A Beginner’s Guide: How Does the Stock Market Work?
The advertisements are all around you. There’s all the talk of saving your money and how doing so isn’t enough to secure your financial future. It’s always being said that, while saving is good, you must combine it with investments to achieve true financial independence.
One of the things you may have observed is that there is a huge buzz around the stock market. In fact, it seems to be a hub for smart investors. You’ve probably even heard stories of people who played the stock market and managed to profit immensely.
All of this must make you want in, right? If it’s such a lucrative opportunity, what do you have to lose? The problem is that you have no idea how to get in on it. You probably know a few of the variables and concepts, but how do you put them together in a manner that can give you a chance at successfully trading stocks?
When people say value investing or earnings movers, all you probably hear is gibberish. The truth is that many of the average investors in the world are also clueless to these terms because they’re irrelevant to their immediate needs.
While there is a certain level of complexity associated with stock trading, you need not understand all of it to be a success story. What you need to understand is how the stock market flows and the basics of trading.
Choosing Your Approach
The first thing that you need to learn and accept about investment is that it is a highly personal venture. Many people who invest and trade seem to be doing the same thing, but it’s highly likely that they aren’t.
Imagine the whole process as being a bus. You may observe that two people are sitting beside each other and riding the same bus. Does it mean that they got on at the same stop? Does it mean that both persons have the same destination? It’s very likely that the two people have different intentions, but they’re just using the same vehicle to their own ends.
This is largely how stock market investing works. You need to find and settle into your own approach to it. This is what governs the actions that you take. There’s the question of how you want to approach the investment and how much of the process you want to undertake on your own.
You may elect for as hands-off an approach as possible. This is facilitated by many brokerage firms that offer management services for your investment. Of course, the actions that your investment advisor takes depend on the goals that you have set and the way you want to approach stock trading. You can think of the investor in this sense as an extension of your will.
The Stock Market Basics
Once you have decided how you want to approach your trading, it’s time to hit the pause button before you open an investment account. Your first order of business is to understand the basic puzzle pieces that make up the stock market and how each is relevant to you.
First, there is the composition of the stock market. It is made up of what are known as exchanges. An exchange is simply a place where buyers and sellers can conduct their market activities around stocks. NASDAQ is one common example of an exchange. While the exchange is a facilitator for market tasks, it also adequately tracks both the demand and the supply of the stocks that are listed on it. The price of each stock is also recorded.
The workflow of this market is different from your traditional one where you go in, select what you want, and pay for it. Physical marketplaces work this way, and so do e-commerce sites. However, the stock market doesn’t work like this.
Instead, you find a broker who represents you on the exchange. The exchanges have specific times that they operate in, and your broker must act within the prescribed windows to meet your needs.
Sometimes you may hear people expressing the state of the entire stock market. Usually, they state that the market is either up or down. While it may sound like it, they are not typically referring to the stock market in its entirety.
Instead, they are referring to what is known as a market index. Market indexes provide useful information for monitoring, since they track groups of stocks. These groupings can be based on the whole market or on various sectors within it. While these market indexes can technically only speak for the members of the stock groupings, they tend to be used to express the state of the overall market.
You can think of it in the same manner that a survey is taken to understand how people in a state feel about a policy. It’s not realistic to interview every person living in the state. Therefore, a group is created and used as a representation of the entire state.
Many investors use the information that they gather from market indexes as a map for their stock trading decisions.
The Art of Trading
If you’re investing in stocks, there are a couple of ways to go about it. The simpler route is to accumulate a variety of stocks and index funds that you retain indefinitely. This diversified portfolio tends to be recommended, as it minimizes risk and is more likely to yield consistent returns.
However, the riskier approach is the one that is used by investors who are interested in “playing” the stock market. These are the investors that take part in the trading of stocks. Instead of retaining your stocks as you would in amassing the portfolio referenced above, you would engage in routinely buying and selling various stocks. The idea is to buy and sell at the right times to maximize your returns.
Short-term market events drive these stock prices and the moves that happen surrounding them. Your intention as a routine stock trader is to buy stocks at a low cost and sell them for a profit. The frequency with which you buy and sell can vary. Some people make less than 15 trades in a month, while there are others that are making several trades each day.
Of course, all this is not a bunch of random activities. Many of the most successful investors are great information collectors, and they are very observant. There are numerous tools that can be used, and when these are combined with research, they can yield some of the best investment returns imaginable.
Bear and Bull Markets
Both animals are fearsome, but in the context of the stock market, one may be more desirable than the other, depending on your approach to investment.
Be that as it may, it is almost universally accepted that bear markets are much more unwelcome than bull markets. When a bear market is in effect, there are tumbling stock prices across the board. If you were to look across various market indexes, you would see stock prices plummeting by 20% or more.
If you were not an investor prior to 2009, then you’ve never seen a bear market in action. This is because there has been a bull market state since that time. In fact, this is the longest bull market period in the history of the stock market. However, at the time of this article in early 2020, the US may be approaching a bear market again, as it is seeing the largest dip since the last bear market.
Of course, a bull market is the opposite of a bear market, which means that there is more appreciation in stock prices across the board.
These market states tend to alternate. Therefore, a bull market is followed by a bear market and vice versa. The state of the market is typically an indication of the economic state. Bull markets happen because there is economic growth, which breeds more confident investors. A bear market is the result of the fear of investors. The fear makes them stand back, and so you are likely to see a decline in the economy.
So you may be wondering if the alternating doesn’t usually result in making a loss when bear markets come around. Your worry, in this sense, is understandable, as your growth can come to a screeching halt during a bear market phase. What you should know is that this is only a short-term problem, since bull market phases tend to be the longer of the two.
Stock Market Correction and Stock Market Crash
A stock market correction and a crash both refer to declines in the overall stock market. However, one is more impactful.
A correction is the less worrisome of the two occurrences. When a correction happens, the market drops by around 10%. The drop is smaller, and it feels more gradual.
When there is a stock market crash, the experience is completely different. As the name implies, the drop is very quick, and the amount tends to be significant. In a crash, stocks can drop across the market by numbers that are upwards of 20% in a day.
A stock market crash can breed the fear that results in a bear market, so you must be prepared for such an occurrence.
Open Your Investment Account
Now that you have a general idea of how the stock market works, the next step is for you to open your investment account. Such an account is mandatory for your investment in stocks. You can use a brokerage account if you want to be more involved in the action. If not, you can open your account via an investment advisor.
While you can use an investment institution, you also have the option of going online and using a robo-advisor.
Note that the brokerage account is less expensive, but going this route means that you need to have a better understanding of proceedings.
When you use an advisor, you can get all the benefits and drawbacks of investing in stocks without needing to get involved in individual investments.