Investing 101: How the Stock Market Works

Afraid to ask simple questions about the stock market? You’re in the right place. We’ll help you out.

Everyone talks about investing in the stock market – newspapers, TV personalities, businessmen, Jim from work. And there’s a lot of opinions. Everything from ‘it’s too risky to invest!’ to ‘invest everything you have right now!’

You feel like that one kid in class who just didn’t get it, but the rest of the class did. So you never raised your hand and asked.

You’ve heard of words like ‘investing’ and ‘stock market’, but what do they actually mean? And how does the stock market work?

This article will break down these words in simple terms and explain how the stock market works.

What Does Investing Mean?

Investing is giving your money to something now in order to receive more money later. The goal is to ‘make your money work for you,’ so to speak.

When people want more money, they often work harder rather than working smarter. They work more hours at work or take on a second job. But all that work comes with a price.

They’re tired, burnt out, and miss time with their family.

This is where investing your money comes in. Ideally, once you reach middle age you have accumulated money that you can invest. This way your money works for you.

But here’s where we ask some big questions: where should you invest your money? What are the risks of investing?

These are questions we constantly ask when considering investing. There are certainly wise and unwise investments.

This is why you should thoroughly research before investing. You should also consider your circumstances and personality. Some people can afford to take riskier investments while others cannot.

There are a lot of ways to invest your money – a savings account, bonds, etc.
But what about investing in Stock?

What is Stock?

Stocks are also called ‘shares,’ which I think is an easier word to understand.

Sometimes one person owns a company, but other times multiple people own a single company.

How does a bunch of people own a single company? Who calls the shots? Who makes the most money?

Here’s what happens: the people divide the company ownership into pieces. This is what shares are, they’re pieces of ownership of a company.

The people who ‘hold’ these shares are called ‘Shareholders.’

Let’s say a company is divided into 100 shares, and Larry has 25 shares. That means Larry owns 25% of the company, and will receive 25% of the money that is given to shareholders.

Pretty cool huh?

But there’s a downside: if the company tanks, guess who loses out big time? Our friend Larry the shareholder.

Not every company has shares, but quite a few do: Apple, Facebook, Amazon, Johnson & Johnson, and more.

Now that you know what stock is, let’s explain what the stock market is.

What is the Stock Market?

First, let’s just look at the word ‘market.’ A market is a group of people who are exchanging goods. It’s possible to do this at a physical location or online.

At a physical marketplace, there are sellers at tents and buyers walking around. They’re exchanging products, monies, and services.

Now let’s combine the two: the stock market is a group of people who are buying and selling shares of companies.

Again, most of this is happening online, not in a physical location. There are over-the-counter exchanges, but most transactions happen electronically.

There are many ways to sell shares, but the most common way is through an auction process:

• A seller announces, “Hey, I own 50 shares of Google, and I want to sell them!”
• Buyer ‘A’ bids $500 a piece.
• Buyer ‘B’ bids $7000 a piece.
• The seller sells the shares to Buyer ‘B’.

The goal is to buy shares of a company that will make profits in the future. Or if you have shares of a company that you think is about to tank, sell the shares.

This why people research stocks and watch the news. They want to know when to buy and sell shares.

Sometimes ‘Stock Market’ Refers to Market Indexes

Time to introduce you to another vocabulary word – market index (the plural form can be ‘indexes’ or ‘indices’).

A market index collects information about stocks from several companies. It keeps track of the costs of stocks.

In the United States, the two most famous market indexes are:

• The Dow Jones Industrial Average (sometimes called the ‘Dow Jones’ or the ‘Dow’ or ‘DJIA’)
• The S&P 500 (Standard and Poor’s or simply ‘S&P’)

These two aren’t buying and selling stocks; they are analyzing stocks.

The Dow Jones analyzes the stock of 30 large, publicly-owned companies. The S&P analyzes the stock of 500 large, publicly-owned companies.

Then they publicly display this information.

Although these two indexes don’t see the entire marketplace, they see a good portion of it. They still see how the top companies are performing.

With these indexes, we can judge the overall stock market. Because if the top 500 companies are doing well, chances are the entire American economy is doing well.

And the opposite is true. If the top 500 companies are doing poorly, chances are the entire American economy is doing poorly.

When we want to know how the American economy is doing, we check the Dow Jones or the S&P 500.

When the news says ‘Stock Market’ it’s usually referring the Dow Jones or S&P 500.

Sometimes people say, ‘The stock market is looking good’ or ‘The stock market went down this week.’

They’re basing that information off of these two market indexes – the Dow Jones and S&P 500.

There you have it! A basic knowledge of what people are talking about when it comes to investing in the stock market.

Keep studying up, and soon you’ll be an expert.