What Is the Stock Market?: A Guide for Business OwnersBefore you start investing, make sure you understand these stock-market basics.
Many of us feel like we should know all about the stock market. After all, our phones come with stock tickers installed. The news breathlessly reports on how many points the DOW has fallen or risen. We’ve all seen pictures of emotional Wall Street traders.
But honestly, it’s surprisingly easy to get through life without knowing how the stock market actually works. It’s a complicated beast, and most of us don’t interact with it that often―unless, of course, you start investing.
So let’s get acquainted with the stock market. We’ll talk about what it is, how it works, and how it can help you make (or lose) money.
What is the stock market?
To get started, we need to define stock. Stock is basically partial ownership in a company. When you break down stock into pieces, you get shares.
Keep in mind that companies often issue many, many shares. For example, 78.8 million shares of Amazon stock makes up only 16% or so of the company.1 When we say that buying stock in a company gives you partial ownership, we mean a very small part.
In the broadest sense, the stock market refers to any place (physical or virtual) where you can buy or sell stock. This usually happens via exchanges, which are specific places for trading stock.
In the United States, the most popular stock exchanges are the New York Stock Exchange (NYSE) and Nasdaq. Note, though, that there are many exchanges throughout the world (which means there’s a global stock market in addition to the US stock market).
So when someone talks about the stock market, they’re usually talking about all the different exchanges together. But sometimes they could mean a specific stock exchange, like Nasdaq.
Before we move on, we should point out each stock exchange has specific trading hours. The NYSE, for example, trades between 9:30 a.m. and 4 p.m. on weekdays (with some exceptions for holidays). In other words, there’s no trading in the middle of the night.
How does the stock market work?
Now that you know what the stock market is, let’s talk about how it actually works.
First, a company has to decide whether it wants to sell shares on the stock market. The stock market provides a valuable way for a company to raise capital, so many large companies (like Apple, Amazon, Microsoft, and more) choose to sell stock. These are called public companies because the public can buy stock.
Not all companies choose to sell shares. These are called private companies. You can learn more in our guide to private vs. public companies.
A stock index is a fancy way of describing a measurement of the stock market’s performance. As with many measurements, a higher number means things are doing better, and a lower number means things aren’t going as well.
There are many different stock indexes out there, each using their own way of measuring how US stocks are doing. But there are a few popular ones you’ll probably hear about the most:
- DOW (Dow Jones Industrial Average), which measures only the performance of 30 big US companies
- NASDAQ Composite, which measures primarily information technology companies on the Nasdaq exchange
- S&P 500, which measures 500 big companies on the US stock market
Each of the indexes gives a partial picture of how the stock market is doing overall. People have very strong opinions about which measure is best, but you can go ask an economist if you really want to get sucked into that controversy.
Mostly, you just need to remember that higher numbers are better and that many people believe the health of each index correlates to the health of the economy overall (another controversial topic).
For example, the DOW plummeted during the stock market crash of 2008, corresponding with the Great Recession. Likewise, when the DOW began to rise in 2009, it signaled the end of the financial crisis and the beginning of economic recovery.
In other words, if the DOW stock market index is up, that’s good. If it’s down, that’s bad. That’s a major simplification, but you get the idea.
When a business decides to become a publicly traded company, it has what’s called an initial public offering, or IPO―a fancy way of saying that the public can buy stock for the first time.
Traders (like you, maybe) can then buy that stock. Of course, they may not want to hold onto that stock forever, in which case they can sell it―hopefully for a profit. These transactions are at the heart of the stock market.
When a company does well, its shares will usually sell for more money. But if things look bad for the company (like the airlines when the coronavirus crisis broke out), then share values can drop―sometimes a lot.
These changes in value will, of course, affect how often and for how much these shares get bought and sold. And that, in turn, affects the overall performance of the stock market. That performance gets measured with something called a stock index.
You may have heard the terms bull market and bear market. They provide a quick shorthand for stock market performance. In a bull market, stock prices are going up, and people are buying. In a bear market, stock prices are dropping, and people are selling.
So that’s how the stock market works on a basic level. But why do you, as a business owner, actually want to buy and sell stock? Well, as with many things, it’s all about the Benjamins.
How do you make money in the stock market?
People flock to the stock market in the hopes of making money. There are two primary ways to do this: trading and dividends.
Trading refers to buying and selling stocks. When you trade, you’re trying to sell shares for more than you paid for them. So naturally, you also want to buy cheap shares that you think will increase in value later.
As you can imagine, trading can be very, very profitable. Let’s say you buy many shares of cheap stock in a company that later explodes in popularity. The stock price will go up, and then you can then sell those shares for much, much more than you paid.
Of course, it’s not a sure thing. You might end up buying shares of a company that has a huge scandal, leading the share price to drop significantly. If you’re lucky, they may go up in value again later. But they might not, and you might have to sell them for a loss.
Put simply, stock trading is a risky investment. You might make it big, but you could lose it all.
As we said earlier, when you buy shares in a company, you’re buying a (very small) part of ownership in that company. As a result, some companies offer dividends to shareholders, or a share of company profits.
Not all companies offer dividends to stockholders, so you’ll want to do your research if you plan on a dividend-based strategy.
And even if a company does offer dividends, those dividends will be based on company performance. If the company is on the verge of bankruptcy, you shouldn’t expect to get anything.
Generally, dividends come from preferred stock, which doesn’t give shareholders any voting rights in the company. Common stock does give voting rights, but you’re less likely to get a dividend.
Some traders will focus on holding onto stocks to earn money from dividends, while others will insist that rapid-fire trading is the best way to make money. Ultimately, of course, you’ll have to decide on an investment strategy for yourself.
What else can you trade on the stock market?
Despite the name, the stock market is also home to other types of trading. For example, exchange traded funds (ETFs), options, mutual funds, bonds, futures, and more all get traded on the exchanges that make up the stock market.
As with all things stock market, these types of securities can get pretty complicated. But here’s a quick rundown.
Bonds are a fixed income security, which means they give you a fixed return on a specified timeline. They can be issued by the government or by corporations.
Thanks to their fixed nature, bonds are often considered less risky than stocks. That said, they also don’t offer as large of a potential profit.
You can trade currencies via Forex, or the foreign exchange market. You’re basically trading one currency against another, like US dollars against Euros. Thanks to fluctuating exchange rates, you can try to strategically buy one currency and sell another to make a profit.
The Forex financial market has much longer trading hours than the US stock market does, since it has to accommodate many more time zones.
ETFs (exchange traded funds) are made up of a number of stocks and other securities (like bonds). They’re designed to mimic a specific stock market index, which means they offer more diversity than an individual stock.
Futures, also called futures contracts, are an agreement to buy or sell something (such as oil, corn, wheat, etc.) at a specified date and price.
Investors generally don’t actually want the specified asset, and they never intend to take possession of it―instead, they’re trying to predict future prices for that asset and sell the future contract at a profit.
A mutual fund is kind of like an ETF, in that it’s made up of stock, bonds, and more. But unlike ETFs, mutual funds use pooled money from many investors (hence the mutual in the name) to buy these assets.
Mutual funds are usually professionally managed, which means someone else (not you) is in control of buying and selling assets to make a profit. Investors then get a proportional piece of that profit.
Options are a type of contract that gives you the opportunity (or option―get it?) to buy or sell an asset (often a particular stock). Like futures, they have a specified date and price. But unlike futures, you don’t have to choose to buy or sell. You simply get the option of doing so.
FAQs about the stock market
How do I invest in stocks?
Generally speaking, you’ll use a stock broker, also called a brokerage to make these transactions. Stock brokerages offer platforms that make it easy to do your trading. In exchange, they often charge commission fees or other trading fees.
Our guide to investing in stocks explains more.
What are the best stock brokers?
You can find the right stock broker for your business in our guide to the best online stock brokers.
Spoiler: our favorite brokerage overall is TD Ameritrade. It’s got competitive pricing, a robust trading platform, and lots of educational information
Is investing a good idea for businesses?
Investing in the stock market isn’t necessarily the best idea for many small businesses.
To explain why, let’s talk about individual investing for a second. Part of the reason individuals invest is because of inflation. If you just keep your money in a bank account long term, you’ll end up essentially losing money because inflation will rise and the value of your money will drop. Even average stock market returns usually beat the inflation rate. In other words, individual investing can help you keep your value. And hey, you might end up making more money.
Part of the reason investing works well for individuals, though, is because they don’t have many other ways to make their money grow (or simply not deflate). Sure, you could use it to get more education, thereby increasing your earning potential. But most people, if they don’t invest, will just have money sitting in a bank account. So generally speaking, investing offers the best returns.
Businesses, though, have tons of things they can do with their money to increase their profitability. They can market their businesses more to get more customers. They can hire more employees to increase productivity. They can expand their locations to allow for more customers. They can buy more inventory―and so on. There’s a reason most businesses don’t just let large sums of money sit in a business bank account.
In other words, the money you would put into the stock market can be better spent investing in your own business. (And that’s not even getting into the financial risk the stock market poses.)
Of course, that’s not always true. We defer to your own expertise when it comes to your business. But you should think carefully before you start spending business funds on a stock exchange.
Being an investor can pay off, but it’s not a surefire way to make money. Still, if you’re going to start trading, an understanding of the stock market will definitely help you.
Do remember that we’ve only given you only a cursory overview of how the stock market works. The financial market is very complicated and people spend years learning about it.
Still, we hope our overview helps you figure out what to do next―whether that means investing or something else.
A savings account may not have the high potential payoffs of the stock market, but it can help you make more from the money you have. Learn more in our guide to the best high-yield savings accounts.
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