The Ultimate Guide to Understanding How the Stock Market Works

What is the Stock Market?

The stock market goes by many names, including the stock exchange, the share market, and Wall Street. These names refer to groups of buyers and sellers exchanging publicly and privately traded stocks representing shares or stakes in a company. Stocks trade on a global scale, with exchanges located around the world.  

Brokers and traders buy and sell stocks with strategies to maximize returns. When someone purchases a stock, they acquire a small piece of the business. Prices move up and down consistently with changes in company performance, political movements, economic reports, world events, and more. While investments fluctuate, the Securities and Exchange Commission acts like a gamemaster, regulating the U.S. market to protect investors. 

Key Players in the Stock Market

The stock market is busy with many individuals working to make trades and grow investment portfolios. Investing is similar to playing on a team, and it helps to know all the positions before entering the competition. 

Here are the key players in the stock market: 

• Stockbrokers: A stockbroker is a trained financial professional who buys and sells stocks and manages an investment portfolio for clients. To trade stocks, you must be a member of the exchange, either NYSE or NASDAQ and licensed by the Financial Industry Regulatory Authority (FINRA). While individuals can directly buy stocks from companies themselves, it’s often easier to trade through a stockbroker. 
• Stock traders: Stock traders are people who trade stocks for themselves or on behalf of a company to make a profit. They need to coordinate their transactions through a stockbroker. Unlike typical investors, traders are in the market to make short-term investments with quick returns. Day traders even turnover shares in a single day. 
• Market makers: Market makers or brokerage houses are individuals or firms who quote purchase and sale prices on stocks to create bid-ask spreads. Market makers play matchmakers to facilitate stock sales based on offered purchase prices. Their main job is to enable stock sales. 
• Investment bankers: Investment bankers represent corporations and help them raise money for expansions and improvements. One of the main ways investment bankers secure funds is by issuing stocks for purchase. 

How Stocks are Traded

Now that you know the players, you can start to plan your moves. Here’s how stocks are traded.

Buying and selling stocks

Stocks can be bought and sold in a variety of ways. Traditionally, you can work with a financial advisor or stockbroker who can help you assess your financial goals and trade on your behalf. You can also do this with online brokers, who work similarly but may offer less personalized attention. Finally, app and robo-advisor trading platforms allow for quick exchanges through an app or web platform, which can work well for experienced day traders.  

Types of stocks

Similarly, the stock exchange has different types of stocks: 

• Individual stocks are one of the most common options, allowing you to purchase a share in one specific company. 
• Fractional shares afford a partial piece of stock. 
• Finally, EFTs and mutual funds pool different company stocks, bonds, and securities together. These types of investments are diverse and can provide more stability. 

Factors That Affect Stock Prices

Stock prices change every day, sometimes by large amounts! Most often, stocks are affected by the rules of supply and demand. (The more people want it, the more expensive it will be.) 

However, other factors also affect stock prices, including:  

• Economic indicators point to whether the economy is flourishing or moving into a recession. Indicators may include interest rates, spending patterns, and other factors that signal the economy's growth. Economic downturns can send prices down, which could make it a good time to buy. 
• Company news and earnings reports indicate how the company itself is doing. If a company undergoes cuts or financial troubles, its stock may become less valuable. Likewise, expansion may send prices and dividends up. 
• Political events and policy changes can disrupt the market as companies and brokers watch for what will happen next.  
• Interest rates and inflation affect the general cash flow of the nation and can lead to stock market changes. For example, low-interest rates can increase spending, raising stock prices. Conversely, inflation can decrease spending, lowering company profits and stock value. 

Risks of Investing in the Stock Market

Like anything, the stock market comes with risks. Account for these risk factors when investing your money and determine what you are willing to take on before investing. 

Here are several stock market risk factors to consider: 

• Volatility in the stock market refers to how much prices change over a period of time. High volatility indicates a stock might be risky because its value is less predictable. Conversely, low volatility could be a sounder investment but may have less payoff. 
• Market downturns occur when the overall stock market declines due to economic factors, which can lead to a recession. Downturns can cause panic among investors, causing them to sell too quickly. 
• Company-specific risks include factors that affect business profit and, therefore, the value of its stock. For example, a poorly managed company might incur financial troubles and have to shut down locations. 
• Regulatory risks include regulation changes or laws that could impact a specific market. For example, laws around cigarette and vaping marketing could decrease sales and stock value for businesses in those industries. 

Rewards of Investing in the Stock Market

Despite the risks, there are plenty of rewards to reap from investing in the stock market. Here are a few rewards to look forward to: 

• Capital gains are the profit from selling an investment, like stocks. Typically, stocks will rise in value over a long enough period. Stocks sold at their new value minus the purchase price yield the capital gain. 
• Dividends are paid to shareholders when a company earns a profit surplus. So, when a company is doing well, it will pay out a cash amount to those with stocks. 
• Portfolio diversification is one of the most significant benefits of investing in the stock market. Investing in various stocks, bonds, and securities works to protect your overall financial portfolio.

Further Resources on How the Stock Market Works

Here are a few more resources on stock market basics to help you start investing in the stock market. 

• NYSE: Stay up to date on stock market trends straight from the source.
• Investor.gov: Get access to essential investment tools.
• SEC: Learn how the Securities and Exchange Commission protects investors.  

Stock Up on Investor Knowledge 

Now that you have a basic understanding of how to buy and sell stocks in the stock market, key players, and types of shares, you can begin to level up your investment portfolio. Just remember, the game of wealth can be complex and challenging, even for experienced players. You can stock up on even more knowledge with the help of an experienced financial advisor. Find an advisor near you with our Credit Union Locator.

Did you know?

Credit unions can provide financial advisory services to their members, helping them prepare investments and expand their portfolios. Unlike large banks, credit unions take a member-focused approach to understand your needs and offer services at an affordable rate.