The Best Way To Learn About The Stock Market – You may have heard that investing in stocks can be a great way to build wealth over time. This is definitely true. But do you really know how the stock market works? Do you know what makes the stock market different from a stock exchange or a stock index? Do you know what is stock?
If you answered no to any of these, you are not alone. Here are the basics of stock markets, stock exchanges and stock indexes.
The Best Way To Learn About The Stock Market
Before we get into the stock market, you need to understand stocks and how they work at a basic level. Here are some basic concepts that can help new investors understand how the stock market works.
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Stocks represent an ownership interest in businesses that choose to make their shares available to public investors. You may also hear stocks referred to as equity or equity securities.
A share of stock represents an ownership interest in a company. If you buy a share of Apple (AAPL -0.55%), you own a small part of the business and share in the company’s success. Rather than being owned by an individual or a private group, some companies (such as Apple) choose to “go public”. This means that anyone can become a partial owner by purchasing shares of the company’s stock.
How does the stock market work? There are entire books explaining the stock market, and there is a lot to explain in a few paragraphs. But you don’t need to dig too deep into the weeds to get a good basic understanding of the stock market. Stock exchanges facilitate the sale and purchase of shares between individual investors, institutional investors and companies.
Most stock trades take place between investors. If you want to buy shares of Microsoft (MSFT 1.17%) and hit the “Buy” button through your broker’s website, you are buying shares that another investor has decided to sell — from Microsoft itself. No. By purchasing shares of a stock, you become an investor in the company.
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Stock price is governed by supply and demand. If a lot of people want to be a part of a company, then the share price of that company goes up.
Stock prices on exchanges are governed by supply and demand, plain and simple. At any given time, there is a maximum price that one is willing to pay for a certain stock – the bid price – and a minimum price that one is willing to set for shares of another stock – the ask price. Think of stock market trading like an auction. Buyers are constantly bidding for shares that other investors are willing to sell.
If there is a lot of demand for a stock, investors will quickly buy the shares because the sellers want to get rid of them. Due to this the price may go up further. On the other hand, if more investors are selling than buying a stock, the market price will fall.
There are many catalysts that can push the market up or down. For example, stock market crash in 2022, inflationary pressures, supply chain issues, rising interest rates and inflationary fears were major reasons for the market’s poor performance in 2022. But, at the end of the day, these factors resulted in more investors selling than buying stocks, which is why we saw stock prices generally decline.
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Taking this a step further, it is important to consider how it is almost always possible to buy or sell a stock you own. This is where market makers come in.
A key concept when it comes to understanding the stock market is the idea of a market maker. Notably, there are not always buyers to match with sellers of a stock. However, stock trades usually happen in seconds. How can brokers buy and sell stocks instantly in your account?
Individuals known as market makers act as intermediaries between buyers and sellers. This ensures that there is always a marketplace for the stocks on the exchange. With such a liquid market, investors can choose to buy and sell shares instantly whenever they want during market hours. Here’s an overview of what investors should know about the process:
Because of market makers, you never have to wait for shares to sell at their full market value. You don’t need to wait until a buyer wants the exact number of shares you have – a market maker will buy them immediately.
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Investors should do the transaction of buying or selling stocks through a broker. In short, a broker is an entity licensed to trade stocks only on a stock exchange. A broker can be an actual person who you tell what to buy and sell. More commonly, it is an online stockbroker — say, TD Ameritrade or Fidelity — that processes the entire transaction electronically.
When someone says that “the market is up” or that a stock “beats the market”, they are usually referring to a stock index.
Often when discussing the stock market, people generalize “the market” to stock indexes. Stock indexes, such as the S&P 500 or the Dow Jones Industrial Average, represent the performance of a large group of stocks or a particular sector. They are used as a benchmark to compare the performance of individual stocks or the portfolio as a whole. For example, the S&P 500 Index U.S. Tracks the performance of the 500 largest publicly traded companies in the U.S.
Indices are a convenient way to make predictions about what is happening in the market. However, it is important to understand that the major stock indexes you see on TV and in the news are not fully representative of the entire stock market.
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Knowing the basics of how the stock market works can help you become a better investor. You will understand why your investments can be bought and sold at a moment’s notice. You’ll also understand that the market operates like an auction system, and prices are governed by supply and demand, not just underlying trading fundamentals.
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Matthew Frankel, CFP® has no position in any of the stocks mentioned. The Motley Fool has posts at Apple and Microsoft and recommends it. The Motley Fool recommends the following options: put March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.
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Calculated by time-weighted returns since 2002. Volatility profile based on a three-year calculation of the standard deviation of service investment returns.
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Invest better with The Motley Fool. Get stock recommendations, portfolio guidance and more from The Motley Fool’s premium services. Fundamental analysis (FA) measures the intrinsic value of a security by examining related economic and financial factors. Intrinsic value is the value of an investment based on the financial condition of the issuing company and current market and economic conditions.
Fundamental analysts study anything that can affect a security’s price, from macroeconomic factors such as the state of the economy and industry conditions to microeconomic factors such as the effectiveness of a company’s management.
The ultimate goal is to determine a number that an investor can compare with the security’s current price to see whether the security is undervalued or overvalued by other investors.
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Fundamental analysis is usually done from a macro to micro perspective to identify securities that are undervalued by the market.
Fundamental analysis uses publicly available financial data to evaluate the value of investments. The data is recorded on financial statements such as quarterly and annual reports and filings such as 10-Q (quarterly) or 10-K (annual). The 8-K is also informational because public companies must file it any time a reportable event occurs, such as an acquisition or a change in upper-level management.
Most public—and many private—companies list annual reports on the investor relations sections of their websites, highlighting financial decisions made and results achieved throughout the year.
For example, you can perform a fundamental analysis of a bond’s value by looking at economic factors such as interest rates and the overall state of the economy. Then, you’ll evaluate the bond market and use financial data from similar bond issuers. Finally, you will analyze financial data from the issuing company, including external factors such as possible changes in its credit rating. you can also read through