Learn About the Stock Market: How the Stock Market Works

The stock market refers to the numerous stock exchanges and markets where stock trading occurs, such as the New York Stock Exchange (NYSE) on Wall Street in New York or the Nasdaq exchange. Each market tracks a different number of companies with an emphasis on certain activities. (For instance, the Nasdaq exchange is where investors can buy and sell shares for various companies with a focus on scientific or technological advancements.)

The stock market is where investors buy, track, and sell stocks, and is part of the flow of both the national and global economy. Investors and stockbrokers use index markets, like the Dow Jones Industrial Average (DJIA) and the S&P 500 Index, to gauge the performances of specific stocks. The market is managed by the United States Securities and Exchange Commission (SEC), a regulatory body that aims to protect investors from financial market manipulation and ensures the security of the national banking system. With the right investment strategies, investing in the stock market can be a lucrative endeavor for market participants, earning investors profits through capital gains or dividends.

A stock is a unit representing equity in a company or corporation. Owning stock allows the holder to reap a percentage of benefits afforded by the company’s assets and profits. The price of a stock can rise and fall in price according to any external or internal factors, including investor confidence, earnings reports, and analyst downgrades. Stocks are generally publicly traded through exchanges, such as the New York Stock Exchange (NYSE) or the American Stock Exchange (AMEX).

Stocks are usually issued when a private company offers its shares to the public for the first time as part of an initial public offering (IPO). Purchase of the stock brings a company the essential capital it needs to grow and expand. If the IPO is successful, it can bring capital to the investor who purchased the stock.

Stocks turn a profit for stockholders in two ways: through dividends, or regular payments made by a company to shareholders or through capital appreciation, which is when the share price increases, allowing shareholders to sell them at a higher price. Stocks are riskier and more volatile than bonds, as trading systems are known for their volatility.

The following is an overview of how the stock market works:

• Companies make their initial offerings. A company must become publicly traded in order to be part of the stock market. To do so, a company makes its initial public offering (IPO) on the primary market (where securities are initially issued), where institutional investors (like banks or hedge funds) can purchase shares directly from the issuer. Companies issue stocks to raise money and grow as a business.
• Bank assesses their value. Initially, a bank sets the company’s value and underwrites the pricing of the individual stock, which is then sold straight to these initial investors. The more money made during an IPO, the higher the company’s equity, which means sellers can command a higher ask price (the minimum acceptable price for the stock).
• Stock circulation. The secondary market, also known as a stock exchange, is where stocks circulate between institutional investors and retail investors—non-professional traders who deal in securities like mutual funds and exchange-traded funds (ETFs)—rather than the investor and the company. It is here where a company’s value gets further divided amongst those who hold ownership.
• Stock prices fluctuate based on supply and demand. However, all markets and securities are subject to volatility, and stock prices fluctuate based on supply and demand. Occasionally, stock prices will drop around 20 percent, which indicates a bear market, or a receding economy. When stock prices jump and the value of company shares increases, it’s known as a bull market. When the supply of shares runs low, and a company is in demand, the share price increases. Too many shares in circulation with less demand causes share prices to decline.
• End of day performances. At the end of each day, an overview of the stock’s performance in the market indexes determines whether they’ve gained or lost value during trading, directly impacting the financial portfolios of owners who hold a stake in the company. The investor’s earnings generally determine how much more they can invest in the market, which can help stimulate the economy and facilitate growth.

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