What is the Stock Market?

DEFINITION

Stock markets are where buyers and sellers of stocks come together to trade shares in companies.



🤔 Understanding the stock market


Stocks are bought and sold on stock markets, which bring together buyers and sellers of publicly traded company shares. Stock markets operate kind of like auctions, where potential buyers name their highest price (“the bid”) and potential sellers name their lowest price (“the ask”). The actual price a trade is executed at is somewhere between the bid and the ask. Trades can be placed by stockbrokers, usually on behalf of portfolio managers or individual investors like you. The stock market in the US is made up of 13 exchanges, the best known are the New York Stock Exchange and Nasdaq.


EXAMPLE

Snapchat-owner Snap Inc. listed its shares publicly on the stock market with its 2016 IPO. Its shares now trade on the New York Stock Exchange with the ticker symbol “SNAP,” and they’re available to buy and sell on the stock market by everyday investors like you.


Takeaway

The world’s stock markets are complex, but are all based upon one simple concept...

Connecting stock buyers with stock sellers to trade under an agreed upon set of rules. This is the key role of every stock market, from New York to Hong Kong.


Primary functions of the stock market


The stock market is where the general public can access stocks of publicly traded companies. They function kind of like a farmers’ market, with buyers and sellers meeting in one place to exchange things. But stock markets are much more complex and regulated, with prices that can change rapidly. Here are three key activities you’ll find in a stock market:


Stock buying: Both everyday retail investors and sophisticated institutional ones can purchase shares of companies.


Stock selling: Every time a stock is bought, someone had to sell it. Stock selling and stock buying are different sides of the same transaction.


Issuance of stocks: If a company wants to raise new money, it can create new shares of itself to sell on the stock market. This is what happens during an initial public offering (an “IPO”) or a secondary public offering. After a stock is issued, it can be bought or sold freely (see those first two bullets above).


Stocks aren’t the only thing that can be bought or sold on a stock market. Other “securities,” such as exchange traded funds or mutual funds, are also traded on the stock market (some details about how they’re priced or traded differ though).


Are there risks to the stock market?


Yes. After you choose a strategy and then invest in the stock market, it’s critical to keep in mind both the short-term and long-term risks. Just as stock prices can rise, they can also fall. Sometimes by a lot. The price of a stock can drop to $0 on the stock market, losing all the money you invested. Given this risk, investors should have a thoughtful strategy in place before investing to guide their decisions.


When people say “the stock market rose,” what do they mean?


Stocks from thousands of companies are traded on stock markets. To understand what happened to stocks in general at any given time, you’ll notice people often look at the stock market indexes, such as the “Dow Jones Industrial Average” or the “S&P 500.” The S&P 500 is a weighted average of 500 of the largest publicly traded companies listed in the US by their market capitalization value. When the S&P 500 increases, you’ll hear investors generally say that “the stock market rose.” When the S&P 500 decreases, you’ll instead hear investors say “the stock market fell.”


How does the stock market work?


The primary role of the stock market is to bring buyers and sellers together to negotiate the trade of stocks. To determine the price, a stock market operates kind of like an auction.

Buyers want to pay the lowest price. Stockbrokers who want to buy (or who represent customers who want to buy) can bid a price they’re willing to pay for a stock. The highest price becomes the “Best Bid.”Sellers want to sell at the highest price. Owners of stock or their stockbrokers can show their willingness to sell by placing an ask, which is the price they’re willing to sell a stock for. The lowest price becomes the “Best Ask.”

The difference between the Best Bid and Best Ask is called the “Spread.” The two sides negotiate to meet in the middle, and the intermediary who executes the trade takes the difference as their fee.

As you follow a stock, you’ll notice the share price moves. The share price can change frequently based on the number of investors looking to buy or sell the stock and the number of trades that happen.

Stocks are traded on an individual basis through the negotiation between the bid and ask prices. Those prices can move together with stocks of other companies as economic, political, and specific news stories affect the movement of markets in general.


Who are the stock market participants?


Here are some of the key players on the stock market you should get to know:


Retail investors like you can buy or sell individual stocks through your brokerage account. When you place an order, it’s sent to exchanges where the trades are executed.


Stockbrokers are “registered representatives” who have gone through training and passed a licensing exam. They can buy and sell securities on behalf of investors. Stockbrokers work for brokerages, which can act as principals or agents in transactions, making money through markups/markdowns (as principals) or commissions (as agents) on trades. Many brokerages charge these fees to their customers who use the brokerage to place orders and execute the trade of a stock.


Portfolio managers act similarly to an owner of a restaurant — they’ll order a ton of food because they’re feeding plenty of people. Portfolio managers make large orders to buy and sell stocks because they manage relatively large stock funds, which can be owned by other investors like you. If you own shares in any type of fund (a mutual fund, retirement fund, pension fund, etc) a portfolio manager handles the bundle of the underlying stocks in the stock fund’s portfolio.


Investment bankers help companies list shares on stock exchanges and they get paid for doing it.


How do you invest in the stock market?


Individual investors like you can buy and sell stocks through brokerage accounts. Some of the largest brokerage companies by amount of customer assets as of Q1 2019 are Fidelity Investments, Charles Schwab, Wells Fargo, and TD Ameritrade. Your brokerage company is required by law to trade for you at the best price available and to clearly show you the commissions or markup/markdown they’re charging.