How Do Stocks Work Simple
‘How Do Stocks Work Simple’ is an introduction on how stocks work. This article talks about how to invest in stocks, some risk factors, stock market resources and some general resources.
Have you ever wanted to make money online? Do you like the idea of getting rich but don’t want to spend 8 hours a day on the computer? Here is how stocks work simple…
How does the stock market work?
The concept behind how the stock market works is pretty simple. The stock market lets buyers and sellers negotiate prices and make trades.
The stock market works through a network of exchanges — you may have heard of the New York Stock Exchange or the Nasdaq. Companies list shares of their stock on an exchange through a process called an initial public offering, or IPO. Investors purchase those shares, which allows the company to raise money to grow its business. Investors can then buy and sell these stocks among themselves, and the exchange tracks the supply and demand of each listed stock.
That supply and demand help determine the price for each security, or the levels at which stock market participants — investors and traders — are willing to buy or sell.
Buyers offer a “bid,” or the highest amount they’re willing to pay, which is usually lower than the amount sellers “ask” for in exchange. This difference is called the bid-ask spread. For a trade to occur, a buyer needs to increase his price or a seller needs to decrease hers.
This all may sound complicated, but computer algorithms generally do most of price-setting calculations. When buying stock, you’ll see the bid, ask, and bid-ask spread on your broker’s website, but in many cases, the difference will be pennies, and won’t be of much concern for beginner and long-term investors.
Historically, stock trades likely took place in a physical marketplace. These days, the stock market works electronically, through the internet and online stockbrokers. Each trade happens on a stock-by-stock basis, but overall stock prices often move in tandem because of news, political events, economic reports and other factors.
To make money investing in stocks, stay invested
More time equals more opportunity for your investments to go up. The best companies tend to increase their profits over time, and investors reward these greater earnings with a higher stock price. That higher price translates into a return for investors who own the stock.
» First things first. You’ll need a brokerage account before you can start investing. Here’s how to open one — it only takes about 15 minutes.
More time in the market also allows you to collect dividends, if the company pays them. If you’re trading in and out of the market on a daily, weekly or monthly basis, you can kiss those dividends goodbye because you likely won’t own the stock at the critical points on the calendar to capture the payouts.
If that’s not convincing, consider this. Over the 15 years through 2017, the market returned 9.9% annually to those who remained fully invested, according to Putnam Investments. However:
- If you missed just the 10 best days in that period, your annual return dropped to 5%.
- If you missed the 20 best days, your annual return dropped to 2%.
- If you missed the 30 best days, you actually lost money (-0.4% annually).
In other words, you would have earned twice as much by staying invested (and you don’t have to monitor the market, either!) for just 10 extra critical days. No one can predict which days those are going to be, however, so investors must stay invested the whole time to capture them.
The longer you’re in, the closer you’ll get to that historical average annual return of 10%.
Stock market basics
The stock market is made up of exchanges, like the New York Stock Exchange and the Nasdaq. Stocks are listed on a specific exchange, which brings buyers and sellers together and acts as a market for the shares of those stocks. The exchange tracks the supply and demand — and directly related, the price — of each stock.
But this isn’t your typical market, and you can’t show up and pick your shares off a shelf the way you select produce at the grocery store. Individual traders are typically represented by brokers — these days, that’s often an online broker. You place your stock trades through the broker, which then deals with the exchange on your behalf. (Need a broker? See our analysis of the best stockbrokers for beginners.)
The NYSE and the Nasdaq are open from 9:30 a.m. to 4 p.m. Eastern, with premarket and after-hours trading sessions also available, depending on your broker.
Understanding the stock market
When people refer to the stock market being up or down, they’re generally referring to one of the major market indexes.
A market index tracks the performance of a group of stocks, which either represents the market as a whole or a specific sector of the market, like technology or retail companies. You’re likely to hear most about the S&P 500, the Nasdaq composite and the Dow Jones Industrial Average; they are often used as proxies for the performance of the overall market.
Investors use indexes to benchmark the performance of their own portfolios and, in some cases, to inform their stock trading decisions. You can also invest in an entire index through index funds and exchange-traded funds, or ETFs, which track a specific index or sector of the market.
Investing Rules That Could Make You Rich
Start investing early
The best way to make money in the stock market is to invest for the long term. In other words, buy strong investments and hold onto them for as long as possible — ideally at least a few decades.
To give your money as much time as possible to grow, it’s best to start investing as early in life as you can. Of course, if you’re off to a late start, you can’t go back in time. But starting to invest now is better than waiting, even if you don’t have much cash to spare.
Say, for example, you’re 35 years old and are just beginning to invest. Right now, you can afford to invest $200 per month, and your investments are earning a 7% average annual rate of return. At that rate, you’d have around $227,000 saved by age 65.
Now, let’s say that instead of starting to invest at age 35, you waited until age 45. At that age, though, you can afford to invest $400 per month, while still earning a 7% average annual return. In this scenario, you’d have roughly $197,000 at age 65. Even though you’re investing twice as much each month, your savings would still fall short of what you’d have by starting to save earlier in life.
Put your money behind stocks
The stock market is famous for its volatility, and putting your life savings behind stocks can seem risky. However, stocks will help your money grow much faster than more conservative investments.
Bonds, CDs, and high-yield savings accounts may be less volatile than stocks, but they also have significantly lower returns. Bonds may only yield returns of around 4% or 5% per year, and even the best high-yield savings accounts pay interest rates of around 1% per year. That likely won’t even keep up with inflation, meaning your money could lose value over time in a savings account.
The S&P 500, on the other hand, has earned an average rate of return of around 10% per year since its inception. While the stock market does have its ups and downs, if you leave your money invested for several decades, you’re likely to earn much higher returns than if you’d invested more conservatively.
It’s still important to make sure you’re investing wisely, however, because not all stocks are created equal. Do your research before buying, and only invest in stocks that are more likely to experience consistent growth over time.
Diversify your portfolio
Diversifying your portfolio involves buying multiple stocks from a variety of industries to limit your risk. This way, if one or two of your stocks don’t perform well, it shouldn’t have a drastic effect on your overall portfolio.
If you’re buying individual stocks, try to invest in at least a dozen or so different companies from multiple industries. If you’re buying funds, like mutual funds or ETFs, that can make it easier to diversify, since each fund may contain hundreds of stocks. However, it’s still a good idea to make sure the funds contain stocks from a variety of industries. Even if you’re invested in hundreds of stocks, if they’re all from one sector, that increases your risk.
It’s possible to make a lot of money in the stock market, as long as you have the right strategy. Regardless of how much you can afford to invest, these three guidelines can help you start building wealth today.
If you’re trying to figure out how to invest for retirement, your first mission is to become educated about the stock market. It will help keep your emotions in check and guide you toward the path that will help create a secure financial future if you do it right. Let’s take a look at the basics of the stock market so you feel a little less confused about these things.