prices Set?

When a company decides to go public, they offer an initial public offering (IPO) to sell stock in their company. When they do this, they work with investment bankers to set a primary market price. That initial price is determined by the valuation of the company and demand in the market.

After the initial offering, the stock becomes available to individual investors on the stock market, such as the New York Stock Exchange (NYSE) or the NASDAQ. This is when prices can begin to fluctuate based on what buyers are willing to pay and what sellers are willing to accept.

As we mentioned earlier, supply and demand can have a big impact on the stock market, but as a company becomes more valuable over time, stock prices can rise as well, making those stocks valuable to their stockholders.

How Does Trading Work?

When you invest, you become one of the stockholders of the company and can buy and sell stocks when you find a stock price that you think is fair. The process of buying shares of stock is pretty simple. This is what happens when you buy a stock.

  • Open a brokerage account.
  • Decide what stocks you’d like to invest in depending on your interests and budget.
  • Order through your stockbroker, or use your online brokerage account, find the stock you’d like to invest in and specify the number of shares you’d like to buy.
  • The brokerage account manager will relay your order through a stock exchange and will buy or sell your shares at the going price for that stock.
  • You will see the transaction in your account.

Now that you understand how investing in stocks works and what happens when you buy a stock, you’re ready for some tips to help you start investing. These are some essential things to keep in mind.

  • Keep your emotions in check. How many times have you reacted to something on impulse only to find that you overreacted with no real cause? When you become emotional about investing, you can make poor decisions and derail your goals.

  • Choose your investments based on facts. Before choosing investments, research the background and financial stability of the company. Remember, when you buy stock in a company, you become part-owner, so doing your homework allows you to make better investment decisions.

  • Take it slow. Investing for the long-term isn’t a race, so choose investments wisely with long-term goals.

  • Diversifying your investments offers the opportunity for greater success. The most important thing you can learn about investing is to diversify. If you focus on a single company and it ends up going bankrupt, you’re done. However, owning stocks in various markets and adding other types of investments gives you a well-balanced portfolio that doesn’t rely on one company’s success, allowing you to recover from a loss more easily.

Why Invest In Stocks?

The simple answer is that owning stocks in various companies with a diversified portfolio can possibly help increase your savings over time to help you reach your financial goals. The three most beneficial elements include:

  • Building with a long-term view. History has shown us that when it comes to investing, a long-term perspective has proven more successful in allowing us to reach our financial goals. Slow and steady seems to be the winning strategy every time.
  • Protect your investments from taxes and inflation. Since we can’t escape taxes and inflation, we may as well give them a run for their money. Investing is the one way to protect your money, allowing for growth over time.
  • Increase wealth. Building a nest egg for the future requires more than a savings account. Putting compound interest to work over time can help to increase the amount of money you can save for the future.

The Bottom Line

Investing has many moving parts. When you’re just starting out, learn what you can, but don’t let all of the new information overwhelm you. Keeping things simple will get you off to a great start. Then, download the Public app to get started when you’re ready!

The above content provided and paid for by Public and is for general informational purposes only. It is not intended to constitute investment advice or any other kind of professional advice and should not be relied upon as such. Before taking action based on any such information, we encourage you to consult with the appropriate professionals. We do not endorse any third parties referenced within the article. Market and economic views are subject to change without notice and may be untimely when presented here. Do not infer or assume that any securities, sectors or markets described in this article were or will be profitable. Past performance is no guarantee of future results. There is a possibility of loss. Historical or hypothetical performance results are presented for illustrative purposes only.