Education

Stock Market

The stock market is a giant marketplace where individuals can buy and sell ownership of various companies through stocks or shares. By purchasing these stocks, you become a partial owner (shareholder) of the company, sharing in its profits and losses. Therefore, if the company performs well and its profits increase, the value of your stock might also go up, and if you decide to sell it when its value has increased, you can make a profit as the stock is at a higher price than what you initially paid.

However, it is very important to remark that the stock market can be a bit like a rollercoaster as it is subject to fluctuations influenced by various factors such as economic conditions, company performance, market speculation, and global events. This means that prices can go up and down quickly. This is why it is essential that you do your own research about the companies you want to invest in, and that you are aware of the risks involved as although stocks can offer opportunities for growth and wealth creation, they also carry the possibility of financial loss.

In simple words, the stock market is a way for regular people to become part-owners of companies they are interested in and, if things go well, make some money by investing in them. But remember, it is crucial to be patient and educate yourself as there are no guarantees for quick financial gains.

What the stock market consists of

The stock market consists of various elements, from the exchanges where transactions take place, to the assets being traded, and the key players involved. Let’s take a closer look at what makes up the stock market:

Stock exchanges: Think of these like huge stores where people buy and sell company shares. In the U.S., prominent stock exchanges include the New York Stock Exchange (NYSE) and Nasdaq.
Stocks or shares: A small portion of a company – it is like having a small ownership!
Bonds: These act as loans as you lend money to big companies or governments, and in return, they pay you back with interest.
Indexes: These are tools that measure how groups of stocks or bonds are doing, and they give an idea of how well things are going in the financial world. The three major indexes in the U.S. are the Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite.
Investors and traders: Some people buy and keep stocks for a long time (investors), while others buy and sell quickly to make money from changes in the market (traders).
Market makers: Specific entities or individuals that have the role of ensuring liquidity in the market by continuously buying and selling certain stocks. They do this by quoting both buying and selling prices for stocks. This constant presence helps ensure there is always a buyer or seller available for those particular stocks, facilitating smoother and more efficient trading.
Regulatory bodies: Also referred to as market makers, they make sure everyone plays fair and safe in the market, protecting people who buy and sell. In the U.S. the primary regulator is the Securities and Exchange Commission (SEC)
Brokerage firms: These act like the middlemen. They help you buy or sell stocks in the market and take a small fee for their service.

How The Stock Market Works

There are two main parts of the overall stock market: the primary and the secondary market.

The primary market is the starting point for companies aiming to raise their capital. This phase is known as an Initial Public Offering (IPO), and it unfolds when a company decides to sell its shares to the public for the very first time. Through an IPO, the company transitions from private ownership to becoming ‘publicly traded,’ allowing anyone from the public to become a partial owner. These stocks are sold directly from the company to the buyers.

Once the shares are sold in the primary market and owned by investors, they enter the secondary market. Here, most of the everyday trading occurs as investors buy and sell these shares among themselves. Therefore, in this phase, the company does not longer sell its shares directly, and does not receive any additional funds from these secondary market transactions as the buying and selling among investors happen independently.
The secondary market includes stock exchanges and over-the-counter (OTC) platforms. The stock exchanges are regulated and organized markets where stocks are traded under specific rules. Companies listed here adhere to exchange-set regulations, ensuring a transparent and controlled environment for investors to trade shares.
In contrast, OTC platforms operate differently. They function as decentralized markets where securities, including stocks, are traded directly between parties without a centralized exchange. These platforms, often online networks, do not rely on a central authority, and instead, decision-making processes and data verification are distributed among participants (known as nodes or peers) across the network. OTC markets usually involve smaller companies or less frequently traded securities compared to stock exchanges, offering a more flexible trading environment.

Moreover, investors in the stock market make money in two main ways. Firstly, some companies share their profits with shareholders by paying dividends, which are like bonus payments given regularly to those who own the company’s shares. Secondly, investors hope that over time, the value of their shares will increase. Just like when you buy something and its value goes up, investors buy shares expecting their price to rise.
Furthermore, investors use two different strategies for buying and selling shares. Some do what is called day trading, where they quickly buy and sell shares in a single day, aiming to make money from small price changes, while others prefer to hold onto their shares for a longer time, possibly years, believing that the company will grow and their shares will become more valuable over time.

Factors that influence prices in the stock market

Stock prices within the market operate on the principle of supply and demand – it is essentially a balance between what buyers are willing to pay (bid price) and what sellers are asking for (ask price).

Think of the stock market as a busy auction place where buyers compete to purchase shares being offered by sellers. When there is a surge in demand for a specific stock, buyers rush to acquire shares faster than sellers are putting them up for sale. This surge tends to drive the stock price upwards. Conversely, if more shares are being sold than bought, the market price decreases.

These market dynamics are categorized into bull and bear markets:

Bull market: This market trend is characterized by rising stock prices over a prolonged period, typically accompanied by increased investor confidence, a positive economic outlook, and a general sense of optimism among market participants. During a bull market, investors’ sentiment is boosted by the belief that the upward trend in prices will continue, leading to active stock purchasing and investment in various assets. In addition, this phase also aligns with economic indicators like low unemployment rates and strong corporate profits, further boosting the optimistic market sentiment.
Bear market: Contrary to the bullish market, a bear market refers to a prolonged period in financial markets where stock prices decline or are expected to fall. This market phase is characterized by decreased investor confidence, a pessimistic economic outlook, and a general sense of caution among market participants. During a bear market, stock prices trend downward over an extended period, leading to an overall market decline. Consequently, investors often exhibit a negative sentiment and might be more inclined to sell stocks and move away from riskier assets, reflecting the prevailing pessimism. Moreover, economic indicators, such as rising unemployment rates or slowing corporate profits, may align with this market trend, further deepening the pessimism and leading to the belief that the downward trend in prices will continue.

Moreover, it is worth noting that during both market trends, market makers play a crucial role as they are in charge of making sure that there is always a marketplace for stocks, aiding in liquidity and allowing investors to buy or sell shares instantly during market hours, regardless of the prevailing sentiment.

Pros and cons

Before entering the stock market, it is very important to thoroughly understand the advantages and disadvantages of investing in stocks, as although it offers the potential for financial growth, there are also inherent risks that must be carefully considered.

Pros

Historically, the stock market has delivered an average annual return of about 10%, making it an appealing avenue for long-term financial goals like retirement planning.
Experienced investors might identify chances for significant short-term gains, although market timing remains a risky strategy for most individuals.
Buying and selling stocks is relatively straightforward, particularly with fractional shares available, enabling small investors to engage with minimal funds.

Cons

The stock market does not fully guarantee positive returns, especially in the short term, as economic downturns or market crashes can lead to substantial financial losses for investors.
Stories of significant gains might tempt investors into impulsive decisions, influenced by emotions and potentially leading to adverse financial outcomes.
Gains made in the stock market are subject to taxation. Short-term gains are taxed at ordinary rates, while long-term gains face lower but still impactful capital gains tax rates.
Emotional attachment to underperforming stocks may hinder an investor’s ability to make necessary adjustments. If a stock you’ve invested in performs poorly, there’s a tendency to hold onto it, hoping it will bounce back. However, if you struggle to accept the loss and make the required adjustments, it can negatively impact your entire investment portfolio’s performance.

Stock indexes’ role in the stock market

Stock market indexes, such as the Dow Jones Industrial Average (DJIA), the S&P 500, and the NASDAQ Composite, act as tools to measure and represent the performance of the stock market. Each of these indexes focuses on different groups of companies and industries to give a sense of how the market is doing as a whole.

The Dow consists of 30 large companies, including well-known names like Apple, Microsoft, and Coca-Cola. It monitors the stock performance of these specific 30 companies to provide an indication of market trends.
The S&P 500 takes a broader approach by tracking the performance of 500 major companies across various industries in the United States. This index offers a more comprehensive view of the market compared to the DJIA because it includes a larger and more diverse set of companies.
The Nasdaq consists of over 2,500 companies, with a focus primarily on technology-related firms listed on the Nasdaq stock exchange. However, it extends beyond just the tech sector and includes companies from healthcare, consumer services, and financial industries, making it a diverse index that reflects a broader portion of the stock market.

Brokerages’ role in the stock market

Brokerages act as intermediaries in the stock market, bridging the gap between buyers and sellers of stocks. They help investors execute trades—buying and selling stocks—using various methods like phone calls, online platforms, or mobile apps, with a fee attached to each trade.

There are two primary types of brokerages:

Full-service brokerages: Offer a wide range of financial services like personalized advice, retirement planning, and investment guidance. They assign a financial advisor to help clients with their investments. Because they provide more services and advice, they charge higher fees.
Discount brokerages: These brokerages focus mainly on helping you buy and sell stocks and other investments online, but they do not offer as much personalized advice or services. Instead, they provide online tools for you to manage your investments yourself. They charge lower fees for trades since they do not provide as much guidance as full-service brokers.

How to invest in the stock market

Entering the stock market as an investor might seem daunting, but the process is more accessible than you might think. Below is a step-by-step walkthrough to help kickstart your investment journey in the stock market:

Set your investment goals: Begin by outlining your financial objectives. Whether it is saving for the future, achieving specific financial milestones, or securing your retirement, defining your goals will guide your investment decisions.
Establish a brokerage account: Choose a brokerage firm that aligns with your investment goals and preferences. Consider factors such as fees, available investment options, ease of use, and customer service quality when selecting your brokerage.
Add money to your Account: Put some money into your investment account to get started. You can even set up regular deposits, so you keep investing regularly.
Explore different investments: Explore the different investment options available through your brokerage account, like individual company stocks, bonds, or ETFs. Remember that diversifying your investments can help reduce risks.
Make your investment: Once you have your preferred investments, proceed by inputting the corresponding symbols or funds into your brokerage platform to make your purchase. Specify the number of shares or units you wish to acquire to initiate your investment.

And that’s it—you are officially an investor!

historical perspective of the stock market

The history of the U.S. stock market is a tale of highs and lows, with bear markets making a significant impact on major indexes like the Dow Jones Industrial Average (DJIA), the S&P 500, and the Nasdaq Composite.

For example, in March 2020, the market experienced a sharp decline due to the widespread impact of the COVID-19 pandemic. As a result, the S&P 500 plummeted approximately 34% from its peak earlier that year, and its downward trend was mirrored by the Nasdaq and the Dow, with the latter falling by around 37% during the same period. Nonetheless, the overall market quickly bounced back in 2020 and 2021 due to optimism about vaccines and hopes for a global economic recovery.

Another market turmoil occurred in May and June of 2022 due to the Federal Reserve increasing interest rates to control high inflation, and consequently causing the S&P 500 to enter a bear market for the first time since March 2020.

Reviewing historical data, the U.S. stock market has witnessed approximately 14 significant bear markets since 1947, with declines in the S&P 500 ranging from approximately 20% to nearly 52%. Moments like the crash of 1929 led to an approximately 89% drop in the Dow for nearly three years, marking the onset of the Great Depression. However, post-2008, central banks intervened significantly, injecting substantial funds into the financial system and maintaining historically low interest rates, with the aim of preventing a complete financial collapse, supporting economic recovery and ultimately stabilizing stock prices.

Ultimately, something that can be deduced from these events is that although bearish markets can seem worrying, in reality, they are a normal part of the market cycle, and they provide investing opportunities during economic downturns. Therefore, despite their challenges, bear markets show that growth and resilience can come after tough times.

how the stock market is regulated

The Securities and Exchange Commission (SEC) serves as the primary regulator of the U.S. stock market, established in response to the 1929 stock market crash. This regulatory body oversees various aspects of the market, including stock exchanges, brokers, financial advisors, and mutual funds. Its core mission is to protect investors’ interests, maintain fairness and efficiency in the markets, and facilitate the formation of capital. The SEC operates independently as a federal agency, separate from the government, and operates without political influence. Its responsibilities encompass ensuring that publicly traded companies provide accurate and truthful information about their businesses and guaranteeing fair treatment of investors by those involved in trading securities. Moreover, the SEC monitors stock market exchanges, imposing specific requirements such as timely financial reporting and prompt disclosure of significant corporate developments to ensure equal access to information among all market participants. Failure to comply with these regulations may lead to penalties, including trading suspension and other disciplinary actions.

stock market trading hours

The stock market in the U.S. operates from 8:00 AM to 3.00 PM CST, on weekdays, excluding public holidays. During these hours, investors can buy or sell stocks on major exchanges like the New York Stock Exchange (NYSE) and the Nasdaq Stock Market (Nasdaq).

Trading within these regular hours is typically preferred by many investors because it usually involves less risk compared to trading outside of these times. Before the market officially opens at 8:00 AM, there is a pre-market session where trading occurs, but it tends to be more volatile. This volatility often leads to wider differences between the price buyers are willing to pay and the price sellers are asking for, which can affect stock prices. When investors trade during the standard hours, their transactions contribute to the overall supply and demand for specific stocks. This buying and selling activity during these hours can have an impact on the prices of those stocks, and this is why many investors choose to trade when the market is open to have a more stable and predictable environment for their transactions.

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