When you want to invest, chances are you’ll look to the stock market to buy shares of stocks, exchange-traded funds (ETFs), or mutual funds. The term stock market is often used interchangeably with stock exchanges, but there’s more to it than that.
Stock exchanges — the parties that make it possible for investors and traders to buy and sell securities — are just one piece of the larger machine that is the overall stock market.
Believe it or not, the stock market isn’t just a place to invest. It’s a complex mechanism that plays an integral role in the United States and global economies. It makes it possible for small companies to access the funding they need to become goliaths and for the average Joe to retire as a millionaire.
What Is the Stock Market?
The stock market is made up of a series of regulated and controlled marketplaces known as stock exchanges. It’s where investors and traders buy and sell shares of stock, exchange-traded funds, and other securities.
In the past, the U.S. stock market was largely localized in the Lower Manhattan District of New York City. That’s because stocks were traded as physical certificates just a few decades ago.
Although I’m sure some physical certificates are still around, most transactions on the stock market happen in cyberspace. Today, the market is all around you.
The stock market includes major stock exchanges like the Nasdaq and New York Stock Exchange (NYSE), as well as multiple smaller over-the-counter (OTC) exchanges where shares of riskier, lesser-known companies are traded.
When you hear someone talking about the stock market, they could be talking about one of three things:
- The Domestic Stock Market. The domestic stock market, or U.S. market, is where shares of U.S.-based companies and other U.S. securities are primarily traded.
- International Stock Markets. The U.S. isn’t the only region with its own stock market. There are dozens of international stock markets around the world that encompass companies from other nations or regions. These include, for example, the Chinese stock market or the European market.
- The Global Stock Market. The global stock market includes all stock exchanges around the world, from the Nasdaq in the U.S. to the Stock Exchange of Hong Kong, the Bombay Stock Exchange, the London Stock Exchange, and more than 60 other global stock exchanges.
How the Stock Market Works
The stock market works by connecting market participants together.
To get a better understanding of how the market works, consider an example of a single individual stock of a hypothetical company we’ll call ABC. ABC is a private company that has grown tremendously in recent years and needs to raise money to keep up with purchase orders and make its manufacturing process more efficient. One way it can do that is to list shares of the company for sale on a major stock exchange in an initial public offering (IPO).
On the date of the IPO, shares of the company’s stock are listed on a major stock exchange and offered to the public by brokers, making it a public company. From there, investors and traders buy the new stock in the primary market transaction (the first time an asset is being sold).
In order to buy the stock, investors and traders work with stock brokers who route orders through market makers and directly through exchanges.
Once all the IPO shares are sold, the stock exchange acts as a secondary market to continue facilitating trades between buyers and sellers. As time passes, the supply and demand will help determine the fair market price of ABC stock. If demand for ABC shares is high, prices rise. Conversely, prices fall when demand is low.
Parties the Stock Market Supports
Several parties are involved in the stock market, each of which are integral to a healthy balance and market growth over time. It’s important that the market supports these parties fairly and as equally as possible.
The participants the market supports include:
- Investors. Investors are individuals and institutions that purchase stock and other securities as long-term investments. These investors support the growth of the companies they invest in.
- Traders. Traders make short-term investments, generally ranging from a few minutes to a few months. Their constant activity is important to liquidity in the market. These traders may be directional speculators, arbitrageurs who look for undervalued opportunities to benefit from a rebound, or technical analysts who rely on technical indicators to tell them when to buy and sell securities.
- Publicly Traded Companies. Stocks represent tiny pieces of ownership of publicly traded companies. If there were no companies to trade, there would be no market.
- Stockbrokers. Stockbrokers facilitate the communication of orders between investors, traders, and stock exchanges. You use stockbrokers to open a brokerage account and actively take part in the market. Brokers generally earn their money through the fees they charge investors, commissions paid for routing orders through specific market makers, or a mix of the two.
- Stock Exchanges. Stock exchanges are where trades actually take place. These companies make money on small fees charged for each trade they facilitate. They also charge brokers, news outlets, and other media providers for market data and charge publicly traded companies a fee to file new offerings.
- Market Makers. Market makers help to ensure liquidity in the market. Market makers buy and sell securities out of their own accounts immediately so investors don’t have to wait for a buyer or seller willing to transact at the stock price they want. Market makers earn money in exchange for the liquidity they provide by charging a spread.
- Portfolio Managers. Portfolio managers invest on behalf of their clients. They have a fiduciary responsibility to act in the best interest of their clients and generally charge commissions for their services.
- Investment Bankers. Investment bankers represent companies, both public and private. When private companies want to go public, they hire investment bankers to assist with the regulatory and listing process. Investment bankers also help companies raise money in follow-on offerings as well as assist in mergers and acquisitions.
- Custodians. Custodians hold investor assets for safekeeping. Think of a custodian like a personal bank for securities.
The Stock Market’s Purpose
At first glance, the market seems to have a singular purpose — to facilitate the purchase and sale of stock for market participants. However, the market has multiple purposes, all of which are important:
- Give Companies Access to Funding. Business is expensive and no matter how great a company is, it may need funding from time to time. The stock market makes it possible for companies to access the investor funding they need.
- Let Investors Share In Corporate Growth. The stock market gives investors the ability to share in corporate growth in exchange for providing companies with needed funding. In some cases, of course, corporate value may fall; investors share in losses as well.
- Act as an Economic Barometer. The stock market is also a great way to gauge the amount of pressure an economy is facing. In general, the stock market representing a region flourishes when economic conditions are positive and struggles when the economy weakens.
- Create Opportunities for Speculators. To be clear, speculation wasn’t one of the original intentions of the stock market. But a new career opportunity emerged as short-term traders learned how to profit from the everyday ups and downs of the stock market. Today, speculators play a major role in liquidity, and their success is crucial to the continued operation of the stock market as we know it.
There are several functions of the market that make it a fair and equitable place to transact.
- Efficient Security Pricing. Stock exchanges, a crucial part of the market as a whole, efficiently balance supply and demand to determine a fair share price for each security listed in real-time and fill orders at requested prices.
- Security. All transactions on the market must be secure and validated. This has become especially important since the introduction of online trading.
- Investor Protection by Exchanges. Exchanges are required to act in the best interest of the investors they serve. For example, exchanges may label some stocks high risk and limit trading in those securities to investors and traders who meet specific requirements.
- Investor Protection by Regulators. The market must also have balanced regulation in order to operate properly. In the United States, the stock market is largely regulated by the U.S. Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA). In other countries, other regulatory bodies are charged with maintaining balanced and fair regulation.
- Liquidity. The market provides liquidity, meaning that it is a place where shares can be turned into cash and vice versa in the most reasonable amount of time possible. Because there are so many market participants trading on the major exchanges, this liquidity is generally provided instantaneously, but there are some exceptions to the rule. That’s especially true when trading on OTC exchanges.
Stock Market Indexes
Stock market indexes track the movement of groups of assets in the market. Some indexes track the movement of the market as a whole while other indexes track subsectors of the market or specific groups of stocks.
In the U.S., the S&P 500 index is the benchmark index of the market. This means the S&P 500 acts as a gauge of the entire domestic market.
But it’s not the only major index. The Dow Jones Industrial Average serves as a gauge of the large-cap market in the U.S., while the Nasdaq composite index is a tech– and biotech-heavy index that’s commonly used to gauge the performance of some of the most technologically innovative companies in the country. There are other indexes that track different styles of stocks or stocks with different market caps.
Moreover, international indexes track markets outside of the U.S. For example, the FTSE SmallCap index tracks small-caps listed on the London Stock Exchange.
Market indexes have a few purposes of their own:
- Market Gauge. Indexes make it easy to gauge the direction of a market or a subset of a market.
- An Investment. Institutional investors that develop exchange-traded funds (ETFs) and mutual funds often use indexes as their investment strategies. The goal of these funds, known as index funds, is to produce investment returns that mimic the returns of the underlying index they follow.
- Economic Gauge. Because there’s a strong correlation between markets and the economies they represent, market indexes are commonly used as an economic gauge. For example, an economist may cite a substantial increase in the S&P 500 index as a reason to be excited about developments in the U.S. economy.
Stock Market vs. Stock Exchange
The terms stock market and stock exchange are often used interchangeably in the investing community, but they mean two different things. A stock exchange is just one piece of an overall market. The stock market includes several exchanges that make it possible for the investing public to buy and sell securities.
Stock Market FAQs
The stock market is a complex, exciting topic. With tens of millions of investors and traders in the United States alone and new participants joining every day, there are bound to be questions about the stock market. Some of the most common questions include:
How Do I Invest in the Stock Market?
In simplest terms, all you need to start investing is a few bucks and a brokerage account. Find the stock you want to buy with your broker and make your investment. But nothing worth doing is ever that simple.
Although the stock market is a great way to build wealth, your investments can also lead to losses if you’re not careful. Always do your research and earn a detailed understanding of exactly what you’re buying before you make an investment decision.
When Does the Stock Market Open & Close?
Market days and hours vary from country to country. In the U.S., the market is open Monday through Friday from 9:30am to 4:00pm Eastern.
Trading also happens before and after a normal trading session. These extended sessions are called pre-market or after-hours trading.
You can trade in the premarket on Monday through Friday from 4:30am to 9:30am Eastern and in the after-hours market from 4:00pm to 8:00pm Eastern. However, premarket and after-hours trading sessions are dominated by institutional investors, leading to wide swings in value that can be risky for retail investors.
What’s the Difference Between the Stock Market & Wall Street?
Wall Street is a blanket term used to describe the financial industry and its participants in the United States, much like the term stock market. However, the stock market is a global phenomenon, whereas Wall Street generally refers to the U.S. financial market.
The stock market is an important component of business and economic development in the United States. It’s also the tool most people use to build financial freedom and a comfortable retirement in the United States.
You may find the stock market to be complex and intimidating at first. As you invest and work in the financial sector, you’ll find it’s an evenly balanced system that, with adequate research, you can use to build your own wealth over time.
However, when you decide to participate in the stock market, it’s important to give it the respect it deserves. You can lose money as easily as you can make it, if not easier, so it’s important to stick to your investment strategy and do your research as you make your trades.