The stock market is a global marketplace where investors buy and sell stocks, which are shares of publicly traded companies.
When you own stock in a company like Microsoft or PepsiCo, you own a small piece of that business. That ownership gives you a claim on its future profits and assets.
Stock prices are set in real time by supply and demand. When more investors want to buy a stock than sell it, the price rises. When more investors want to sell than buy, the price falls.
Say you buy 100 shares of a company at $50 a share. If the company grows its profits, investors can see that as a sign of its strength, and they’ll buy more stock. That demand may push the share price up to $65, and your stake has grown to $6,500 from $5,000.
But if the company expects profits to drop, the stock may not look as attractive to investors, and they’ll want to sell it. The share price could drop to $35, and your stake has now shrunk to $3,500.
That constant trading and repricing, multiplied across thousands of companies and millions of investors, is the stock market.
How Do Stock Exchanges Work?
You’ll hear “stock market” and “stock exchange” used interchangeably, but they’re different. The stock market is the overall network of individual stock exchanges.
An exchange is like a giant auction house. It matches buyers and sellers who agree to trade shares of stocks at agreed-upon prices. Those trades happen thousands of times per second.
Instead of physically going to an exchange, individual investors place their orders through a brokerage account. The brokerage then routes their order to the exchange, where the stock is bought or sold.
The two largest stock exchanges in the United States are the New York Stock Exchange and the Nasdaq.
What makes Stock Prices Move?
Three main factors determine whether a stock price goes up or down.
- Company performance: Strong profits and sales growth tend to send share prices up. Weak results and poor management tend to push them down.
- Broader economic environment: Conditions beyond a company’s control such as rising interest rates, inflation, or a recession can drag down even healthy companies as investors get more cautious.
- Investor sentiment: Expectations about the future, not just current results, are factored into a stock’s price. A company can report solid profits, but its stock can still fall if investors expected even more.
The Major Stock Market Indexes
An index tracks a particular group of stocks to follow their performance. Investors use them to get a broader picture of how the market is doing. These are the three most recognized indexes in the U.S.
S&P 500
The S&P 500 tracks 500 of the largest publicly traded U.S. companies. It’s the benchmark most investors use to judge the market as a whole because it covers about 80% of all the stocks traded in the U.S., spanning a wide range of companies and sectors.
You can’t invest directly in the S&P 500, but you can buy a fund that tracks its performance. These types of index funds can be a great start for first-time investors because they provide instant diversification.
Dow Jones Industrial Average
The Dow tracks 30 large, well-established U.S. companies. It’s the oldest major U.S. index, dating back to 1896.
It may be one of the world’s most recognizable indexes, but because the Dow only covers 30 stocks, it’s a narrower and less complete gauge of the market than the S&P 500.
Nasdaq Composite
The Nasdaq Composite tracks every company listed on the Nasdaq exchange, which leans heavily toward technology and growth companies.
That focus makes it more volatile than the S&P 500, because it rises faster when tech stocks are thriving and falls harder when they’re not.
Why Should You Care About the Stock Market?
Simply put, people invest in the stock market to make money. Cash sitting in your checking account does nothing to generate income. In fact, it loses purchasing power to inflation every year, while stock ownership in profitable businesses has historically grown.
Since its launch in 1957, the S&P 500 index has returned an average of about 10% a year, according to Fidelity Investments. That’s a long-run average, however, not a promise. In some years, the S&P 500 has climbed more than 30%. In others it’s fallen around 30%.
But even though past performance never guarantees future results, staying invested over long stretches has historically smoothed out the stock market’s ups and downs.
How Do You Avoid Losing Everything?
Before you invest a single dollar, you need to be aware that any stock can fall sharply, or even go to zero.
Diversification is your main defense.Spreading money across hundreds of companies through an index fund, rather than betting on one or two stocks, means one company's collapse can’t wipe out your entire investment.
Your time horizon matters also matters. Most investors are in it for the long haul because the stock market will climb and fall from year to year, but over a decade or more, it’s historically risen.
A misconception about investing in the stock market is that it’s basically gambling. While they both involve risk, gambling is based almost entirely on chance.
When you buy a stock, however, you own a piece of a real, ongoing business with sales, employees, and assets. Over long periods, that ownership has tended to compound in value and build wealth.
