Understanding How the Stock Market Works (+ 5 Pro Tips)

Do you understand how the stock market works?

If you watch a lot of movies, you might think you do. But Hollywood has a skewed perspective. Movies glamorize trading … Stock prices move wildly up and down … Traders frantically 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 thoughtful approach to the market — with smarter risk management — you can experience that as well.

In this post, I’ll teach you all about the stock market. Read on to learn what it is and how to get started. Plus, I’ll share tips on how to make the most of your stock market adventure.

Let’s jump right into it…

What Is the Stock Market?

This post is all about the stock market … So let’s start with a clear definition of what the stock market is.

The ‘stock market’ is a broad term used to describe a collection of exchanges across that world. Traders use these exchanges to buy and sell pieces of companies — commonly known as stocks or shares.

Exchanges allow companies to list their shares (if they meet certain criteria). The owners of those companies can sell some or all of their stake. The markets also allow traders and investors to buy and sell those shares and potentially profit from the success of those companies.

Almost every developed nation has at least one stock market that traders use to trade the stocks of that country’s companies.

Of course, there are huge markets in the U.S. — the NYSE and the Nasdaq. But there are also markets in the U.K., Australia, Germany, Singapore, Hong Kong, and many other nations.

In a nutshell, that’s the stock market. Now let’s look at the inner workings of the market…

How the Stock Market Works

If you’re new to trading or investing, it can seem daunting to learn how the share market works. That’s because most people overcomplicate it.

In reality, all you need to know is how the market works. It’s basically like an auction…

There are buyers and sellers of stocks. The market is where they negotiate prices through stock bids and asks. (Need help with market terminology? Start here.)

Think of a house up for auction … An auctioneer starts the bidding at a certain price, and buyers start bidding up … They go until they reach the maximum price anyone’s willing to pay.

The stock market works in a similar way. But there are multiple sellers and multiple buyers. It’s called a double-sided auction process.

For example, a stock may be worth $10 in the morning. Then something excites buyers and they bid the price up to $12 by noon. But then a bad news story about the company comes out.

Suddenly, the holders are desperate to sell. They lower the offers until the stock price dips down to $8 by the end of the day.

That’s a super general view of how a stock can move in a trading day.

Historically, trading was done on the floors of exchanges, and traders would scream out orders. Now, with modern technology, we use laptops, software, and trading platforms to trade electronically on exchanges.

Overall, the stock market isn’t complicated. It’s just a place for buyers and sellers to meet up and find the right price to exchange their stocks.

How the Stock Market Affects the Economy

The stock market is widely seen as a powerful indicator for the economy — both for a given country and globally.

That’s because the stock market is made up of companies. And their values rise and fall depending on economic health. When the economy is strong, people tend to spend more. They generally make more sales and have more profits. So their values rise.

Many top economists, traders, and investors believe that the stock market predicts the future of the economy. Stock prices are a way for market participants to vote on what they think can happen in the future.

Does the stock market directly affect the economy? You could say that a country opening a stock market is a sign of economic progress.

And you could argue that if a stock market sees a decline, people may be scared to spend money. They may believe a decline is a sign that the economy could soon turn downward.

At StocksToTrade, we like to keep it simple. If the major stock indexes are up, it can be a sign that the economy is looking strong.

How Does a Stock Index Track the Stock Market?

To track the movements of the overall stock market, you can look at the performance of a handful of stocks and get a basic idea of how things are going.

If the stock prices for Microsoft (NASDAQ: MSFT), Apple (NASDAQ: AAPL), and Walmart (NYSE: WMT) are up for the year, the market probably is too. Most stocks correlate with the overall market.

Rather than just looking at stocks, though, savvy traders will look at things called stock market indexes. That includes the S&P 500, Dow Jones Industrial Average, Nasdaq 100, for example.

A stock market index is a numerical value that tracks the stock prices of a collection of individual stocks.

So the S&P 500 tracks the stock prices of America’s 500 largest publicly traded companies. Some companies may decline in price … But if the S&P 500 is positive overall, the stock market is seen as overall positive.

If you want to track the indexes, the easiest way is to look at index ETF tickers, such as SPY or QQQ. You can track them easily with StocksToTrade … Grab a 14-day trial for just $7.

Why the Stock Market Was Created

By now, you probably understand that the stock market is useful for traders and investors. But maybe you’re wondering: Why would a company list its shares on a stock exchange?

In reality, trading shares is just a byproduct of the market. The original function of a stock market was so company owners could sell off their ownership stakes. It was also to allow companies to get capital from investors to help grow their businesses.

For example, let’s say you own a company making toys called XYZ toys. You’ve grown it over 20 years. Now your company is a large toy manufacturer that makes $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 initial public offering (IPO), you can sell your shares to thousands of traders and investors.

As the company owner, you can walk away with a large amount of cash. And the individual investors collectively own the toy company you built.

For another example, let’s say you want to continue owning a slice of the company, but you need $200 million in capital to grow the business. In that situation, you could have an IPO and sell a portion of the firm for $200 million to investors. You could use that money as growth capital.

You end up owning a smaller stake in the company … But now your company has the capital to grow (and potentially make your stake worth more eventually).

Major Milestones of the Stock Market

If the stock market could speak, it’d have some amazing stories to tell.

The stock market’s been around for many centuries. It’s seen countless highs and lows through changing economies, wars, and developments in society and technology.

That’s one of the greatest things about being involved with the market — it’s always interesting. Let’s look at some of the biggest stock market periods of the past few decades…

The Gloomy 1970s

The 70s were gloomy times for the stock market. The economy endured what’s called stagflation. That’s where there’s minimal economic growth, high unemployment, and rising costs.

The 70s 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 though … Across the pond in London, the major English stocks lost close to 73% of their value at one point.

The Roaring 1980s

In contrast to the 70s, for the most part, the 80s saw a boom in the stock market.

It was an era of pro-free-market economic policies put in place by leaders like President Ronald Reagan and Margaret Thatcher. These policies helped stimulate first-world economies and open up opportunities for business and innovation.

The Dow opened the decade at the 2,883 level and finished out the decade at 5,591 — the leading American stocks almost doubled in size.

But the 80s weren’t without bad times…

On Monday, October 19, 1987 — widely known as 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.

Thankfully, the economy didn’t follow the markets off a cliff. The global markets recovered in the following years. That’s the happy ending of the famously roaring 80s.

The 2008 Subprime Crash

Now, let’s look at a stock market crash that’s a little closer to home…

Prior to 2007, the American economy was the envy of the world. Real estate was booming, people could easily borrow money, and the stock market was making highs.

It seemed like nearly everyone was making money.

This boom was a result of various economic policies, technical and financial innovation, and a hearty dose of euphoria. But sadly, many of those policies and innovations weren’t that smart … And those good times came to a screeching halt.

We saw an economic storm of monumental proportions. The housing market collapsed. Banks went bankrupt. Even famous 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. Times were so scary that many believed we were basically reliving the Great Depression of the 1930s.

Thankfully, things recovered reasonably quickly. Central banks all over the world stepped in and lowered interest rates to historic lows. Not saying that’s a great thing, but it seemed to coax an economic recovery and a decade-long bull market.

How Can I Learn the Stock Market?

Getting started in the stock market can at first be daunting. Analyzing stocks, reading charts, entering orders, making trade plans, setting your risk management … 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 fundamental skills, you can do it.

It’s hard work, not gonna lie. But you may even really 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.

Even better news is that you’re in the right place… Here on the StocksToTrade blog, we live and breathe the markets and we love educating traders.

Want more trading resources? Check out our SteadyTrade podcast or follow us on YouTube.

And once you start trading, you’ll need to analyze and watch stocks in real time. To do that, you need a solid trading platform. Take our StocksToTrade platform for a spin — get your 14-day trial for just $7.

How Does the Stock Market Crash?

Market crashes terrify most traders and investors, especially newbies.

Stock markets historically gain in value over time. They tend to track society’s progress and growth. But sometimes economic situations can change fast. This shouldn’t scare you off from investing in or trading stocks.

As I said, the stock market has always recovered. The market crashes of the previous century are just blips on the long upward trend of the global stock market. And for smart traders, stock market crashes can mean amazing buying 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 overall stock market. We keep an eye on which way prices are trending.

It’s how we can see when a stock is no longer trending upward and possibly 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. But you gotta know what you’re doing. So it’s key to prepare for them by developing your trading skills and knowledge.

How to Trade or Invest in the Stock Market

Investing in the stock market — or trading in it — is super simple these days.

All you need is a stock brokerage account, capital to buy, and a trading platform to analyze stocks.

Not all brokers are equal. So do your research. Go with larger firms that stick to U.S. regulations. Check out this post on how to find the right broker for your needs.

How much capital do you need to start trading? Honestly, not much. Some of the best stock market traders today started with around $1,000. If you’re just getting started, be sure to save up first. You can paper trade while you save to learn the ropes.

For a trading platform, think about this…

You want to check a stock’s fundamentals, look at charts, keep a watchlist of exciting stocks, and scan for promising trading opportunities. You can do all on the StocksToTrade platform. Check it out today with a 14-day trial for just $7.

Is it Possible to Make Money in the Stock Market? 5 Smart Tips

Over the years, I’ve seen people make the assumption that stock market success is only for the elites — fund managers, billionaires, well-connected people, and wealthy celebs.

This couldn’t be further from the truth. In fact, a retail trader with a small account can potentially have a clear advantage over a fund manager investing billions of dollars.

As a small trader, think of yourself as a speedboat riding the waves of the ocean. At any time, you can change direction in an instant and go with the flow of the market.

On the flip side, the fund manager with billions of dollars is like a huge oil tanker. If they want to change direction, they better 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 of the market.

Now, here are 5 tips to help you trade smarter…

1. Watch the Indexes

Indexes are a numeric representation of a collection of stocks. That may sound complicated, but it should be easy to get your head around.

One of the major indexes is the S&P 500. It represents the price of the top 500 stocks listed on American exchanges. It’s seen as a major indicator of what’s happening in the broad stock market.

Other major indexes are the Dow, which is the top 30 stocks, and the Russell 2000, which is a collection of 2,000 small stocks. There are also many lesser-known but useful indexes.

When determining the broad strength of a market or sector, a good first step is to look at an index or two and consider the price action and trend.

It’s pretty 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 buzz, and more — all from a single platform. Grab a 14-day trial for just $7 now.

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 what’s hot in the market and where the money’s flowing. An easy way to help you determine what’s trending is to keep track of the leading stocks.

Leading stocks are those that make the biggest percentage gains.

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 quickly see which stocks are the hottest.

Next, it’s a good idea to keep a watchlist of these hot stocks. That’s your collection of stock tickers that’s easy for you to come back to again and again.

With StocksToTrade, you can access scans to help you find the hottest stocks and keep unlimited watchlists. Check it out for yourself today with a 14-day trial for just $7.

Sign up for our weekly watchlist here.

3. Use Charts to Time Your Trades

It’s no accident that when you see a top trader sitting in front of their screens, you see them looking at a bunch of stock charts.

Stock charts are graphical representations of stock price changes over time. By reading the price action in 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 that looks solid fundamentally. But sometimes, you buy these stocks and the price might not move.

By adding chart reading 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. That might be a proven support level or consistent uptrend. Check out this post to learn more about reading charts.

4. Focus on Small-Cap and Penny Stocks

Are you a trader with a small account?

That can be a great thing! You have a ton of opportunities to be involved with the hottest, fastest-moving stocks. These opportunities are generally found at the smaller end of the market, in small-cap 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 10%, 20%, 50% or more in a single day.

There’s often not enough trading volume or liquidity for the big traders to get involved … That means less competition for you. If you know what you’re doing. Beef up on your education!

It’s key to be able to find these small-cap and penny stock plays as they’re about to happen. And you need a stock screen that can help you find stocks that fit your criteria and strategies.

StocksToTrade has built-in, easy-to-use scans that can help you find the great setups in no time. Come and check it out with a 14-day trial for just $7.

5. Keep Learning

As with anything worth doing in life, stock trading requires you to constantly learn and develop your skills.

That could involve reading about stocks, learning to analyze company fundamentals, paper trading new strategies, or poring over countless charts.

If you really want to step your game up, consider learning directly from a pro trader…

How Do the Pros Approach the Stock Market?

The stock market has the potential to be a fantastic wealth-creation machine … 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.

But what if you could cut to the chase and see exactly how a professional trader approaches the stock market? StockToTrade Pro could be just what you’re looking for…

StocksToTrade Pro is our elite trading community where 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 through our chat room, as well as attend cutting-edge trading webinars. We take our trading education seriously. And if you do too, I invite you to join us at StocksToTrade Pro today.

Conclusion: How the Stock Market Works

Developing an interest in the stock market can add so much to your life if you go about it the right way. It’s not just about the money. either.

Through the stock market, you can learn about the global economy, new technology, societal changes, and so much more.

If you develop your skills enough, you can work to build a career as a trader or investor. That could mean being your own boss, working from home, setting your own hours…

I feel so fortunate every day that years ago I set off on the path to becoming a stock trader. I hope that you’ll follow in my footsteps if this post lights a fire in you.

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. And check out all of our resources.

Just make that first step … Find an interesting stock, bring it up on your trading platform, read the associated 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!