How do stocks work? With all the recent hype in trading, it’s a good question to ask.
But here’s what the pros ask themselves: How does the stock market work?
If you watch a lot of movies, you might think you have an idea of how the market works. But Hollywood has a skewed perspective. Movies glamorize trading. They show stock prices jumping up and down … traders racing to buy and sell…
That can be your experience of the stock market — if that’s what you want.
But if you want a calmer and more thoughtful approach to the market — with smarter risk management — read on.
In this post, I’ll get into how the stock market works and how to get started trading. Plus, I’ll share tips on how to make the most of your stock market adventure.
Let’s jump right into it!
Table of Contents
- 1 How Do Stocks Work: What Are Stocks?
- 2 How Do Stocks Work: Types of Stocks
- 3 How Do Shares Work in the Stock Market?
- 4 How Does Trading Stocks Work?
- 5 How Do Stocks Work: Why Should You Own Stocks?
- 6 How Does Buying and Selling Stocks Work?
- 7 How Do Stocks Work: Who Are Stock Market Investors and Traders?
- 8 What Is the Stock Market?
- 9 How the Stock Market Works
- 10 How the Stock Market Affects the Economy
- 11 How Does a Stock Index Track the Stock Market?
- 12 How Do Stocks Work: Major Milestones of the Stock Market
- 13 How Do Stocks Work: How Can I Learn the Stock Market?
- 14 How Does the Stock Market Crash?
- 15 How Do Stocks Work & How to Trade or Invest in Stocks
- 16 How Do You Earn Money From Stocks? 5 Smart Tips
- 17 How Do the Pros Approach Stocks?
- 18 Conclusion: How Do Stocks Work?
- 19 One Platform. One System. Every Tool
How Do Stocks Work: What Are Stocks?
A stock — also called a share — is ownership of a fraction of a company. People can buy shares and own part of the company. We call this investing, or taking out stock.
There are a lot of different types of investment vehicles. The umbrella term is securities. So, stocks are a type of security. There are also options, commodity futures, certificates of deposits (CDs), and bonds. For this post, we’ll keep it stock-related.
Another term for stocks is equity. Sometimes companies pay their employees in equity. Investors take equity — though the term is mostly used to mean big investors taking big positions.
In some SEC filings, you’ll see companies talk about what percent of the equity an institution or investor owns. This type of fundamental research can give you insight into insider trading.
How Do Stocks Work: Types of Stocks
There are five basic types of stocks. Let’s start with the most common terms you’ll encounter as a trader…
- Common shares. Anyone can trade these. If you place an order, most of the time you’ll get common shares by default.
- Preferred shares. Exclusive stocks with strict dividend rules. You can buy these. In most cases, you’ll have to tell your broker you want preferred shares.
Here are some common investment terms. You may not use them much in trading, but market knowledge is never a bad thing.
- Growth stocks. These are startups and companies that buyers expect will grow over time. With these, you might be in it for the long haul.
- Value stocks. Sometimes the market undervalues a company. You might find the price of a stock is out of sync with the company’s earnings per share (EPS). You could buy the shares and wait for the stock price to catch up to the company’s performance.
- Income stocks. Also called blue chips. These are shares of companies that pay good dividends. The best income stocks are companies that keep raising their dividends.
A company that wants to be on the market can do an initial public offering (IPO). Once the company hits the stock exchange, shares go to investors and traders. Before long, they’re all owned by someone.
In 2020, special purpose acquisition companies (SPACs) became popular. A SPAC is like a company doing an IPO. But instead of raising money to improve, a SPAC is raising money to take over another company. They’re also called blank-check companies.
When you buy a share on the market, you’re buying it from a trader, investor, or institution. When you sell those shares, there’s someone on the other side of your trade. Again, an investor, trader, or institution.
The transfer of shares goes through a clearinghouse. The money and share ownership gets tracked and recorded. It takes about three business days — T+3. That’s the time of transaction plus three days.
We call that period the settlement time. If you’re trading with a cash account, your cash won’t settle until the time has passed. It’s the same with a margin account, but with a margin account, your broker will loan you the money until settlement.
How Does Trading Stocks Work?
You’ll need a broker. You can trade stocks with any investment account — even a 401(k), IRA, or Roth IRA.
Most brokers have their own trading platforms where you can place trades. You put your order in and your broker tries to fill it. The price you’re willing to buy at is called a bid.
If someone is willing to sell the stock at your bid, your broker can pick it up for you. When you’re ready to sell a stock — or you want to short sell a stock — you tell your broker the price you want for it.
There’s no guarantee your order will get filled. You’re not alone in the market. If you’re trading a liquid stock, there’ll be thousands of other orders from thousands of other traders.
Other buyers may have placed their orders before you. They may have larger orders. If there aren’t enough shares sold at that price, you might not get filled.
And if you’re trying to sell and other sellers are ahead of you, you’ll need buyers. So if there aren’t enough buyers to take your shares, you might not get filled.
With StocksToTrade’s broker integration feature, you can place orders right on your trading platform. You’ll also get beautiful charts, built-in scanners, news feeds, and more. Try it for 14 days for only $7!
How Do Stocks Work: Why Should You Own Stocks?
I can’t give you investment advice. For me, trading is my preferred way to be in the markets. But I can tell you this…
You work for your money. Your money should work for you. Buying stocks is a time-honored means of growing wealth. That doesn’t mean it’s the best.
You could bury your money in your backyard and lose it to inflation. You could put it in a high-yield savings account and grow it over time.
Or you can own stocks. Over the last 50 years, the stock market has been the most profitable option. Not every stock, mind you, but in general.
Until March 2020, we were in the longest bull market in history. You could argue that we’re still in that same bull run — just with a dramatic pullback.
If you had invested in an index fund in 2010 — more on index funds later — you would have quadrupled your money by now. That’s all hindsight of course. And it’s why I prefer to be more hands-on with shorter-term trading strategies. It’s what I teach.
This is the golden age of stock trading. If you’re asking yourself, “Is it easy to earn money from stocks?” I’d say no. But I can tell you there’s never been a better time to learn.
If you’re a serious and dedicated student, we’d love to have you on the SteadyTrade Team. You’ll get hands-on, twice-daily mentorship and a community of traders to help you learn the ropes. Join the team today!
How Does Buying and Selling Stocks Work?
Now you’re getting ready to buy the stock. It’s time to think about order types. You can put in a market order, a limit order, or a stop order.
- A market order means you’ll pay any price. Your broker will try to get you the best price — but the best price might not be what you expect.
- A limit order lets you set the price you want. But there’s a chance you don’t get filled. If no one wants to sell at your price, you won’t be able to buy it. But you won’t pay more than you expect.
- A stop order is an order that triggers at a certain price. You can use this to buy if a stock breaks out. You set your trigger price. You set the type of order you want to place at that trigger price. If the price hits your trigger, your order gets placed.
The reverse is true for selling and short selling. If you have a position and you’d like to sell, the same order types are available.
For stocks trading on major exchanges, brokers route orders through electronic market makers. Those market makers match buyers and sellers on the exchange.
For OTCs, brokers route orders to broker-dealer networks. On these networks, broker-dealers buy and sell over-the-counter securities.
How Do Stocks Work: Who Are Stock Market Investors and Traders?
You can think of this as a grid with four quadrants. You’ve got retail and institutional traders. Then you’ve got long-term investors and short-term investors.
Institutional traders are the goliaths in the market. They’re hedge funds, mutual funds, and other forms of big money.
Retail traders are individual traders using their own money.
Short-term institutional investors are institutions and funds that tend to use algorithms and complicated equations to trade. High-frequency traders (HFTs) are in this group.
Long-term institutional investors are usually mutual funds. Sometimes they’re investors looking to make big changes at a company.
On the retail side, you have your traditional investors. And you’ve got day traders.
So you’ve got long and short-term institutional money and you’ve got long and short-term retail money.
Technology has democratized just about everything — including trading and investing. These days anyone can get started with a couple hundred bucks and a cell phone. Again, that can make it sound easy. It’s not. Be fully aware of what you’re getting into.
What Is the Stock Market?
The stock market is a broad term used to describe a collection of exchanges across the world. Traders use these exchanges to buy and sell shares of companies.
Exchanges allow companies that meet certain criteria to list their shares. Traders and investors can buy and sell shares in hopes of profiting from price movement.
Almost every developed nation has at least one stock market.
There are huge markets in the U.S. — the New York Stock Exchange (NYSE) and the Nasdaq. But there are also markets in the U.K., Australia, Germany, Singapore, Hong Kong, and many other nations.
How the Stock Market Works
If you’re asking ‘how do stocks work,’ you likely need to know how the market works. The market works like a double-sided auction. Instead of several buyers and one seller, there are crowds of buyers and sellers. The market is where they negotiate prices through stock bids and offers.
For example, a stock may be trading for $10 in the morning … then something excites buyers and they bid the price up to $12.
Later in the day, the company puts out bad news. Now shareholders are desperate to sell. They lower their offers until the stock price dips down to $8 by the end of the day.
That’s a very basic idea of how a stock’s price can move in a trading day.
In the past, traders would scream out orders on the trading floor. Now we use laptops, software, and trading platforms for electronic trading.
The stock market isn’t complicated. It’s a place for buyers and sellers to meet up and find the right price to exchange their stocks … But that doesn’t mean trading is easy.
Markets can shift direction in an instant. That’s why one of the many things I like about StocksToTrade is the Breaking News Chat feature. Two stock market pros sift through all the news and hand-deliver exactly what you need to know.
How the Stock Market Affects the Economy
Company shares make up the stock market. Their values rise and fall depending on economic health. When the economy’s strong, people spend more. Companies sell more products and services, earning more profits. So their values rise.
The stock market is a powerful indicator of economic health. It’s a forward-looking indicator, representing where traders and investors think the economy is headed.
Some market observers say the stock market predicts the economy’s future. The stock market works as a way for people to vote on what they think can happen. If the major stock indexes are up, it’s a sign that investors are optimistic about the economy’s future.
How Does a Stock Index Track the Stock Market?
The most popular indexes are the Nasdaq Composite, Standard and Poor’s 500 (S&P 500), and the Dow Jones Industrial Average (the Dow). Watching them is a way of tracking the stock market.
The Nasdaq Composite includes all the companies trading on the Nasdaq. The S&P 500 is a market-cap-weighted average. The Dow is another average, but it’s not market-cap-weighted.
These indexes average or combine the values of the companies they track. When the Dow and S&P 500 were created, teams of people worked daily to keep up. These days, computers bring updates by the tick.
The Nasdaq was always an electronic exchange. Its composite index never required the labor demanded by the other major indexes.
If you want to track the indexes, the easiest way is to look at exchange-traded funds (ETFs), like SPY or QQQ.
How Do Stocks Work: Why Was the Stock Market Created?
So, you can see how the stock market is useful for traders and investors. But why would a company list its shares on a stock exchange?
Trading is a byproduct of the market. The original purpose of the stock market was for company owners to sell shares and use the proceeds as capital to help grow their businesses.
The stock market still works that way. For example, let’s say you own a company that makes toys. You’ve grown it over 20 years. Now your company is a large toy manufacturer making $100 million a year in profits.
But you’re ready to retire and want to find someone to buy your company. At this point, you could list your company on a stock exchange. Through an IPO, you can sell your shares to investors.
As the company owner, you can walk away with a large amount of cash. And the investors own the toy company you built.
Here’s another example: Let’s say you want to keep a slice of the company, but you need capital to grow the business. In that situation, you could sell some of the company for capital and use that money for growth.
How Do Stocks Work: Major Milestones of the Stock Market
If the stock market could speak, it’d have some amazing stories to tell.
Stock markets have been around for centuries. Amsterdam hosted the first stock market, back in the 17th century.
The market’s seen wild swings. It’s survived changing economies, wars, and societal and technological developments.
That’s one of the greatest things about studying the market — it’s always interesting. So in our ‘how do stocks work’ lesson, let’s look at big stock market periods of the past few decades.
The Gloomy 1970s
The 1970s were grim times for the stock market. The economy was going through stagflation. There was minimal economic growth, high unemployment, and rising inflation.
The decade also saw a horrendous stock market crash. The major stocks on the Dow lost over 45% of their value. This was one of the worst stock market crashes of all time.
That wasn’t even the worst of it. Across the pond in London, the major English stocks lost close to 73% of their value at one point.
The Roaring 1980s
The 80s, for the most part, saw a boom in the stock market.
It was an era of free-market economic policies. These policies helped stimulate first-world economies. They opened up opportunities for business and innovation.
But the 80s weren’t without bad times.
On Monday, October 19, 1987 — Black Monday — the Dow fell by over 22% in a single day. This set off a chain reaction, and many global stock markets saw huge declines.
But the economy didn’t follow the markets off a cliff. The global markets recovered in the following years. The Dow opened the decade at 2,883 and finished it at 5,591. The leading American stocks almost doubled in value.
The 2008 Subprime Crash
Before 2007, the American economy was the envy of the world. Real estate was booming. People had no trouble borrowing money. The stock market was setting new highs. It seemed like everyone was rolling in dough.
This boom was a result of economic policies, innovations, and a hearty dose of euphoria. Many of those policies and innovations weren’t that smart. The good times came to a screeching halt.
We saw an economic storm of monumental proportions. The housing market collapsed. Banks went bankrupt. Institutions like Bear Stearns and Lehman Brothers died a quick death. The stock market took a beating.
The Dow lost over 50% of its value, with global markets suffering similar damage. Many thought we were headed for a depression like the Great Depression of the 1930s.
Things recovered in good time. Central banks all over the world stepped in and cut interest rates to historic lows. Not saying that’s a great thing, but it coaxed on economic recovery and a decade-long bull market.
The 2020 Market Crash
In less than eight months, 2020 put stock market history to shame.
2020 began the 11th year of a bull run. That in itself was historic, but no one could’ve predicted what was to come.
Between February 19 and March 23, the stock market experienced a historic crash. On March 12, for the second time in history, the SPY hit a circuit breaker.
Then came the famed V-shaped recovery.
People were stuck at home with nothing to do. Sporting events were out, so sports betting wasn’t an option. And people could trade for ‘free.’ Stay-at-home orders, commission-free brokers, and stimulus checks fueled a historic recovery. By August 24, the SPY was back to all-time highs.
That’s when Tim Sykes and I made this “Volatility Survival Guide.”
How Do Stocks Work: How Can I Learn the Stock Market?
Getting started in the stock market can seem daunting. Fundamentals, technicals, trade plans — there’s so much to consider.
The good news is that it’s easier to learn now than it’s ever been. You have access to so much information. If you follow solid advice, learn from the right teachers, and focus on developing solid skills, you can do it.
It’s hard work, not gonna lie. But you may actually enjoy it.
In fact, I’d say that developing a deep interest in the stock market can be a fulfilling hobby. Many of the professional traders I know are some of the happiest people I’ve ever met.
Check out some of these interviews on the SteadyTrade podcast. You’ll see what I mean.
How Does the Stock Market Crash?
How do stocks work? For one, they rise and fall. Market crashes terrify most traders, especially newbies.
Stock markets gain in value over time. They tend to track society’s progress and growth. Of course, economic situations can change fast. This shouldn’t scare you away from investing in or trading stocks.
As I said, the stock market has always recovered. The market crashes of the previous century are blips on the global stock market’s long upward trend. And for smart traders, stock market crashes can mean amazing opportunities. Savvy investors can even pick up bargain investments.
It’s all about how you approach the market.
At StocksToTrade, we watch the price action of the market. We keep an eye on which way prices are trending.
That’s how we can see when a stock is no longer trending upward and might be trending downward. It can be a cue that’s time to switch up our trading strategy.
Crashes and downturns aren’t great, but they can come with opportunities. You gotta know what you’re doing. So it’s key to prepare for them by developing your trading skills and knowledge.
How Do Stocks Work & How to Trade or Invest in Stocks
Buying and selling stocks is simple these days. All you need is a brokerage account, capital, and a trading platform.
Not all brokers are equal. So do your research. Go with larger firms that stick to U.S. regulations — assuming you’re based in the U.S.
How much capital do you need to start trading? Some of the best stock market traders today started with as little as $1,000. With the right risk management, you can make that work for you. Be sure to only risk money you’re willing to lose. You can always paper trade as you save.
How Do You Earn Money From Stocks? 5 Smart Tips
Some people assume that stock market success is only for the elites.
This couldn’t be further from the truth. A retail trader with a small account can have an advantage over a fund manager. That’s not to say it’s easy.
As a small trader, think of yourself as a speedboat riding the ocean waves. At any time, you can change direction and go with the market’s flow.
The fund manager with billions of dollars is like a huge oil tanker. If they want to change direction, they have to plan well ahead. It won’t be easy, and it’ll involve a ton of buying or selling before they can get with the flow.
Here are five tips that can help you trade smarter.
How Do Stocks Work Tip #1: Watch the Indexes
When determining the strength of a market or sector, a good first step is to look at an index or ETF. Consider the price action and trend.
It’s easy to view the major indexes. In your stock platform, type in the following tickers:
- SPY for the S&P 500 Index
- DIA for the Dow Jones Industrial Average Index
- IWM for the Russell 2000 Index
Not set up with a trading platform? We’ve got you covered. With StocksToTrade, you can access quotes, charts, scanners, news feeds, social media, and more — all from one platform. Grab a 14-day trial for just $7.
How Do Stocks Work Tip #2: Keep a Watchlist of the Leading Stocks
Even when the broad stock market is down, various stocks and sectors will still do well.
It’s always smart to know which sectors are hot and where the money’s flowing. Traders track leading stocks to see what’s trending.
You can use your trading platform to look for the biggest gainers for the past day, week, month, or year. It’s one way to see at a glance which stocks are the hottest at the moment.
It’s a good idea to keep a watchlist of stock tickers to check again and again.
I put out a weekly watchlist every Sunday. It’s got four or five of the stocks I’m keeping a close eye on. Sign up for my no-cost weekly watchlist here.
How Do Stocks Work Tip #3: Use Charts to Time Your Trades
It’s no accident that you see top traders sitting in front of screens full of stock charts.
Stock charts are graphical representations of stock price changes over time. By reading the price action on a chart, you can make smarter trading decisions. It’s part of how you figure out when to enter and exit a trade, as well as where to place your stop loss and profit targets.
It’s one thing to buy a stock with solid fundamentals. But sometimes, you buy these stocks and the price doesn’t move.
By adding technical analysis into the mix, you can understand when the market’s excited about a stock. And you can see when traders rush in to buy a stock, which can push the price up.
As a rule of thumb, don’t enter a stock position unless you see a compelling situation on the chart. I’m talking about stock chart patterns.
How Do Stocks Work Tip #4: Focus on Small-Cap and Penny Stocks
Are you a trader with a small account?
That can be a great thing — if you know what you’re doing! There are a ton of opportunities to trade the hottest, fastest-moving stocks. Opportunities abound in the world of small-caps and penny stocks.
These are stocks of small companies with prices of below $10 or so per share. A little hype around a small stock can send the stock price moving 50% or more in a single day.
But education here is key.
How Do Stocks Work Tip #5: Keep Learning
As with anything worth doing in life, stock trading requires you to learn and develop your skills.
Read all you can about stocks. Learn how to analyze fundamentals. Find new strategies and practice them. Stare at charts until your eyes bleed.
If you want to be a trader, it’s going to take a lot of work. But I’ve never once regretted all the work I’ve put in.
How Do the Pros Approach Stocks?
It’s possible to make money trading stocks. But finding and executing the best trades requires a tremendous amount of skill.
There’s a huge chasm between the skill levels of beginner and professional traders.
What if you could cut to the chase and see exactly how a professional trader approaches the stock market? The SteadyTrade Team could be what you’re looking for.
In my SteadyTrade Team webinars, I share my screens, thoughts on the markets, and the exact stocks I look at every trading day.
You can also interact with me and other traders. We’ve got cutting-edge trading webinars. Don’t worry if you’ve missed some. They’re all archived.
We’re serious about our trading education. And if you are too, join us!
Conclusion: How Do Stocks Work?
Developing an interest in the stock market can add so much to your life if you go about it the right way.
Through the stock market, you can learn about the global economy, new technology, societal changes, and so much more.
How do stocks work? Stock trading has been one of the most rewarding parts of my life. I feel fortunate every day that years ago I set off on this path. I hope that this post lights a fire in you and you’ll follow in my footsteps.
This post isn’t enough to get you started in the markets. But don’t feel overwhelmed. Remember that every long journey starts with a single step. So check out our resources.
Take that first step. Find an interesting stock, bring it up on your trading platform, read the news and watch its chart.
If you don’t have a go-to trading platform, now’s a great time to get StocksToTrade. You can grab a 14-day trial for $7.
How much time do you spend each day studying and watching the stock market? Tell me below — leave a comment!