How Does the Stock Market Work?

Note: Netspend is not an investment advisor. The knowledge in this post is general information and should not replace the advice of an investment advisor. For more information, please reach out to an investment advisor in your area.


There are many ways to invest your money, from putting it into a high-interest savings account to buying real estate. One common method you'll hear top money experts talking about is investing in the stock market, but not everyone's familiar with how this financial tool can be used to build wealth over time.

While it can take years to become an experienced investor, today's tech tools, apps, and guides make it easy for even first-time investors to buy the stock they like and possibly watch it grow in value. The stock market comes with some risk, and not everyone will become rich by putting their money in stocks. In fact, some prefer to avoid it completely and invest in other financial vehicles.

However, here are the basics about stocks and how the stock market works so you can decide if it's a good investment choice for you. Please remember it's always a good idea to speak with a qualified financial advisor before putting any money you can't afford to lose into stocks or other market investments.


What is a stock?

When a company gets big enough to want to "take it public," it creates an initial public offering (IPO) to break itself up into pieces (called "shares") that it can sell to investors. These investors then become part owners of their business.

Not all companies choose to offer IPOs, but if they do, this is the first step to offering a stock that we see on the stock market. Apple (AAPL) and Amazon (AMZN) are two examples of companies that offered public shares as stocks.


What is the stock market?

Just as if you were to buy a pair of sneakers or some scented candles at the shopping mall, you can buy stocks on the stock market. This term covers all of the various stocks that brokers buy and sell during the day. It is the platform where trading (buying and selling) takes place.


What is the stock exchange?

Within the stock market are several umbrellas that house groups of stocks. You may have heard of the New York Stock Exchange (NYSE) or the Dow Jones (sometimes called "The Dow.") These are their own marketplaces that set rules for the unique group of stocks contained within their marketplaces. Together, the NYSE, Dow, and others make up the larger stock market.

Some people may use the term stock exchange and stock market interchangeably, so ask if you're not sure what they are referring to.


How does the stock market work?

While there are many things that can happen during a typical day of trading, the basics of the stock market are this:

Remember the IPOs that were initially offered to investors? These generally get resold by investors on the stock market. That's where anyone who wants to invest can buy. When you buy shares of Apple stock, you aren't actually buying from Apple; you're buying from another investor. If you already have Apple shares and you aren't interested in keeping them, you are also free to sell them, but there's a catch.

The simple goal of investing in stocks is that you want to buy them for cheaper than what you sell them for. That's what investors try to do, and while they don't always succeed, this is how people typically earn money on the stock market. Those investing in stocks for the long term might buy a stock when the company is new, and the stock isn't very valuable, then wait until the company grows and becomes very profitable. This is how some people who invested in Walmart or Amazon when they were very small now own very expensive stocks that are worth a lot of money.

This isn't typical for most stock owners, however. You can't easily predict the next Amazon and buy stocks when they are so cheap that no one notices. In fact, it can be really hard to know what a stock price will do since it depends on many factors, with supply and demand just being one of them.


What can affect stock prices?

In addition to supply and demand, the following can cause stock prices to fall across the board:

  • Inflation — If the value of the dollar goes down over time, your stock's price won't be worth as much

  • Economic difficulties — The unpredictable nature of the economy means we can't ever have full control over the market — or the value of the stocks we own

  • Performance — Not every company can be an Amazon or an Apple. Many businesses have failed to thrive or have failed completely. If you own stocks in a company that goes bankrupt or gets bought out by another company and doesn't do well, your stock value may plummet.

Here are some ways to avoid risk in the stock market:

  • Don't buy more than you can afford to lose. Since stock investing is designed to occur over a long time, it's not a good idea to put money into it that you may need right away or that you can't afford to lose in the short term. Stock prices can drop, and if you can't afford to wait until they bounce back, stock investments may not be the best way for you to invest at the moment.

  • Diversify. Most money gurus will tell you not to put all your eggs in one basket. This is the same for stocks. If you own several stocks all in healthcare technology, you are risking losing money if there's a new law passed that suddenly makes that type of technology obsolete. If you had invested in a few healthcare technologies and then put the rest in petroleum companies or agribusiness, you could see the other stocks continue to do well while your healthtech stocks suffer for a bit. By having your money in several types of stocks, you decrease the chance that all will lose value at the same time.


How to invest in stocks

There are many online marketplaces that let you invest in stocks for free or at a very low cost, but you should take the time to understand how stocks play a larger role in your financial planning. If you do invest, consider stocks to be just one way to grow your money over time, and seek out professional advice with any questions about the risk and potential rewards of the stock market.

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