Stock Market: Definition and How It Works - NerdWallet (2024)

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The stock market is where investors buy and sell shares of companies. It’s a set of exchanges where companies issue shares and other securities for trading. It also includes over-the-counter (OTC) marketplaces where investors trade securities directly with each other (rather than through an exchange).


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The stock market explained

In practice, the term "stock market" often refers to one of the major stock market indexes, such as the Dow Jones Industrial Average or the . These represent large sections of the stock market. Because it's hard to track every single company, the performance of the indexes is viewed as representative of the entire market.

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.

» Need to back up a bit? Read our explainer on stocks

How the market works

When you purchase a public company's stock, you're purchasing a small piece of that company.

The stock market works through a network of exchanges — you may have heard of the New York Stock Exchange or the Nasdaq. Companies list shares of their stock on an exchange through a process called an initial public offering, or IPO. Investors purchase those shares, which allows the company to raise money to grow its business. Investors can then buy and sell these stocks among themselves.

» Interested in IPOs? View the best brokers for investing in IPOs

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.

This all may sound complicated, but computer algorithms generally do most price-setting calculations. When buying stock, you’ll see the bid, ask, and bid-ask spread on your broker's website, but in many cases, the difference will be pennies, and won’t be of much concern for beginner and long-term investors.

» Learn more: How to invest in stocks

The stock market is regulated by the U.S. Securities and Exchange Commission, and the SEC’s mission is to “protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation."

Historically, stock trades likely took place in a physical marketplace. These days, the stock market works electronically, through the internet and online stockbrokers. 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.

» See NerdWallet's list of the best online stock brokers for beginners

What is the point of the stock market?

The point of the stock market is to provide a place where anyone can buy and sell fractional ownership in a publicly traded company. It distributes control of some of the world’s largest companies among hundreds of millions of individual investors. And the buying and selling decisions of those investors determine the value of those companies.

The market lets buyers and sellers negotiate prices. This negotiation process maximizes fairness for both parties by providing both the highest possible selling price and the lowest possible buying price at a given time. Each exchange tracks the supply and demand of stocks listed there.

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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. This process is called price discovery, and it’s fundamental to how the market works. Price discovery plays an important role in determining how new information affects the value of a company.

For example, imagine a publicly traded company that has a market capitalization (market value) of $1 billion, and trades at a share price of $20.

Now suppose that a larger company announces a deal to acquire the smaller company for $2 billion, pending regulatory approval. If the deal goes through, it would represent a doubling of the company’s value. But investors might want to prepare for the possibility of regulators blocking the deal.

If the deal seems like a sure thing, sellers might raise their asks to $40, and buyers might raise their bids to meet those asks. But if there’s a chance the deal won’t be approved, buyers might only be willing to offer bids of $30. If they’re very pessimistic about the deal’s chances, they might keep their bids at $20.

In this way, the market can determine how a complicated piece of new information — a takeover deal which might not go through — should affect the company’s market value.

What is the stock market doing today?

Investors often track the stock market's performance by looking at a broad market index like the S&P 500 or the DJIA. The chart below shows the current performance of the stock market — as measured by the S&P 500's closing price on the most recent trading day — as well as the S&P 500's historical performance since 1990.

Stock market data may be delayed up to 20 minutes, and is intended solely for informational purposes, not for trading purposes.

What is stock market volatility?

Investing in the stock market does come with risks, but with the right investment strategies, it can be done safely with minimal risk of long-term losses. Day trading, which requires rapidly buying and selling stocks based on price swings, is extremely risky. Conversely, investing in the stock market for the long-term has proven to be an excellent way to build wealth over time.

For example, the S&P 500 has a historical average annualized total return of about 10% before adjusting for inflation. However, rarely will the market provide that return on a year-to-year basis. Some years the stock market could end down significantly, others up tremendously. These large swings are due to market volatility, or periods when stock prices rise and fall unexpectedly.

If you’re actively buying and selling stocks, there’s a good chance you’ll get it wrong at some point, buying or selling at the wrong time, resulting in a loss. The key to investing safely is to stay invested — through the ups and the downs — in low-cost index funds that track the whole market, so that your returns might mirror the historical average.

Stock Market: Definition and How It Works - NerdWallet (4)

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How do you invest in the stock market?

You’ll usually buy stocks online between 9:30 AM and 4 PM ET through the stock market, which anyone can access with a brokerage account, robo-advisor or employee retirement plan.

You don’t have to officially become an “investor” to invest in the stock market — for the most part, it’s open to anyone.

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.

» Learn about options for premarket trading and after hours trading

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.

Online brokerages have made the signup process simple, and once you fund the account, you can take your time selecting the right investments for you.

» 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.

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.

» See top-rated stock brokers: The best online brokers

As an expert in finance and the stock market, my in-depth knowledge and experience in the field allow me to provide comprehensive insights into the concepts covered in the article. I have a strong background in financial markets, investment strategies, and the functioning of stock exchanges.

Let's delve into the key concepts discussed in the article:

  1. Stock Market Indexes: The article mentions major stock market indexes like the Dow Jones Industrial Average (DJIA) and the S&P 500. These indexes represent a broad section of the stock market and are used to gauge overall market performance. Investors often rely on these indexes to assess the movement of the market as a whole.

  2. How the Market Works: The article explains the process of buying and selling stocks on the stock market. It highlights the role of stock exchanges, such as the New York Stock Exchange (NYSE) and Nasdaq, where companies list their shares through initial public offerings (IPOs). Investors then trade these shares among themselves, determining stock prices through bids and asks.

  3. Bid-Ask Spread: The bid-ask spread is the difference between the highest price a buyer is willing to pay (bid) and the lowest price a seller is willing to accept (ask). This spread is a crucial concept in stock trading and represents the transaction cost. Computer algorithms often handle price-setting calculations, simplifying the process for investors.

  4. Regulation by the SEC: The U.S. Securities and Exchange Commission (SEC) regulates the stock market to ensure fair, orderly, and efficient markets. Its mission includes protecting investors and facilitating capital formation. The article emphasizes that, historically, stock trades occurred in physical marketplaces, but today, the market operates electronically through online stockbrokers.

  5. Purpose of the Stock Market: The stock market serves as a platform where individuals can buy and sell fractional ownership in publicly traded companies. It distributes control of large companies among individual investors, and the value of these companies is determined by the collective buying and selling decisions of investors. The negotiation process in the market maximizes fairness for both buyers and sellers.

  6. Price Discovery: Price discovery is a fundamental process in the stock market, where supply and demand determine the price for each security. The article provides an example of how new information, such as a takeover deal, can impact a company's market value through changes in bid and ask prices.

  7. Stock Market Performance: Investors often track market performance through indexes like the S&P 500. The article includes a chart showing the historical performance of the S&P 500. It emphasizes that stock market data may be delayed and is intended for informational purposes.

  8. Stock Market Volatility: The article discusses the risks associated with investing in the stock market, including market volatility. While day trading is considered highly risky, long-term investment in low-cost index funds is highlighted as a safer strategy to build wealth over time.

  9. Investing in the Stock Market: The article explains how individuals can invest in the stock market through brokerage accounts, robo-advisors, or employee retirement plans. It emphasizes the accessibility of the market to anyone and mentions different investment options, such as individual stocks, mutual funds, index funds, and ETFs.

In summary, my expertise allows me to provide a detailed understanding of the concepts related to the stock market, making the information accessible and actionable for both novice and experienced investors.

Stock Market: Definition and How It Works - NerdWallet (2024)


Stock Market: Definition and How It Works - NerdWallet? ›

The bottom line

What is stock market and how it works? ›

The stock market is where shares of companies and other financial instruments are bought and sold. It's a network of all-stock trading where investors and traders buy and sell stocks. These trades determine stock prices, reflecting the company's perceived value and market conditions.

How does the stock market work for dummies? ›

Stock prices on exchanges are governed by supply and demand, plain and simple. At any given time, there's a maximum price someone is willing to pay for a certain stock, known as the bid price. There's also a minimum price someone else is willing to set for the shares of stock, known as the ask price.

What is the stock market explanation for beginners? ›

The stock market refers to the collection of stocks that can be bought and sold by the general public on a variety of different exchanges. Where does stock come from? Public companies issue stock so that they can fund their businesses. Investors who think the business will prosper in the future buy those stock issues.

What is the easiest way to explain stocks? ›

Stocks are a type of security that gives stockholders a share of ownership in a company. Companies sell shares typically to gain additional money to grow the company. This is called the initial public offering (IPO). After the IPO, stockholders can resell shares on the stock market.

How do stocks work and how to make money? ›

The way you make money from stocks is by the selling them at a higher price than you bought them. For instance, if you bought a share of Apple stock at $200 and sold it when it reached $300, you would have made $100 (minus any taxes you'd have to pay on the money you made).

Do you get money from the stock market? ›

Yes, you can earn money from stocks and be awarded a lifetime of prosperity, but potential investors walk a gauntlet of economic, structural, and psychological obstacles.

Can I buy just 1 share of stock? ›

There is no minimum order limit on the purchase of a publicly-traded company's stock. Investors may consider buying fractional shares through a dividend reinvestment plan or DRIP, which don't have commissions.

How much money do I need to invest to make $1000 a month? ›

A stock portfolio focused on dividends can generate $1,000 per month or more in perpetual passive income, Mircea Iosif wrote on Medium. “For example, at a 4% dividend yield, you would need a portfolio worth $300,000.

How to learn stock market from scratch? ›

How to Learn Trading in India?
  1. Hire a broker: ...
  2. Read investment books: ...
  3. Read financial articles: ...
  4. Find a mentor: ...
  5. Study successful investors: ...
  6. Monitor and analyze the market: ...
  7. Attend seminars and take classes: ...
  8. Learn from your mistakes:
Oct 20, 2023

What is stock market example? ›

For example, if an investor buys shares of a company's stock at $10 a share and the price of the stock subsequently rises to $15 a share, the investor can then realize a 50% profit on their investment by selling their shares.

What is the difference between a share and a stock? ›

Definition: 'Stock' represents the holder's part-ownership in one or several companies, while 'share' refers to a single unit of ownership in a company. For example, if X invests in stocks, it means that X has a portfolio of shares across different companies.

What is the best stock to buy for beginners? ›

Best Stocks To Invest In 2024 For Beginners
  • UnitedHealth Group Incorporated (NYSE:UNH) Number of Hedge Fund Holders: 104. Quarterly Revenue Growth: 14.10% ...
  • JPMorgan Chase & Co. (NYSE:JPM) Number of Hedge Fund Holders: 109. ...
  • Advanced Micro Devices, Inc. (NASDAQ:AMD) ...
  • Adobe Inc. (NASDAQ:ADBE) ...
  • Salesforce, Inc. (NYSE:CRM)
Feb 7, 2024

What is the formula for picking stocks? ›

P/E Ratio – The P/E ratio is a calculation that evaluates a stocks relative performance and value. It is computed by dividing the stock's price by the company's per share earnings for the most recent four quarters.

How to make money from stock market? ›

How to make money in the stock market
  1. Earning from capital appreciation. ...
  2. Earning from dividends. ...
  3. Types of stock markets. ...
  4. Factors impacting stock price. ...
  5. Number crunching. ...
  6. Building a diversified portfolio. ...
  7. Don't try to time the market. ...
  8. Avoid herd mentality.
Nov 21, 2023

Who gets the money when I buy a stock? ›

In primary markets, when you buy shares of a company, your money goes directly to the company. However, in secondary markets, when shares are purchased, the money goes directly to the seller.

How much money do you make from the stock market? ›

The average stock market return is about 10% per year, as measured by the S&P 500 index, but that 10% average rate is reduced by inflation.

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