Though the stock market has been around for more than 400 years, there is still quite a bit of misunderstanding and mystery surrounding what it actually is, especially for new or novice investors. In the early 1600s, countries like Great Britain and Holland needed a way to make their bank accounts larger to progress as industrialized countries. The powers that be looked for companies that were doing well and made them a deal to trade them some money in exchange for a small part of their profits. To say that it went well is an understatement.
As a result of this financial success, regular people wanted to be involved. The idea caught on and Dutch companies began issuing shares on pieces of paper called stocks. People met in a central location, like an actual market, to swap their paper stocks. These meetings were the original stock exchanges and the origin of what we now know to be the stock market.
In the developed world, major stock markets emerged in the 19th and 20th centuries. All of the world’s major economic powers have highly-developed stock markets that are still active today. Today, practically every country in the world has its own stock market.
Even though it was borne of a very simple concept, to buy, sell, and trade pieces of a company, the stock market can be confusing and complex in theory and practice. And not surprisingly, there are some commonly held myths about the stock market that are important to debunk.
Myth: The stock market is the economy.
Fact: The stock market is not the economy.
Although the stock market and the economy do mostly move in the same general direction over the long run, they are two different things entirely. The stock market is where investors connect to buy and sell investments—most commonly, stocks, which are shares of ownership in a public company. The economy is the relationship between production and consumption activities that determine how resources are allocated. The production of goods and services is used to fulfill the needs of the people who are consuming them.
Myth: What goes up must come down.
Fact: Theoretically and historically, yes; but it’s not that simple.
Between every market drop and rebound, there are levels of growth and decline—it’s very rarely dramatic drops and rises. Instead, there are recognizable patterns and trends that we’ve been able to identify as part of those highs and lows. They are the following: Accumulation, Markup, Distribution, and Downtrend.
- The Accumulation phase occurs after the market has bottomed and the innovators and early adopters begin to buy, figuring the worst is over.
- The Markup phase occurs when the market has been stable for a while and moves higher in price.
- The Distribution phase begins when sellers begin to dominate as the stock reaches its peak.
- A Downtrend occurs when stock prices are tumbling down.
Myth: Investing in the stock market is like gambling.
Fact: Investing inherently differs from gambling because of intention and practice.
Buying a stock means that you are buying a piece of a company and are entitled to significant rights as an owner. You can later sell that stock, and you may or may not make money compared to when you purchased it.
Gambling is giving someone money for no other reason than the chance to get more money back. There is nothing more attached and you own nothing.
Intentionally, they are different because of the ownership. The outcome could be positive or negative for both, but only with stock purchases is there the guarantee of ownership for as long as you own stock.
In practice, you could “play” the market like you play gambling games. This speculative type of investing is akin to gambling in that here is very little at play besides the hopes of making a quick buck. When you make stock purchases and flip them by selling them off quickly, this is known as day trading.
It’s a challenge to turn a profit through day trading, and although every day trader believes they can make money, most people who attempt day trading end up with a net loss.
One reason that day traders might lose money is the lack of a solid strategy. Just looking at a chart of historical stock price data is not an effective way to create a successful plan. If you develop a strong strategy, it can be used in any market condition.
Myth: The stock market is only for the ultra-wealthy.
Fact: The market is shifting to be more inclusive than ever.
Historically, the stock market has had the perception of being a closed-door affair, open only for brokers and people in-the-know. Almost 90% of stocks are owned by 10% of the people in the U.S. Seem unbelievable? What makes that more difficult to understand is that a large majority of that remaining 90% of people own stock through a 401k offered by their employer. So, despite the fact that almost half of all households own stock shares either directly or indirectly through mutual funds, trusts, or various pension accounts, the richest control the value of the vast majority of stock purchasing and shareholder power in the U.S.
Free investing apps like Public are breaking down these doors and making the market available to more people, regardless of their status. These companies allow more access by doing away with minimums, dropping commission fees to zero, and offering the ability to buy fractional shares, so you can own a piece of a company you love with any amount of money.
Fractional shares can definitely work to your advantage. If you want to gain exposure to (which is a fancy financial way of saying buy) a stock that is more expensive than what you have budgeted, fractional shares are a popular place to start for many investors.
Myth: The market is always going up.
Fact: The market has its ups and downs.
Since its inception, the U.S. stock market has historically returned profits to its investors. Stock market returns do vary greatly from year-to-year and rarely fall into the average range, but with that being said, over the last 100 years, the stock market’s average annual return is about 10%, before inflation is taken into account.
Myth: You can time the market.
Fact: Most professional investors say don’t bother.
Timing the market is an investment strategy where investors trade stocks based on predicted price changes. It requires that investors correctly guess when the market will go up and down, and make quickly timed and corresponding investments to turn that market movement into profit. It’s an elusive concept that more often than not just doesn’t work.
Peter Lynch, a manager of the Magellan Fund at Fidelity Investments between 1977 and 1990, has a very impressive record as an investor and mutual fund manager. While managing the Magellan Fund, it averaged an annual return of 29.2%—more than twice the return of the S&P 500 for that same period.
How did Peter Lynch achieve this remarkable feat? Was it by investing in stocks at exactly the right time and then selling them when their prices increased?
Nope. He held that the greatest returns were to be made by investing for the long-term. Peter Lynch says that holding investments for the long-term was the most effective strategy and that the price at which you bought a share was not important. How long you held it was what mattered.
The bottom line
Though it is a mysterious entity that most of us are not privy to, the “rules” surrounding the stock market are changing, fast. More people are welcome to invest without being restrained by fees and minimums. Public even makes it possible to invest in parts of a share versus one whole share of expensive stock.