Many people call the stock market the greatest wealth-creating mechanism of all time. Millionaires often credit stock market investing as the key to their wealth.
Despite the fact that the Standard & Poor’s (S&P) 500 has seen an average annual return of 9.5 percent since 1978, and the Dow Jones Industrial Average has seen a return of 10.3 percent since 1979, according to the New York Stock Exchange, there’s no guarantee of positive future returns. That’s why being informed before you start is essential.
For those who are intimidated by investing, we’re starting a series for you: Stock Market for Beginners. We’re beginning with the basics, cutting through jargon and misleading advice — and subreddits — to explain what the stock market is and how to start investing in it.
What Is the Stock Market?
Perhaps you first picture a chart like the one shown here:
Or maybe you envision the famous charging bull, its nemesis the bear, or the most recently added Fearless Girl statue on Wall Street:
Some people picture a screen with countless numbers, percentages, and lines all over it:
As a kid, I pictured people screaming at one another while looking at huge screens on the floor of the New York Stock Exchange.
You probably thought to yourself, “The stock market is where investors sell stocks and bonds.” That’s what I thought, too.
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Now, I have a degree in economics and a decade of investing experience. Still, that was my first stab at a definition, one that Hollywood and the media love to exalt. And in truth, before technology took a front seat, most trading was done in the trading pit, person to person.
Most of us hear a lot of Wall Street jargon, but we can’t pinpoint a definition of the stock market. Some of us associate it with popular indexes like the Dow Jones Industrial Average or the S&P 500. For instance, you might near analysts say things like:
“The Dow is approaching a record high of 34,000.”
“The S&P 500 dipped 32 points today.”
The U.S. stock market is where individuals or institutional investors can publicly buy or sell shares, often as company stocks. Each share you buy means you own a tiny piece of a company. In addition to the indices you should know, such as the Dow Jones Industrial Average (DJIA) and the Russell 2000, there are a myriad of other assets you may purchase on the stock market.
You can trade with international companies, currencies, and commodities, too. For our purpose, let’s just stick with the idea that a market is where buyers and sellers initiate and execute trades. But it’s not a single market — rather, it’s exchanges that are scattered all over the world.
Though it’s essential you know the basics, any adult can invest if you are able to sign up for an investment account, which generally requires you to be at least 18 and to provide your government-issued ID and Social Security number. We mention this so you don’t feel investing is unattainable for you. We all start somewhere.
The stock market is for buying and selling stocks, or ownerships in companies, much the same way other things are sold.
And just like with supply and demand with any market, the same is true for the stock market. A buyer will place an order — or a “bid” for a stock if they believe it is good value or will appreciate over time. A seller can offer their shares for sale — or an “ask” if they would like to sell at a certain price.
Just as in any other market, stocks can become overpriced in the eyes of a consumer, so they decide not to buy a certain stock, or television, or swanky dress shirt. The same principles are at play.
In reality, neither the DJIA nor the S&P 500 is the stock market. These are indexes; they measure the value of a certain set of stocks.
The DJIA represents a price-weighted average of 30 of some of the most commonly traded stocks on the market. The 30 stocks are chosen from among the most prominent U.S. stocks. Changes to the makeup of the index are rare. The DJIA is a widely used barometer for the health of the market.
The S&P 500, on the other hand, is an index containing 500 of the largest publicly traded companies on the market, each selected for inclusion by the U.S. Index Committee, which meets on a monthly basis.
Pundits and commentators use the indexes’ upward and downward movements to indicate the current status of the stock market. However, the indexes themselves are mere slices of a larger pie.
Changes in the Stock Market
Investors and commentators know to expect small changes in the stock market day in and day out. Most investors focus on trends that last weeks, months, or years.
A bull market, for instance, is “a time when stock prices are rising and market sentiment is optimistic. Generally, a bull market occurs when there is a rise of 20 percent or more in a broad market index over at least a two-month period,” according to the Securities and Exchange Commission (SEC).
On the other hand, bear markets refer to “a time when stock prices are declining and market sentiment is pessimistic. Generally, a bear market occurs when a broad market index falls by 20 percent or more over at least a two-month period,” according to the same source.
Most people will associate bull markets with excitement over buying and holding equities. Bear markets can make us cringe, but they are a normal part of market volatility. Investors see their portfolios lose value, and they often sell, much to the detriment of their long-term wealth.
Remember a paper loss is not the same as a realized loss.
If you experience a paper loss, you still have time to recover. A realized loss, on the other hand, will not have the same potential for recovery, since it’s already sold. If you think you are selling due to emotion, try to wait a few days to see if you still believe it’s the right move.
In essence, the stock market is driven by two emotions: greed and fear.
It’s not possible to time the market, though more and more people day-trade at their own risk. You can’t predict what the market will do in the short term. You can’t say for sure it will go up, nor can you say for sure it will go down.
Markets do not go up every year, but typically trend up across time, and counting on that is how smart investors make money. They buy quality stocks and hold them for the long term, patiently waiting for the value to move upward over time.
Today’s stock market is an emergent phenomenon that arises from countless financial interactions each millisecond. Corporations raise money by issuing stocks or bonds for sale on an exchange. Similarly, governments may issue bonds to raise capital. People and institutions then buy and sell these securities on exchanges for their own benefit.
Economists often say that the financial markets grease the wheels of the modern economy. Without the stock market (and investor money), corporations and governments wouldn’t be able to take on as many large-scale initiatives.
“One way to view the relationship between the stock market and the economy is if the two were connected with a rubber band,” says Dennis J. O’Keefe, a certified financial planner. “The economy is the larger object and moves as it will. The market can pull further away in one direction or another, but will always be pulled back to balance.”
Nobody — not even a government — can control the stock market’s performance.
You make your own investing decisions, but your decisions have a tiny influence on the whole market. In fact, you could even argue that each decision influences the whole world.
After all, the stock market allows corporations to receive money by issuing shares of ownership. It allows corporations and governments to raise money through bonds. It greases the wheels of the global market, and the global market — with all its charms and faults — couldn’t exist without it.
The Bottom Line
Yes, the stock market is big and if you want to take a deep dive it can get complex. But don’t let that scare you away from investing in it. For most of us, investing is something we do at first through a workplace 401(k) plan that may offer investing options, or perhaps a college 529 savings plan.
Whatever the case, you don’t need to have a master’s degree in finance to start. You don’t need to understand every financial nuance to make a profit.
You do need to understand what you’re buying, the basic fundamentals and fees, and decide your time horizon (do you have five years until retirement or 30?) — and based on that how comfortable you are with risk. Once you have those basic concepts out of the way, which any online investing app or stockbroker will ask, you are on your way.
In this series, we explain financial products that beginners can use and understand to start their investing journey. We recognize that all financial products have their place, but most people start with the basics. Thankfully, it’s never been easier for beginners to invest in the markets.
In the United States, the SEC regulates stock market activity. It sets the rules and aims to protect investors. It wants to promote fair, transparent, and orderly capital formation through market activities.
Movies like Flash Boys and The Big Short would have you believe that the stock market is “rigged” against the little guy. However, today, you can invest money in excellent companies at low cost. The stock market isn’t a “rich boys” club. It’s an investment tool for people like you and me.
The Next Installments of Stock Market for Beginners
The upcoming installments of our six-part series on investing for beginners cover the following topics:
- Stock Market for Beginners: Should I Invest in the Stock Market?
- Stock Market for Beginners: Do I Need a Financial Adviser? Tips for New Investors
- Stock Market for Beginners: Strategic Investment vs. Gambling
- Stock Market for Beginners: Investing Tips
- Stock Market for Beginners: How to Start Investing in Stocks for Beginners
To read the next piece, Should I Invest in the Stock Market?, click here.
Past performance is not a predictor of future results. Individual investment results may vary. All investing involves risk of loss.