How The Stock Market Works: Stock Market Basics for Beginners

The stock market is the best wealth creator in the entire world, yet remains a confusing concept for a lot of people. In fact, most people don’t know the stock market basics.

When it comes to investing, many people wonder where to start. It’s difficult to pick a single starting point with so many investment terms to learn and strategies out there.

That’s why I’m here. To help you get started and launch your investing practice. The best time to start is now.

Today, we’ll cover the basics such as what the stock market is, how the stock market works, and how to invest in the stock market for beginners.

When you understand the stock market basics, you will be able to enter the market with the knowledge you need to create incredible wealth.

Let’s get started.

Stock Market Basics

There are a few things every investor should know before entering the stock market. When you master these basic principles, you will be able to make wiser investment decisions.

What Is A Stock?

A stock is a type of security that gives investors (also called “owners” or “stockholders”) a share of ownership in a company. In other words, when you buy a stock in a company i.e. Apple or Amazon, you then own a tiny piece of that company.

When you purchase stock in a company, you can choose to purchase one tiny piece or many tiny pieces. The number of stocks you buy is also called your “share” or shares. When the stock price goes up, the value of your shares increases and so does the return on your investment.

In order to buy a company’s stock, it has to be publicly traded on the stock market, which brings us to our next stock market basic.

What Is The Stock Market?

The stock market is not actually a physical place of any kind. It’s a vast network of economic transactions where buyers and sellers trade stocks with one another. Generally speaking, most people use the term “stock market” to refer to the total collection of various markets and exchanges where these activities take place.

It’s also important to note that the stock market is not the economy, but it does affect the economy.

When people refer to the stock market going up or down, they are often referring to one of the major stock market indexes such as the Dow Jones Industrial Average, referred to as “The Dow”, or the S&P 500.

These indexes track a large number of the top companies traded on a stock exchange and are good representations of how the stock market is trending as a whole. How the major stock indexes are trending over a period of time is often an indication of how the economy is doing at a given time.

Among the various exchanges, the New York Stock Exchange is the most famous. However, there are many exchanges where one can purchase stock, most of which are linked together electronically. When a stock is actually purchased by the average person, it is done so through a brokerage.

What Is A Brokerage?

A brokerage is a middle man between buyers and sellers of stock. Every individual investor needs to go through a brokerage or stockbroker to purchase stock. You can either partner with a broker who will engage in buying and selling activities on your behalf in accordance with your goals for a fee, or you can use an online brokerage firm and do all the buying and selling yourself.

I encourage you to learn how to invest your money on your own and open up a brokerage account with an online broker. You won’t have to pay fees, and you’ll have more fun!

How The Stock Market Works

Now that you know what a stock is, what the stock market is, and what a brokerage is, let’s discuss how they all work together. This is how the market works.

Companies List on an Exchange

As I mentioned above, in order to buy stock in a company it has to be publicly traded on a stock exchange. Companies decide to go public for a variety of reasons. When they initially go public, through an Initial Public Offering of shares, or IPO, they raise money through investors wanting to purchase shares.

They can then use this money to work on projects such as new products, expanding operations, hiring, etc. Going public also affords companies the ability to attract top talent with stock options and provide current employees with equity.

Supply and Demand

When a company goes public its initial stock price is set by a bank based on the company’s value and demand from institutional investors. After the company is public, its stock price is set by basic supply and demand. The more investors who want to purchase a piece of the company, the higher its stock price goes and vise versa.

Watch this video to learn more about how stocks work and how stock prices are determined:

Why Invest in The Stock Market

Now, you’re probably wondering, “why do I want to own a tiny piece of a company anyways?”

Great question.

When you own a piece of a company, you benefit from its success and profit from its profits. When you choose to invest in great companies, you can experience a great return on your investments.

Over the long run, investing in the stock market produces the best returns of any investment. Better than bonds, better than gold, and even better than real estate IF you do it the right way.

How To Invest in The Stock Market

Learning to invest is like learning to speak a new language. When you first start out, it can be a challenge. First, you need to learn the basics of the language. Then you need to practice the language. Eventually, you can speak a new language well. The same is true with investing.

And you’re well on your way to learning the basics of the language. In fact, you’re already on step 3 of my investing plan for beginners.

Before you move onto the next step, do these few things to set yourself up for success.

Set Your Goals

First, answer the question, “Why am I investing?” Do you want to set yourself up for retirement, create a passive income, or work toward a future home or college fund?

Knowing your “why” will help you understand your timeline for making returns, determine the type of stocks that make the most sense for you, and help you make wiser investment decisions as you go.

Determine Your Risk Tolerance

Next, determine your risk tolerance. If you’re young and have plenty of time to ride the stock market waves, you may be more risk-tolerant or you may not have a lot of money to lose and so, you’re less risk-tolerant. If you’re nearing retirement, on the other hand, and will need supplemental income soon, you may be a bit more risk-averse, or you may want to be more aggressive given your shorter timeframe.

Regardless of your age, you can invest in the stock market with little money and still reap the rewards. And if you’re just getting started, that’s what I suggest.

Open A Brokerage Account

Before you can actually invest in the stock market, you need to open a brokerage account. As I mentioned above, the best way to invest is to do so on your own. Most professional investors (we’re talking 96%) don’t beat the market. You are better off learning how to invest on your own and making trades through a brokerage account.

Check out this post to find the right brokerage for you.

Develop A Strategy

Now, you wouldn’t walk into the Superbowl without a game plan or a big debate without a speech, and you shouldn’t start investing in the stock market without a strategy.

The key to success in the stock market is simple: buy wonderful businesses and buy them when they are on sale. This is the strategy we teach at Rule #1 Investing and the strategy you can count on to deliver incredible returns.

I don’t want you to miss this —

Central to the Rule #1 investing strategy, and the reason it works, is only investing in WONDERFUL businesses.

To determine whether or not a business is “wonderful” and worth considering investing in, we rely on four components. Ask yourself these questions before buying a company’s stock:

1. Do I understand the business and the industry it is in?

2. Does the business have staying power?

3. Does the CEO have talent and integrity?

4. What is the true value of the business?

To help you learn how to answer these questions, I’ve put together a guide on how to pick stocks. Read this and you can learn how to invest in accordance with this strategy too.

Start Today

The best part of learning to invest is that once you learn to do it, you can do it for the rest of your life.

So, what are you waiting for?

Now, that you know the basics, you’re ready to get started! Download my Guide to Investing for Beginners. It’s a completely free resource that will help guide you as you begin this journey.

Now… go play.