Decoding How The Stock Market Works

May 04, 2023 · 6 mins read
Decoding How The Stock Market Works
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The stock market: a term that can evoke a wide range of emotions from individuals. Some view it as the golden ticket to financial freedom, while others may associate it with painful memories of past financial crashes. Despite the mixed perceptions, one thing is clear: the stock market plays a crucial role in building wealth for many people.

Your personal retirement account, 401(k), or even your pension plan’s success is closely tied to the stock market’s performance. This may seem daunting, but it all comes down to the simple concept of buyers and sellers exchanging shares in an auction-like setting.

The stock market defined

The stock market is a hub where investors can buy and sell shares of stock in various companies. These stocks represent fractional ownership in a business, allowing investors to potentially profit from the company’s success.

To ensure fairness and protect investors, the Securities and Exchange Commission oversees the operation of “national securities exchanges” where stocks and other financial instruments are traded. While there are many exchanges out there, the New York Stock Exchange and Nasdaq Stock Market are the most popular among Americans.

Investing in stocks

Well, there are a few ways you can do it! The most common methods include market orders, limit orders, and stop orders.

Market orders are the quickest and easiest way to buy or sell stocks. They’re executed immediately at the current market price. This means you’ll get the stock at the best available price at that moment.

Limit orders are a bit more specific. With a limit order, you set a specific price at which you want to buy or sell a stock. If the stock reaches that price, your order will be executed. If it doesn’t, the order won’t be filled. This can be a useful tool if you have a specific price in mind or want to control your buying/selling price.

Stop orders are a type of order that’s triggered once the stock reaches a specific price. This is often used as a way to limit your losses or protect your gains. For example, if you own a stock that’s currently worth $50 and you want to sell it if it drops to $40, you can set a stop order at $40. If the stock drops to $40, the stop order will trigger, and your shares will be sold automatically.

How you buy and sell stocks

When you place a market order, you’ll buy stocks at or near the current ask price, or sell at or near the current bid price. However, keep in mind that the posted bid and ask prices are based on the last executed order, so your order may not execute at the exact same price.

Limit orders work similarly to market orders, but with an added limit price. If you’re buying, your order will only execute at the limit price or lower. If you’re selling, it will only execute at the limit price or higher. Don’t get this confused with stop orders, which combine market and limit orders. With a stop order, you wait until the stock reaches a specific stop price, and then your broker will execute a market order

Generating returns

Individual stocks can be volatile and can change in value based on many factors, both inside and outside of the company.

But don’t let that scare you away! Despite the risks, investing in stocks has the potential to generate returns over time. In fact, the S&P 500 has produced an average annual return of 10.26% over the past 10 years. That’s some serious dough!

So, how exactly do stocks make you money? There are two primary ways: through dividends and capital appreciation. Dividends are a portion of a company’s profits that are paid out to shareholders, usually quarterly. Capital appreciation, on the other hand, is when the value of your shares increases over time, allowing you to sell them for a profit.

Rising share prices

This means that as the stock price rises, investors can sell their shares for a higher price than what they originally paid. Let’s say you bought 100 shares of stock XYZ for $10 each, totaling $1,000. If the stock price rises to $12 per share a year later, your investment is now worth $1,200. That’s a profit of $200 just from the stock price increasing!


These payouts are a slice of a company’s earnings that are given out to its shareholders. And the best part? They’re usually paid out on a regular basis, like clockwork.

But did you know that some companies go above and beyond and offer special dividends outside of their regular payout schedule? That’s right - they’ll surprise their shareholders with an extra cash payout just because they can. It’s like finding money in your pocket you forgot you had!

Now, it’s important to note that there are no hard and fast rules about when these special dividends will be issued. It’s totally up to the company’s discretion. But for investors, it’s just one more reason to keep an eye on the companies they’ve invested in. Who knows - you may just get a nice little surprise in the form of an unexpected dividend payout.

Managing risk

It’s important to seek advice from a financial advisor before making any investment decisions to reduce your risks.

Luckily, there are ways to mitigate the risk of investing in stocks. One option is to invest in a mutual fund or index fund, which diversifies your portfolio across multiple stocks and sectors. This means that if one stock goes belly-up, it won’t have as significant an impact on your investment. Additionally, consider investing some of your capital in other asset classes such as bonds to reduce your overall exposure to the stock market.

Should I invest in stocks?

Sure, stocks come with risks, but with a little self-education and professional advice, you can minimize those risks and potentially earn big returns.

Don’t believe us? Just look at the numbers. The S&P 500 has seen an impressive 10.26% return recently, while the average interest rate on a 60-month CD at the bank is a paltry 0.95%. That’s a huge difference! By finding the right stocks or funds to fit your investment goals and risk tolerance, you can make stock investing work for you. Don’t let fear hold you back from exploring the world of stock investing. With the right approach, you can reap the rewards of potentially high returns while minimizing the risks.

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