Known by many as the millionaire maker, the stock market has proven that if you play your cards right, you too can be a millionaire.
You may be someone who’s interested in investing in the stock market but really are unsure of where to begin or what the stock market even is.
The financial world may seem like a far away place where only old rich white men reside but this world may be more accessible than you think.
But before you can dive right in, you need to get to know the basics. The journey of a thousand miles begins with the first step. So let’s get started.
What is the stock market?
The stock market is not a physical place but it is just like any other market where there are people selling goods and others wanting to buy those goods. In the stock market’s case, those goods are stocks, bonds, mutual funds, index funds, exchange-traded funds, and treasury bills and notes.
It is often compared to an auction house as the prices of stocks and bonds often fluctuate throughout the day based on supply and demand and the ‘whims’ of the market.
There are actually two markets – a primary market and a secondary market. The primary market is where investors buy shares (stocks) directly from the issuing institution. The secondary market is the market that we are all familiar with and is where the trading of the stocks purchased in the primary market takes place.
When we are talking about the stock market we are actually referring to the secondary market.
Stock Market Exchanges
Stock market exchanges are where the actual trading of stocks and bonds occur. Sometimes they do have physical locations, like the New York Stock Exchange, but most transactions take place online.
There are many stock exchanges around the world such as the London Stock Exchange, Shanghai Stock Exchange, and the Tokyo Stock Exchange.
The main exchanges in the US are the New York Stock Exchange (NYSE) and the National Association of Securities Dealers Automated Quotations System (NASDAQ).
Believe it or not, the stock market does close. They are only opened Monday through Friday from 9:30AM to 4:00PM.
Only certain brokers and their clients have access to and can make pre-market and after-market trades.
When companies ‘go public,’ they decide on which stock exchange to list their company.
What is a stock market index?
A stock market index is a group of selected stocks based on specific criteria that can be used to measure the performance of the stock market. Depending on the index, it may only measure a specific subset of the market.
There are a number of major indexes in the US and you may have heard them mentioned a lot in the media. They are:
- S&P 500
- Nasdaq Composite
- Dow Jones Industrial Average (DJIA)
The S&P 500
The Standard & Poor’s 500 index is an index of 500 of the largest companies in the US. Because of its composition, it represents almost 80% of the US market.
It is market capitalization weighted, meaning that the companies that are included in the index are done so on the basis of the total value of all the stock of the company. In other words, it is based the company’s total market valuation.
The S&P 500 is made up of the companies with the largest market capitalization. Large cap companies tend to be worth $10 billion or more.
The Nasdaq Composite
The Nasdaq has the public sentiment of being the technology companies’ hub. As such, it is a good indicator of the tech market.
The Nasdaq Composite Index, like the S&P is market-capitalization weighted. It even includes some companies that are not based in the US and small speculative companies.
The Dow Jones Industrial Average
DJIA is one of the oldest and most referenced indexes. It is sometimes referred to as the Dow 30 as it includes 30 of the largest companies in the US.
Unlike the S&P 500, the Dow is price-weighted and not market capitalization weighted. This means that the companies with the higher stock price will have more effect on the Dow’s movement because they have more weight.
The Dow is known for having good dividend paying, blue-chip companies.
Because these three indexes they represent a large part of the economy, they can be used to predict economic trends.
There are more indexes than just those main ones. There are even ethical and socially responsible stock market indexes such as the Dow Jones Sustainability Index and Sharia compliant indexes for Muslims.
You’ll hear about some of these every now and then.
Russell 2000
This index was created in 1984 and is comprised of the smallest small cap stocks of the Russell 3000 which represents 98% of the US market. It is used as a benchmark for small cap stocks and is said to outperform its large cap stocks by 2% every year.
MSCI World
MSCI stands for Morgan Stanley Capital International. It is a market cap weighted equity index that is made up of large and mid-cap companies from all the developed countries. It is used as a benchmark for the global world market.
Wilshire 5000
This index contains almost all of the publicly traded companies in the US and is sometimes referred to as the “total stock market index”.
What are stocks?
When companies are formed, they have the option of issuing shares or part ownership of that company to others. These shares are known as stocks.
Once you purchase a stock you become a shareholder of a company and have part ownership in that company. Owning certain stocks gives you the power to vote in matters concerning the company.
Common Stock vs. Preferred Stock
There are two different kinds of stock you can purchase when investing in the stock market: common stock and preferred stock. Common stock gives you voting rights in a company while preferred stock do not.
As a Common stock holder you are entitled to a share in the profits. This may come in the form of dividends (or regular pay outs) or through an increase in the value of the stock. You also receive voting rights.
In contrast, preferred stock owners receive fixed dividends from the company but no voting rights. Furthermore, they are required to be paid their dividends before dividends are paid out to the common stock holders.
In addition, in the event that the company goes bankrupt and all their assets are sold, preferred stock holders are higher on the food chain so they will be paid back first should there be money to do so.
Read your preferred stock purchase agreement well though as these may be callable, meaning the company can buy these back from you at any time.
Some preferred stock are callable.
Private vs. Public stocks
Public stocks are the stocks we all hear and read about in financial news and reports. These are issued by companies who have ‘gone public’ meaning they went through the process of issuing shares of their company to be sold, the Initial Public Offering (IPO).
On the other hand, private stocks are not issued to the general public but a select group of private investors and employees. The sale of these stocks must be approved by the company.
The downside to investing in these kinds of stock is that they are not very liquid and it may prove hard to sell these stocks when you want or need to.
Different Classes of Stock
All stock is not created equal. For example, some stocks have more voting rights than others. Some companies issue these different classes of stock because they want more voting power to be held by a certain group of people.
They are usually signified as Class A, Class B, or Class C stocks. Some companies may choose to allocate more voting rights to certain classes.
With Class A stock holders having the most voting power and so on. They do this to retain the voting power of founders and company executives.
Others may simply separate stock into different classes based on company divisions, stock pricing, and the amount of dividends that can be received.
If you want to know more about the other types of securities check out an article I wrote for beginners to get started investing in the stock market.
Why do stocks go up and down?
Stocks go up and down, for the most part, based on supply and demand. If many people want to buy a particular stock, the price of that stock will increase.
Likewise, if there are many people trying to sell a particular stock, that stock’s price will decrease accordingly.
However, this supply and demand free market model is a bit simplistic and does not take into account human nature. Human emotion is a major guiding hand in the price of stocks and what causes markets to crash so severely.
When people are employed, making good money and overall feeling good about the economy, they are more optimistic. This leads them to buy more and so stock prices go up. In contrast, as soon as fear starts to set in, people begin selling off their stocks and prices decrease.
All of which spurs more fear/loss aversion based selling which, if severe enough, can lead to a stock market crash.
And the media doesn't help. The news plays a huge part in influencing the population as a whole. With headlines screaming at you to buy one day and sell the next, investing can be an emotional rollercoaster, if you let it.
While it’s not set in stone, many would define a stock market crash to be when the market loses 20% or more of its value.
It is important to note though that the stock market is cyclical. So what goes up must come down and vice versa. Even if the market is down right now, know that it will eventually go back up. It always does.
A Bull Market vs. A Bear Market
To put it simply, a bull market is when the market is going up. So prices are rising, dividends are plentiful, and every one is happy.
Bull markets are accompanied with decreasing unemployment rates, company growth and expansion, increasing profits for companies, a growing GDP, and economic expansion.
In contrast, a bear market is when the market is going down. So prices are falling, dividends may be cut, and people are afraid of losing their money.
Bear markets are usually marked by rising unemployment rates, decrease in growth, and a slowing down of the economy. A stock market crash is in a bear market.
Learn about how to invest in a bear market here.
The onset of a bull market can signal an economic boom on the horizon while the start of a bear market could signal a future recession.
A bull market can last for 7 years or more whereas bear markets are, thankfully, usually only 1-3 years. Even The Great Depression only lasted about 3 years.
What is a market correction?
A correction is a drop in stock prices of about 10% but could be up to 20%. This a correction due to the fact that the stock market had been overpriced.
Therefore, it self-corrected to a fair price that better reflects the true value of the stock.
All in All
The stock market is not so complex as it may have seemed at first. Once you get to know some of the basics and some of the lingo, traversing the market will be a cake walk.
Okay, well maybe not a cake walk but definitely doable. The next step is to learn how to invest in the market.
Related Question
Is it better to invest in a bull or bear market?
I wouldn't say it is better to invest in one more than the other but there are different strategies for investing in either market. These strategies mainly depend on your risk tolerance and knowledge of advance trading techniques.
Overall, as a beginner investor, your best bet is to keep investing as you normally would in either market. Follow the plan that you set out initially and continue to dollar cost average into the market.
*DISCLAIMER: The Information provided in this post is simply the opinions of the blogger and is given in the spirit of educational fun. It is not investment advice. Please do your own research and decide what is right for you before investing in any asset. If necessary, seek the help of a certified professional in discussing your options.