The stock market is a blanket term for an environment where stocks can be bought and sold. Stocks consist of shares in publicly-listed companies. The stock market allows companies to raise money while giving investors the chance to own a piece of a growing business and trade these pieces with each other.
The United States stock market generally consists of its leading stock exchanges and over-the-counter (OTC) markets. These exchanges are namely the New York Stock Exchange (NYSE), NASDAQ, and Chicago Board Options Exchange (CBOE).
The stock market does involve trading stocks, but it also includes other financial securities such as exchange-traded funds (ETFs), commodities, precious metals, bonds, and derivatives.
Meanwhile, the stock exchange is a marketplace where shares are bought and sold to raise new capital for the companies and individuals involved.
There are stock exchanges in many of the world’s countries, and some countries have more than one location to trade stocks.
The major cities considered key financial hubs include New York, London, Tokyo, Frankfurt, Paris, Zurich, Hong Kong, Sydney, Mumbai, and Singapore.
How the stock market works
When a company is created, shares are issued in what is known as the primary market.
The stock exchange is a secondary market because those primary market shares are being sold to new owners by the original company shareholders.
For instance, when Microsoft (NASDAQ: MSFT) went public via IPO in 1986, Bill Gates owned 45% of the company shares. Today he owns around 1.3% of the tech conglomerate.
That may seem surprising, but for Microsoft to become the colossal size it is today, Gates had to be willing to part with some of his shares to entice new capital and allow the business to grow. His original shares were sold on the stock market to new investors.
In the United States, an agency called the SEC protects investors by regulating the US capital markets.
Types of stock market
In addition to stock exchanges are over-the-counter (OTC) marketplaces.
The OTC markets are less-stringently regulated than exchanges because it consists of a broker-dealer network of traders dealing in various securities. These securities include equities, currencies (forex), commodities, precious metals, and derivatives.
Nevertheless, some of the quotation systems used by broker-dealers operating through the OTC are obligated to follow some level of regulation. For instance, the OTCBB is an inter-dealer quotation system used in the US.
Sometimes stocks that are not listed on conventional exchanges such as the NYSE or NASDAQ are available OTC.
However, most securities listed on the OTCBB must be registered with the SEC or other federal regulatory authority with jurisdiction. This gives some level of reassurance to investors.
Want to know how to buy shares on the stock market? Read our guides to investing on the NYSE, TSX, CSE and OTC exchanges.
Advantages of a stock market
A stock market creates a way for businesses to raise capital. It is a massive industry that generates thousands of jobs and boosts economic activity.
Access to capital
It takes money to make money, and that’s particularly true in business. Companies need money to grow, but raising the capital necessary to expand can be fraught with difficulty in the private sector.
The stock market provides a unique way for public companies to generate capital from various entities, from hedge funds and banks to individual investors.
Transparency
The value of a company stock gives onlookers a perceived idea of how that business is performing.
If its share price is high, the public has confidence in its ability to function. But it may be struggling to grow and accomplish targets if its share price is low.
Stock prices naturally fluctuate, so this metric in isolation can be deceiving, but it gives investors a rough idea nonetheless. When companies thrive and grow more prominent, the economy benefits.
Pension pots
The stock market creates a way for institutions and individuals to accumulate generational wealth. For instance, private and state pension funds invest in the stock market to generate significant returns.
Historically stocks have outperformed other investment types over the long term. That’s because the foundation of the stock market is real-life companies building brands, adding societal value, and providing jobs.
Disadvantages of a stock market
Although many parts of the stock market are regulated, some parts operate like the Wild West. There are two sides to every trade, so when one side wins big, the other loses.
This makes the stock market a risky place for inexperienced investors to put their money.
No guarantees
Although the stock market has historically proven a strong investment vehicle, there are no guarantees the future will replicate the past.
Dynamic market forces can wreak havoc at any moment. For instance, the arrival of the Covid-19 pandemic created a record stock market crash in March 2020. Stock markets globally plummeted, generating a 30% loss in just 40 days.
In fact, between February 12 and March 23, 2020, the Dow Jones Industrial Average (DJIA) lost 37%.
The DJIA is a stock market index containing 30 prominent companies listed on stock exchanges. For instance, it includes Apple (NASDAQ: AAPL), Chevron (NYSE: CVX), IBM (NYSE: IBM), Home Depot (NYSE: HD), and McDonald’s (NYSE: MCD).
But more remarkable was the global stock market’s rapid recovery. According to Schroders, within five months, those stock market losses had been recouped. Since then, the US stock market indices have gone on to hit record highs.
Extreme volatility
Stocks are subject to extreme volatility, which is increasingly prevalent in the modern world.
With climate change and the threat of cyber-attacks ever making headlines, there are mounting fears that the stock market will be subject to much more volatility in the years ahead.
For savvy traders, volatility can be a fast way to make big money, but for others, it’s a quick way to lose a fortune.
Where’s the Value?
For individual investors, the stock market offers a simple way to invest in well-known companies.
Investors can generate a consistent return from investing in dividend stocks or accumulating capital gains.
There are many strategies investors can adopt when looking to invest in the stock market:
Passive investing, active investing, day trading, swing trading, dividend investing, value investing, growth investing, dollar-cost averaging, and momentum investing are all stock market investing strategies.
The stock market offers a way to take an overarching view of world trade as it helps balance the supply and demand of the world’s businesses.