How The Stock Market Works

Do you need a better grasp of how the stock market works? Maybe you already know a little but want some pointers on how to approach the markets…

Sound like you? Then this post is just for you.

Here’s a rundown covering exactly how the stock market works, some key historical eras, and most importantly, how to spot trends to help you find smart trading opportunities.

Let’s dive right in!

What Is the Stock Market? How the Stock Market Works

‘Stock market’ is a term that refers to a collection of exchanges worldwide where traders and investors buy and sell pieces of companies, commonly known as stocks or shares.

There are stock exchanges located all over the globe. The biggest exchanges are in the U.S. — the NYSE and the Nasdaq. But there are also major exchanges in London, Tokyo, Hong Kong, Sydney, and many other places.

The History of the Stock Market

Prior to organized stock exchanges, people who wanted to buy or sell stocks would have to seek out other traders to buy and sell with.

With society’s progression, an organized exchange was created where people could meet at a set place and trade stocks.

The first instance of an organized exchange was in London in the late 1700s. Traders would meet at a specific cafe and trade amongst each other. The cafe eventually changed its name to the Stock Exchange, which later grew into the London Stock Exchange.

Over time, this innovation that made it much easier to trade stocks spread throughout the world, and over the years, exchanges have evolved into what we see today.

Why the Stock Market Was Created

By now, you probably have the idea that one of the major uses of a stock market is to allow people to easily buy and sell stocks. But that leaves a big question: Why do companies want their stocks traded in the market?

Companies use the stock market for a variety of reasons. Some companies require capital to expand or continue operations, so they sell shares to investors through the stock market.

Even if a company doesn’t require a cash injection from investors, often the current owners would like a way to sell part or all of their stake in a company. Listing their company on a stock exchange can be a way to make that happen.

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 and seen countless highs and lows with economies expanding and contracting, wars waged and battled, and ever-changing developments in society and technologies.

Here’s a brief rundown of some of the most significant stock market times of the past fifty years:

The Gloomy 1970s

The 70s were gloomy times for the stock market as the economy endured what’s called stagflation. That’s where there’s minimal economic growth and high unemployment while costs continue to rise.

The 70s also saw a horrendous stock market crash that saw a collection of major stocks, known as the Dow Jones Industrial Average, lose 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, the 80s saw, for the most part, a boom for the stock market.

The world saw an era of pro-free-market economic policies put in place by leaders such as 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 5591 — the leading American stocks almost doubled in size.

But the 80s weren’t without bad times. The world saw a brutal, infamous crash in 1987.

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, and the world’s stock markets eventually 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 economic 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 historical lows. Not saying that’s a great thing, but it seemed to coax an economic recovery and a decade-long bull market.

How to Spot Trends: Key Techniques to Watch Market Strength

If you’re going to trade or invest in stocks, you’ll want to keep an eye on what’s happening in the stock market.

If you’re a value investor, you’ll probably look for stocks that have taken a hit in price. If you’re a momentum trader, you’ll probably look for stocks in strong uptrends and look to ride that wave.

Whatever your approach to the market, here are some basic but powerful techniques to help determine the current strength or weakness in the stock market:

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.

FOR EXAMPLE: One of the major indexes is the S&P 500. You probably hear it mentioned in the news. The S&P 500 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 Jones Industrial Average, 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

 

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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 stock are the hottest.

Once you see which sectors and stocks the market is excited about, it’s a good idea to keep a watchlist of them. A watchlist is your collection of stock tickers that’s easy for you to come back to again and again over time.

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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.

Conclusion

I hope you have a better understanding of how the market works by now … maybe you’re even ready to talk stocks at a dinner party.

If you’re just getting started in the stock market world, you’re in for a treat. It’s endlessly exciting, always changing, and it can provide many opportunities.

It’s always good to know the history of any of your endeavors, and I genuinely hope you enjoyed learning about the history of the market. This is just a tiny tip of the iceberg. There’s so much more you can learn.

Ready to dive in and try some trend-spotting techniques? Are you more excited than ever to learn the crazy world of the stock market? Join us at StocksToTrade Pro — and make sure you’re using a solid trading platform where you can easily view quotes, news, charts, and more. StocksToTrade makes all of that easy … Try it today — a 14-day trial is just $7!

How long have you been involved in the markets? Are you a newbie or a veteran? What made you take your first market plunge? I’d love to hear your story — share it below!