How does investing in the stock market work

Investors benefit by exchanging their money for shares on the stock market. As companies put that money to work growing and expanding their businesses, investors reap the benefits as their shares of stock become more valuable over time, leading to capital gains.

In addition, companies pay dividends to their shareholders as their profits grow. Although the terms are used interchangeably, the stock market is not the same as a stock exchange. When people talk about how the stock market is performing, they mean the thousands of public companies listed on multiple stock exchanges. And more generally, the stock market can be thought of as encompassing a very broad universe of bonds, mutual funds, exchange-traded funds ETFs and other securities beyond just stocks.

A stock market index tracks the performance of a group of stocks that represents a particular industry or segment of the stock market, like the technology, energy and transportation sectors. Often, one of three large indexes is used as shorthand to describe the performance of the U.

The stock market generally refers to markets and exchanges where equity shares and related securities are traded. Other types of financial assets have their own markets. Kat Tretina is a freelance writer based in Orlando, FL. She specializes in helping people finance their education and manage debt. John Schmidt is the Assistant Assigning Editor for investing and retirement. Before joining Forbes Advisor, John was a senior writer at Acorns and editor at market research group Corporate Insight.

Select Region. United States. United Kingdom. Kat Tretina, John Schmidt. Contributor, Editor. Editorial Note: Forbes Advisor may earn a commission on sales made from partner links on this page, but that doesn't affect our editors' opinions or evaluations. How Does the Stock Market Work? Stock Market vs Stock Exchange Although the terms are used interchangeably, the stock market is not the same as a stock exchange. What Is a Stock Market Index?

Other Types of Markets The stock market generally refers to markets and exchanges where equity shares and related securities are traded. OTC describes securities trading that takes place outside of major stock exchanges.

OTC trades are primarily made directly between sellers and buyers, and prices may or may not be publicly available. Most bonds are traded OTC, and many stocks—including penny stocks —are also traded over-the-counter.

Commodities Markets. One of the best ways for beginners to get started investing in the stock market is to put money in an online investment account, which can then be used to invest in shares of stock or stock mutual funds. With many brokerage accounts, you can start investing for the price of a single share. Learn what it is and how to open one. There are several ways to approach stock investing. Choose the option below that best represents how you want to invest, and how hands-on you'd like to be in picking and choosing the stocks you invest in.

Virtually all of the major brokerage firms and many independent advisors offer these services, which invest your money for you based on your specific goals.

In many ways, it teaches new investors some of the most proven investing methods: making small contributions on a regular basis, focusing on the long-term and taking a hands-off approach. Most k s offer a limited selection of stock mutual funds, but not access to individual stocks. Once you have a preference in mind, you're ready to shop for an account.

Limited time offer. Terms apply. Generally speaking, to invest in stocks, you need an investment account. For the hands-on types, this usually means a brokerage account. For those who would like a little help, opening an account through a robo-advisor is a sensible option. We break down both processes below. An important point: Both brokers and robo-advisors allow you to open an account with very little money.

An online brokerage account likely offers your quickest and least expensive path to buying stocks, funds and a variety of other investments. We have a guide to opening a brokerage account if you need a deep dive. You'll want to evaluate brokers based on factors like costs trading commissions, account fees , investment selection look for a good selection of commission-free ETFs if you favor funds and investor research and tools.

A robo-advisor offers the benefits of stock investing, but doesn't require its owner to do the legwork required to pick individual investments. Robo-advisor services provide complete investment management : These companies will ask you about your investing goals during the onboarding process and then build you a portfolio designed to achieve those aims. This may sound expensive, but the management fees here are generally a fraction of the cost of what a human investment manager would charge: Most robo-advisors charge around 0.

And yes — you can also get an IRA at a robo-advisor if you wish. As a bonus, if you open an account at a robo-advisor, you probably needn't read further in this article — the rest is just for those DIY types. Going the DIY route? Don't worry. Stock investing doesn't have to be complicated. For most people, stock market investing means choosing among these two investment types:. Stock mutual funds or exchange-traded funds. Mutual funds let you purchase small pieces of many different stocks in a single transaction.

When you invest in a fund, you also own small pieces of each of those companies. You can put several funds together to build a diversified portfolio. Note that stock mutual funds are also sometimes called equity mutual funds. Individual stocks. Building a diversified portfolio out of many individual stocks is possible, but it takes a significant investment.

The upside of stock mutual funds is that they are inherently diversified, which lessens your risk. For the vast majority of investors — particularly those who are investing their retirement savings — a portfolio comprised mostly of mutual funds is the clear choice. But mutual funds are unlikely to rise in meteoric fashion as some individual stocks might.

The upside of individual stocks is that a wise pick can pay off handsomely, but the odds that any individual stock will make you rich are exceedingly slim. Read our review of Morningstar. New investors often have two questions in this step of the process:. How much money do I need to start investing in stocks? The amount of money you need to buy an individual stock depends on how expensive the shares are. Share prices can range from just a few dollars to a few thousand dollars.

Stock ownership implies that the shareholder owns a slice of the company equal to the number of shares held as a proportion of the company's total outstanding shares. Most companies have outstanding shares that run into the millions or billions. While there are two main types of stock— common and preferred —the term equities is synonymous with common shares, as their combined market value and trading volumes are many magnitudes larger than that of preferred shares.

The main distinction between the two is that common shares usually carry voting rights that enable the common shareholder to have a say in corporate meetings like the annual general meeting or AGM where matters such as election to the board of directors or appointment of auditors are voted upon while preferred shares generally do not have voting rights.

Preferred shares are so named because preferred shareholders have priority over common shareholders to receive dividends as well as assets in the event of a liquidation. Common stock can be further classified in terms of their voting rights. While the basic premise of common shares is that they should have equal voting rights—one vote per share held—some companies have dual or multiple classes of stock with different voting rights attached to each class.

In such a dual-class structure , Class A shares , for example, may have 10 votes per share, while the Class B subordinate voting shares may only have one vote per share.

Dual- or multiple-class share structures are designed to enable the founders of a company to control its fortunes, strategic direction, and ability to innovate. Today's corporate giant likely had its start as a small private entity launched by a visionary founder a few decades ago.

Technology giants like these have become among the biggest companies in the world within a couple of decades. However, growing at such a frenetic pace requires access to a massive amount of capital. In order to make the transition from an idea germinating in an entrepreneur's brain to an operating company, they need to lease an office or factory, hire employees, buy equipment and raw materials , and put in place a sales and distribution network , among other things.

These resources require significant amounts of capital, depending on the scale and scope of the business startup. A startup can raise such capital either by selling shares equity financing or borrowing money debt financing. Debt financing can be a problem for a startup because it may have few assets to pledge for a loan—especially in sectors such as technology or biotechnology , where a firm has few tangible assets —plus the interest on the loan would impose a financial burden in the early days, when the company may have no revenues or earnings.

Equity financing, therefore, is the preferred route for most startups that need capital. The entrepreneur may initially source funds from personal savings, as well as friends and family, to get the business off the ground. As the business expands and capital requirements become more substantial, the entrepreneur may turn to angel investors and venture capital firms.

When a company establishes itself, it may need access to much larger amounts of capital than it can get from ongoing operations or a traditional bank loan. It can do so by selling shares to the public through an initial public offering IPO.

This changes the status of the company from a private firm whose shares are held by a few shareholders to a publicly-traded company whose shares will be held by numerous members of the general public.

The IPO also offers early investors in the company an opportunity to cash out part of their stake, often reaping very handsome rewards in the process. Once the company's shares are listed on a stock exchange and trading in it commences, the price of these shares fluctuates as investors and traders assess and reassess their intrinsic value. There are many different ratios and metrics that can be used to value stocks, of which the single-most popular measure is probably the price-to-earnings PE ratio.

The stock analysis also tends to fall into one of two camps— fundamental analysis , or technical analysis. Stock exchanges are secondary markets where existing shareholders can transact with potential buyers. It is important to understand that the corporations listed on stock markets do not buy and sell their own shares on a regular basis.

Companies may engage in stock buybacks or issue new shares but these are not day-to-day operations and often occur outside of the framework of an exchange. So when you buy a share of stock on the stock market, you are not buying it from the company, you are buying it from some other existing shareholder. Likewise, when you sell your shares, you do not sell them back to the company—rather you sell them to some other investor. The first stock markets appeared in Europe in the 16th and 17th centuries, mainly in port cities or trading hubs such as Antwerp, Amsterdam, and London.

These early stock exchanges, however, were more akin to bond exchanges as the small number of companies did not issue equity. In fact, most early corporations were considered semi-public organizations since they had to be chartered by their government in order to conduct business. Prior to this official incorporation, traders and brokers would meet unofficially under a buttonwood tree on Wall Street to buy and sell shares. The advent of modern stock markets ushered in an age of regulation and professionalization that now ensures buyers and sellers of shares can trust that their transactions will go through at fair prices and within a reasonable period of time.

Today, there are many stock exchanges in the U. This in turn means markets are more efficient and more liquid. These shares tend to be riskier since they list companies that fail to meet the more strict listing criteria of bigger exchanges. Larger exchanges may require that a company has been in operation for a certain amount of time before being listed and that it meets certain conditions regarding company value and profitability. In most developed countries, stock exchanges are self-regulatory organizations SROs , non-governmental organizations that have the power to create and enforce industry regulations and standards.

The priority for stock exchanges is to protect investors through the establishment of rules that promote ethics and equality. The prices of shares on a stock market can be set in a number of ways. The most common way is through an auction process where buyers and sellers place bids and offers to buy or sell.

A bid is the price at which somebody wishes to buy, and an offer or ask is the price at which somebody wishes to sell. When the bid and ask coincide, a trade is made. The overall market is made up of millions of investors and traders , who may have differing ideas about the value of a specific stock and thus the price at which they are willing to buy or sell it.

A stock exchange provides a platform where such trading can be easily conducted by matching buyers and sellers of stocks. For the average person to get access to these exchanges, they would need a stockbroker. This stockbroker acts as the middleman between the buyer and the seller.

Getting a stockbroker is most commonly accomplished by creating an account with a well-established retail broker. The stock market also offers a fascinating example of the laws of supply and demand at work in real-time. For every stock transaction, there must be a buyer and a seller.

Because of the immutable laws of supply and demand, if there are more buyers for a specific stock than there are sellers of it, the stock price will trend up. Conversely, if there are more sellers of the stock than buyers, the price will trend down. The bid-ask or bid-offer spread the difference between the bid price for a stock and its ask or offer price represents the difference between the highest price that a buyer is willing to pay or bid for a stock and the lowest price at which a seller is offering the stock.

A trade transaction occurs either when a buyer accepts the ask price or a seller takes the bid price. If buyers outnumber sellers, they may be willing to raise their bids in order to acquire the stock.

Sellers will, therefore, ask higher prices for it, ratcheting the price up. If sellers outnumber buyers, they may be willing to accept lower offers for the stock, while buyers will also lower their bids, effectively forcing the price down.

Some stock markets rely on professional traders to maintain continuous bids and offers since a motivated buyer or seller may not find each other at any given moment. These are known as specialists or market makers.

A two-sided market consists of the bid and the offer, and the spread is the difference in price between the bid and the offer. The more narrow the price spread and the larger size of the bids and offers the amount of shares on each side , the greater the liquidity of the stock.