Last Updated on September 2, 2022 by Daniel Cardoba
The stock market is the primary place where you can buy or sell a share of ownership for almost every company in the world.
As such, understanding what’s going on in the stock market is critical to your investing success. In this article, we’ll explain everything from what the stock market is to how it works.
What Is Stock Market?
A stock (or equity) is a piece of ownership in a company. If you own 100 shares of XYZ Corporation, you’re a part-owner of the company. When you buy/sell a stock, you’re actually buying/selling part of the company, i.e., 1% of the total shares outstanding.
You can think of it like this: a person has 100 shares of stock in a business but only owns 1%. So when you buy/sell a stock, you become one of the owners of the business. This means that when you buy stock, you get “shares” of the business – and in some cases, you get a portion of the profits and losses of the business.
Stock market refers to how this process happens and how you can participate in it as a business owner.
The Basics Of Stock Market
How does the stock market work? Let’s look at some basic information about it below:
a) Shares are bought and sold in public markets through brokers. Brokers are financial institutions that act as intermediaries between the buyers and sellers of stocks.
b) A broker buys shares from a buyer and sells them to a seller. They charge a commission for their services.
c) A stock exchange also provides other services such as clearing houses for transactions, data collection, etc.
d) There are two types of exchanges: over-the-counter (OTC) and listed. OTC is the older form, while public listing is more common now. These days, there are hundreds of exchanges around the world.
e) To list a stock, it needs to be approved by regulators. Once it gets approval, the company will then issue new shares and begin trading.
f) On the other hand, to delist a stock, the company may give its shareholders the option to convert their shares into cash. This would mean selling or giving away all the shares.
g) The price of a stock change constantly throughout the day. If the price increases during the day, the value of your investment increases. It decreases if the price falls
h) You can use technical analysis tools to predict future movements of prices. For example, you can plot the price history of the stock on a chart and see if it makes a trend line.
i) Buying and selling is done through a broker. Your brokerage account acts as the intermediary and manages your investments.
j) Many investors choose to invest in index funds, which track the performance of a certain benchmark. Index funds are cheaper than actively managed funds because they have lower fees.
How Can I Make Money With Stock Market?
There are several ways to profit in the stock market. The simple logic of stock market trading is like this:
a) Buy low and sell high.
b) You need to be able to identify bullish and bearish trends
c) You need to time the market.
Let’s discuss each of the above steps in detail:
a) Buy low and sell high. Investing in a strong company with a good growth rate is important. However, the most important thing is that you should not buy a weak company just because it seems cheap. Instead, wait until the company has shown promising improvements. Remember that the stock market is all about predicting future performance and not really about their current performance.
b) Bullish and bearish trends. Trend following involves identifying whether the market is trending up or down. To minimize your risk, you might not want to trade against the current trend. For example, if the current trend is bullish, you might not want to open short positions, but you want to wait until there is some market correction from the recent bullish pattern.
c) Timing the market. Timing the market means trying to figure out when the next big move is coming.
Timing the market can be tricky since it relies heavily on technical analysis. Technical analysis uses charts to identify trends.
Why Does The Stock Market Become An Important Part Of Our Economy?
We’ve talked a lot about the stock market, but let’s talk about how the current economy behaves around the stock market. To understand this, we need to understand what the economy is and how it functions.
The US economy is considered the largest in the world. It includes companies involved in manufacturing, services, agriculture, transportation, construction, banking, insurance, retail, etc.
As such, the stock market becomes important because it helps create jobs, pays wages, provides benefits to employees, and allows businesses to grow. In short, the stock market is the lifeblood of the American economy.
As a result, many modern new companies actually rely on their stock price to make money. In a way, they remind me of cryptocurrencies, where their actual money-making method is dependent on dumping their own stock on retail traders.
That’s why during the 2022’s bear market, many smaller companies struggled to survive since they don’t have an actual income source, and their prices crash on the stock market.
It’s widely believed that the recent market rebound in the stock market will not last, and we might get a new low by the 4th quarter of this year. If this is the case, many smaller companies that rely on their stock price might not be able to continue operating and pay their employees.
At the end of the day, stock market is still more about speculation than fundamentals. Even when it comes to trading high-cap stock, you shouldn’t look at the current performance. Stock trading is all about “what this company might do 6-12 months from now”.
If you believe company XYZ is promising and will do great in 1-2 years to come, that’s where you invest. You shouldn’t invest in companies if you believe their performance has peaked.
Investopedia has some good resources to learn more in-depth about stock trading, check it here.