Stock Market Basics Everyone Should Know
I f you aren’t all that familiar with the stock market and how it works, it’s a good idea to get acquainted with the basics before you begin to invest in it. There are several components that you should spend time exploring, including what exactly it is and how it works. Explore some stock market basics, and learn some important terms to get started trading and investing.
What Is the Stock Market?
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The stock market is a broad term that is used to describe a group of exchanges and markets where traders and investors can regularly buy, sell, or issue shares of publicly held organizations. There can be several stock markets or stock-trading venues within one region or country that enable stock and other security transactions. All financial activities conducted within a formal marketplace or exchange are done so under clearly defined regulations that can vary from market to market.
It’s important to differentiate the terms stock market and stock exchange. While these terms are often used interchangeably, a stock exchange is typically a subgroup of a larger stock market. So, when someone says that they trade in the stock market, what they mean is that they sell and buy stocks, shares, or other financial vehicles from a stock exchange that is grouped within the overall stock market for their particular region or country.
The most popular stock exchanges in the United States are Nasdaq, the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX), and the Chicago Board Options Exchange (CBOE). Other leading stock exchanges throughout the world include the London Stock Exchange, the Toronto Stock Exchange, the Shanghai Stock Exchange, and the Tokyo Stock Exchange.
What Causes Stock Prices to Rise and Fall?
Understanding what causes stock prices to rise and fall is one of the necessary basics when investing in the stock market. Several factors influence stock prices, with the most prevalent forces being:
- Fundamental factors: Fundamental factors take into account two primary elements: valuation multiples and an earnings base. Items that contribute to how fundamental factors affect a stock’s price include how much growth is expected in the earnings base, the level of the earnings base, how much of a risk is anticipated, and any perceived discount rates.
- Inflation: Inflation can significantly impact the price of stocks. Deflation (when the cost of services and goods is decreasing) will often have a significant inverse correlation with stock values, while high inflation will often have a negative impact on stock prices as it results in a loss of pricing power for organizations.
- Trends: Many stock prices will move as a direct result of short-term trends. Stocks that move up following a trend are considered to be gaining momentum, while stocks moving down based on a trend are considered to be losing momentum or ‘reverting to the mean.’
- Supply and demand: A basic force behind the rise and fall of stocks is supply and demand. When more people want to purchase a particular stock, that stock’s value will rise in price. However, when traders lose interest in the stock and more people are selling the stock than buying it, the stock will typically decrease in price.
Other factors that influence a stock’s value include the media, natural disasters, the opinions of trusted investors, and political circumstances.
Bull Market vs. Bear Market
There are two different conditions that a financial market can be in, and these conditions are characterized as bull and bear markets.
A bull market is a condition in which stock market prices are rising or are anticipated to rise. While there isn’t a specific definition used to identify a bullish market, a common characterization used among traders to denote a bull market is when stock prices increase by 20%. This stock price increase typically happens after stock prices have dropped by 20% and before another 20% decline.
Bull markets most often happen when the economy is in a good place or is strengthening, so a steady decrease in unemployment and a solid increase in gross domestic product are common characteristics of this type of market.
A bear market is the opposite of a bull market and is when the stock market experiences extended periods of price decreases. The term bear market is often used to describe a market condition in which stock prices have fallen by at least 20% and is typically accompanied by reduced economic prospects and negative investor sentiment. A bear market can occur cyclically or can be a more long-term market condition, such as during a recession.
Important Stock Market Terms You Should Know
There are several stock market terms you should be familiar with before investing in the market. The most common terms you’ll see in reference to the stock market and its activities include:
- Annual report: A company prepares this report based on its recent annual earnings. This report is meant to impress current shareholders and attract new ones. A poor annual report can be an indicator that it’s time to sell a particular stock.
- Broker: A broker is a financial professional who sells or buys investments, such as stocks and bonds, on your behalf.
- Bid: A bid is how much money a trader will pay per share of a particular stock. The bid is usually a little less than the ask price, or how much the seller of the stock wants to make per share.
- Dividend: A dividend is a distribution of a company’s earnings to its shareholders. Dividends are typically paid out on a quarterly or annual basis, and not all companies offer dividends. Companies that offer dividends may make cash payments or offer additional stock.
- Index: An index is a benchmark that traders and other stock market professionals use as a reference market. For example, if a stock offers a 9% return but the market index showed a 13% return for that stock, then the 9% return wasn’t really all that great.
- Initial public offering (IPO): An initial public offering, usually referred to as simply an IPO, is the first offering or sale of stock a company makes to the public. IPOs happen when the company goes public.
- Moving average: A moving average is the average of a stock’s price during a set period of time. Common time periods that moving averages are based on include 50- and 200-day moving averages.
- Order: An order is an investor’s or trader’s bid to purchase or sell a set amount of stock or an options contract. For example, you’ll need to place an order to purchase or sell 100 shares of stock.
- Portfolio: A portfolio is an investor’s collection of investments. Portfolios can have as little as one stock or several different stocks as well as other financial vehicles such as bonds, real estate, and stock options.
- Sector: There are several sectors within the stock market, and each stock belongs to a particular sector. Common sectors include the technology sector, energy sector, financial sector, and real estate sector.
- Volatility: Volatility refers to a stock’s price movement. When a stock’s price has extreme ups and downs on a regular basis, it would be considered a highly volatile stock. The more volatile a stock is, the more of a risk it is to invest in it.
- Volume: Volume refers to the number of shares of a particular stock that’s traded within a set time frame. It can also refer to the number of shares you buy of a particular stock.
The stock market can be intimidating when you first start out, but with patience and practice, you’ll be trading in no time. When you learn the basics of the stock market, you can be better prepared to start trading and investing.