What is the Stock Market ?
It is a place where shares of pubic listed companies are traded. The primary market is where companies float shares to the general public in an initial public offering (IPO) to raise capital.
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Once new securities have been sold in the primary market, they are traded in the secondary market—where one investor buys shares from another investor at the prevailing market price or at whatever price both the buyer and seller agree upon. The secondary market or the stock exchanges are regulated by the regulatory authority.
A stock exchange facilitates stock brokers to trade company stocks and other securities. A stock may be bought or sold only if it is listed on an exchange. Thus, it is the meeting place of the stock buyers and sellers.
How the Stock Market Works
The stock market is not a single market but a number of stock exchanges scattered around the world where traders and investors buy and sell shares of publicly traded companies. Shares change in price constantly in response to the law of supply and demand.
A share of stock is a tiny ownership stake in a public corporation. The stock's price primarily reflects the expectations of stock investors and market analysts on the company's future earnings.
Traders who think a company will do well bid the price up, while those who believe it will do poorly bid the price down. Sellers try to get as much as possible for each share, hopefully making much more than what they paid for it. Buyers try to get the lowest price so that they can sell it for a profit later.
Where Is the Stock Market?
Two of the world’s largest stock exchanges are in the United States: the Nasdaq and New York Stock Exchange (NYSE). Combined, they are worth trillions of dollars in market capitalization, reflecting the value of all of the shares listed on the exchanges. As of the end of 2018, the NYSE reported its market cap as $28.5 trillion. As of the end of 2019, the Nasdaq reported its market cap as $9.8 trillion.
Each exchange matches buyers with sellers, but they do it differently.
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The Nasdaq is a dealer market. Investors do not buy and sell directly to one another. The transactions go through a dealer.
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The NYSE uses an auction method to set prices. Before the 9:30 a.m. opening bell on weekdays, investors enter their buy and sell orders. The orders are matched up, with the highest bid price paired with the lowest asking price. Buy and sell orders continue to flow in until 3:50 p.m.
U.S. financial markets are very sophisticated, and, as a result, information on companies is easy to obtain. This transparency increases the trust of investors from around the world. As a result, the U.S. stock market attracts more investors. That makes it even easier for a U.S. company to go public.
What Is a Stock Market Index?
The overall performance of the U.S. stock market is tracked over time by three principal indices: the Dow Jones Industrial Average, or DJIA (stock prices of the top 30 U.S. companies), the S&P 500 (stocks of 500 large-cap U.S. companies), and the Nasdaq. Many components and sectors of the markets are followed by their own indices. For example, the Russell 2000 reports on 2,000 small-cap companies.
Other countries have their own stock exchanges and indices. The five biggest are the London, Tokyo, Shanghai, Hong Kong, and Euronext exchanges. Each exchange is tracked by an index, while global indices track stock performance across borders. For example, the MSCI Index tracks the performance of stocks in emerging market countries such as China, India, and Brazil.
Why Invest in the Stock Market?
The stock market contributes to the U.S. economy. Investors who believe the economy is growing will invest in stocks because a strong economy helps companies increase their earnings. The stock market is an important way for companies to raise capital to expand or start their businesses. So, an investment in the stock market is an investment in economic growth. Newer companies use an initial public offering (IPO) to sell their shares in established exchanges like the NYSE or the Nasdaq and raise capital to grow.
Investors who take shares in IPOs can potentially profit as new companies become public.
A strong economy leads to an expansion phase of the business cycle. This is known as a bull market and it occurs when there is an increase of 20% or more across the broad market index for at least two months in a row.
Most of the stocks traded are common stocks. But some investors buy preferred stocks. They pay an agreed-upon dividend at regular intervals and they don't have voting rights. They are less risky but they also typically offer a smaller return. Preferreds trade effectively like perpetual bonds with a fixed yield and offer some downside protection.
Noted
Stock market investing is considered the best way to achieve returns that beat inflation over time, and the returns, on average, outpace those of other investments, such as bonds or commodities.
Investors can make money in two ways—by trading and by holding. Investors who trade will buy and sell stock frequently, taking advantage of small ticks in price. Investors who buy and hold prefer to let their stocks appreciate in value over time. In many cases, the companies whose shares they buy reward them further with regular payments of dividends.
Risks of Stock Market Investing
The most significant downside is that you can lose your entire investment if the stock price falls to $0. If the company goes bankrupt, stock investors are paid last. For that reason, stock investing can be an emotional rollercoaster.
Warning
Fees can take a big bite out of your investment as well, and the potential for fraud is a serious concern.
If investors think the economy is slowing or stagnant, they may instead invest in bonds, which are a safer investment, although they do come with their own risks. Bonds give a fixed return over the life of the loan and typically do well during the contraction phase of the business cycle.
When stock market prices decline less than 10%, it's known as a stock market correction. When prices fall that much or more in one day, it's known as a stock market crash. A crash can trigger a recession. The history of stock market crashes shows this is a regular occurrence.
When prices fall 20% or more, it's known as a bear market. A bear market lasts at least two months, although the average can be around 11 months and can reach lengths of as much as 20 months or more.
How to Invest in the Stock Market
There are at least eight ways for you to invest in the stock market.
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The quickest and least expensive is to buy stocks online. Online or “discount” brokers like E-Trade, Merrill Edge, or TD Ameritrade charge no fees for trading stocks and small fees for some other purchases such as mutual funds. A new generation of app-based brokers including Robinhood and Acorns also has emerged. This is do-it-yourself investing, making it easy to place trades with a click on your iPhone or Android device. The free services offer no professional or individualized guidance.
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If you need more guidance at a reasonable price, join an investment club, which is a group of people who research and invest together.
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A full-service broker will cost more but could be worth the price. They will give you professional recommendations based on your goals, risk profile, and budget.
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Large investment banks like Goldman Sachs or Bank of America-Merrill Lynch provide financial planning in addition to executing trades.
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A money manager charges the most but will do all the work for you.
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Fee-only financial advisors charge annually and provide advice on selecting investments, or make the trades for you.
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Rather than buying individual stocks, you could invest in one or more index funds or mutual funds. Many individual investors choose to so in order to gain access to a broad array of investments selected by professionals.
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The riskiest choice is a hedge fund. They may also invest in derivatives, which can increase the returns but will also increase the risks.
Frequently Asked Questions (FAQs)
When does the stock market open and close?
The stock market opens at 9:30 a.m. EST every weekday except for holidays when the market is closed. It closes at 4 p.m. on most days, except on holidays when the market closes early. Many brokerages also offer access to extended-hours trading. For example, a brokerage may allow traders to place orders from 7 a.m. through 8 p.m.
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How do you make money on the stock market?
There are two ways you can make money with stocks. One way is through capital gains, which is when you sell a stock for more than you paid to buy it. When stocks go up, investors who hold stocks could potentially profit by selling their stocks and actualizing capital gains, or they can hold onto them longer in hopes that they will rise further and create more capital gains. The other way investors make money with stocks is through dividends. When a company issues a dividend, it pays shareholders a portion of the profits.
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What Is a Secondary Market?
A secondary market is a market where existing securities or other assets are bought and sold. They differ from primary markets, which are where the assets originated. Generally, most investors will only trade on secondary markets.
In this guide, we’ll cover the many different types of secondary markets, what asset types trade on them, and how they compare to primary markets.
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Definition and Examples of Secondary Markets
Secondary markets are where assets are traded after they are issued. In a secondary market, transactions are made with other investors, not the issuer of the security. You can compare the process to buying items from the classifieds, or buying a used car from a dealership, rather than from the manufacturer itself.
For example, stocks and bonds purchased in a retirement plan or through a brokerage account are transacted on secondary markets.
Let’s say you have two portfolios: one is an employee stock ownership plan and one is with a discount brokerage. When you buy stock directly from the company as with the first plan, it is a primary market transaction. When you buy in the discount brokerage account through stock exchanges, it is a secondary market transaction.
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How Secondary Markets Work
Investors trade with one another in secondary markets, rather than the issuing organization. Secondary markets hold their name because when you trade on one, the trading occurs after the asset is already issued on the primary market.
While stocks are the most commonly traded security on a secondary market, the mortgage market is another good example to refer to when discussing the secondary market.
A financial institution writes a mortgage for a consumer, which creates a mortgage security. Next, the bank or other financial institution can then sell it to Fannie Mae or Freddie Mac on the secondary market to finance the construction and sale of housing, creating a secondary transaction.
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Types of Secondary Markets
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There are many types of secondary markets, and the way they work might differ depending on how they are structured and what types of assets are being traded. You’ve likely heard of some secondary markets, like the popular stock exchanges. Let’s go over the most common types of secondary markets, with examples:
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Stock Exchanges
Public stocks trading on exchanges such as the New York Stock Exchange (NYSE) or the NASDAQ trade on the secondary market. Transactions are handled by brokers who work with market makers to provide bid and ask prices for individual investors and institutions.
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IMPORTANT
For the most part, any time you buy a stock, you’ll be buying it on a secondary market. There are exceptions, like if you participate in an employee stock ownership plan, but even in these instances you would likely need to sell the shares on a secondary market.
Fixed Income Instruments
Fixed income instruments from Treasury bills to corporate bonds all trade on a secondary market. The bond market, however, isn’t as open and liquid as the stock market. You can rarely find a real-time quote for a bond. Instead you work through intermediaries like broker-dealers.
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Bonds are issued at par value. Then once they are on the secondary market, their prices fluctuate based on factors such as credit, market conditions, and interest rates.
Mortgages
Mortgages are technically a subset of fixed income, but there are enough differences for them to earn their own section. As mentioned, generally, once your mortgage originates it is sold by the lender to a market operator like Freddie Mac, which was chartered by Congress to be a secondary mortgage market. The buyer then pools mortgages together into one big security and sells that to investors who buy the income stream.
Noted
The role of Fannie Mae and Freddie Mac is to help provide liquidity, stability, and affordability to the larger mortgage market. By attracting investors who may not otherwise invest in mortgages, the pool of funds available for housing is expanded. That makes the secondary mortgage market more liquid, and also lowers interest rates paid by homeowners and borrowers.
Small Business Loans
Government guaranteed small business loans can also be pooled and sold to investors, just like mortgages. This happens most often with the Small Business Administration’s 7(a) loan program. Banks originate loans and then sell the guaranteed portion on a secondary market to a financial institution that pools the loans together.5
The secondary market provides a guaranteed payment stream for investors, and allows banks to sell loans for a quick premium. The banks can then go out and lend the money again.
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Private Companies
Employees who are issued shares of private companies (meaning that no shares are trading on a public stock exchange) often have trouble selling the shares if they need to raise cash to pay taxes or for some other reason. When the shareholders are allowed to sell shares, they do it through online secondary markets where accredited investors will take the shares off their hands.
Buyers in this case generally include wealthy individuals, venture-capital firms, hedge funds, private-equity firms, and institutional investors
Primary Markets vs. Secondary Markets
Primary Market
Secondary Market
Asset
Initial Public Offerings (IPOs)
Financial institutions
Banks and other lenders
Venture capital funds; employee offerings
Stocks
Fixed-Income Securities (Bonds)
Mortgages & Small Business Loans
Private Companies
NYSE, NASDAQ, etc.
Through broker-dealer intermediaries
SBA 7(a); packaged in mortgage pools or ETFs
Online markets to specialized investors
Primary markets are where assets are originally issued. The easiest way to compare the two is to go through the various markets covered above and explain how the primary market works for each.
Stocks
The primary market for stocks is through initial public offerings (IPOs). The company’s management presents the offering to financial institutions and then sells shares to them. The shares then become available on a stock exchange.
Warning
Individual investors will likely not be able to invest in an IPO at the offering price, as it is reserved for underwriters or clients initially involved in the process. Most individual investors will have to buy shares on the secondary market days later.
Fixed Income
The bond primary market is very similar to the stock one. The issuer tours financial institutions pitching the bond and then sells it to them. The financial institutions then make the bond available for sale on the secondary market, where it trades through broker-dealers.
Mortgages & Small Business Loans
Both of these are originated by banks and non-bank lenders. The lenders underwrite the loan and issue the original money to the borrower. The lender then sells the loan, or part of it, to financial institutions that make it available on a secondary market.
Private Companies
Private companies generally sell shares to venture capital funds or issue them to employees as an incentive or company benefit. This is considered the primary market until or unless the business decides to go public with an initial public offering.