Stock Market 101
When you hear about the stock market does it feel like you’re listening to a different language? One you really want to learn but just can’t seem to grasp? You’re not alone, that’s for sure.
Does a lack of confidence about how the stock market works put you off investing too? It doesn’t have to. We can help you understand what a stock market is, and how it works so the thought of investing seems less overwhelming.
What are stocks?
Let’s break it down, starting with the basics. Stocks, also known as equities, are a security representing partial ownership of a publicly traded company. So, when you buy stocks in a company, it means you own a part of that company. A share is the unit of stock; the more shares you buy, the more stock you have in a company. Stocks are issued by companies to raise money to grow their business.
There are two main types of stocks, one is called a common stock and the other is a preferred stock. The main difference between the two is that common stocks give shareholders the right to vote on company matters and participate in the growing earnings of the company while preferred stocks don’t. Preferred shares may come with a higher fixed dividend payout.
What is a stock market?
An easy way to think about think about the stock market is to consider it as a network of stock exchanges where traders and investors buy and sell shares of publicly traded companies.
Private companies list shares of their stock on an exchange through a process called an initial public offering (IPO). Investors purchase those shares, which allows the company to raise money from the public to grow its business. Once the company is listed on a stock exchange it is now a public company and investors can buy and sell the company’s shares on an exchange which tracks the stock price.
The supply and demand helps determine the price for each security at which investors and traders are willing to buy or sell.
How does the stock market work?
To better understand how the stock market works, it helps to know that there are two types of markets: the primary market and the secondary market.
The primary market is where securities are created, and a company lists their shares through an IPO. Remember, an IPO is when a company first lists their shares publicly.
The secondary market, which is essentially the stock exchange, is where the supply and demand of these shares (along with the thousands of other stocks on the market) are bought, sold, and traded every day. The TSX is open weekdays from 9:30am – 4:00pm (ET), the NYSE is open for business Monday to Friday, during the hours of 9:30am – 4pm (ET), the NASDAQ follows the same opening and closing schedule as the NYSE.
When it comes to trading shares on a stock exchange, there are two main types of investing strategies. Day trading, as the name implies, buying and selling the same shares within one day, sometimes making trades that last for just minutes or even seconds. The intent is to take advantage of small fluctuations in price. Then, there are more long-term trades or investments where the buyer holds shares for longer periods of time and hopes to take advantage of the company’s long-term growth in earnings.
The stock market serves two important purposes. First, it helps companies raise money often referred to as capital from the public by offering shares for sale, which can be used to fund and expand their business. Secondly, it gives an investor, who purchases those shares, an opportunity to have a share in the company’s profits. Investors can profit from owning stocks in one of two ways. Some stocks pay regular dividends (a given amount of money per share) at regular intervals which provides a return on the amount of money invested in the shares. Alternatively, a return can also be earned through capital appreciation which is when the stock price increases.
Bull and bear markets
What do a bull and a bear have to do with the stock market? They refer to market conditions, whether it’s increasing or decreasing in value. One day the market goes up, and then the next day it goes down. These are called market fluctuations and they’re part of how the whole system works. The bull and the bear are two symbols that have long been associated with the stock market. A bear market is one where stocks are declining in value over a period of time and a bull market, is where stock prices are rising over a period of time. Typically, one market type follows the next and in general, the average bull market tends to outlast a bear market.
There are major market indices (the plural of index) that track the performance of a group of stocks. These indices are used to represent the movement of specific stock exchanges such as the TSX or NYSE and they’re the ones that are being referenced when the market goes up or down. Indices work by measuring a weighted average value of a collection of securities.
Some of the major indices are the TSX Composite, the Dow Jones Industrial Average (DJIA), the S&P 500 and the Nasdaq composite index. When an index drops, it means the average value of all the stocks in the index are down from the previous business day.
Commonly known stock exchanges in North America
The size of a stock exchange is directly related to the number and size of companies that are listed on the exchange. Below are three of the most commonly known American and Canadian stock exchanges.
- TSX (Toronto Stock Exchange) is located in Toronto, Canada. It is the 9th largest exchange in the world by market capitalization1. A wide range of companies from Canada and all over the world are listed on this exchange.
- NYSE (New York Stock Exchange) is an American stock exchange in the Financial District of Lower Manhattan in New York City and is the world's largest stock exchange1 by market capitalization of its listed companies with billions of trades happening daily.
- NASDAQ (National Association of Securities Dealers Automated Quotations) is an electronic marketplace based in the United States and is focused on high technology listings. It is ranked second on the list of stock exchanges by market capitalization of shares traded1, behind the New York Stock Exchange.
What are brokerages?
Think of a brokerage firm as a type of financial institution that acts as a go-between (or broker). They help investors buy and sell stocks by working with both sides: the buyer and the seller. There are multiple ways to place a trade. You can place your buy and sell orders by phone, online or an app. Most brokerage firms charge per trade.
There are two main types of brokerage firms, Full-Service and Discount Brokerages.
Full-service brokerage firms are known for having a collection of diversified financial services and usually assign an advisor to each client. Sometimes they’re also able to offer additional financial services, including planning, consulting, wealth management and trust services. It’s worth noting that a higher level of service usually means a higher price tag.
Rather than provide financial consulting or planning services, discount brokerages are a form of direct investing (or online investing), which provide self-directed investors access to online market research, online education, and a range of direct-access trading platforms. For example, with TD Direct Investing, you're able to make trades over the phone, online, or through an app. Keep in mind that even though commissions may be lower, there can be a monthly fee associated with the more complex platforms. However, with TD Direct Investing, you may qualify for a waived maintenance fee, free streaming market data, and lower trading commissions.
Why invest in the stock market?
The most obvious reason to consider investing in the stock market is to help grow your money over time. You’re also supporting other companies to grow and supporting the economy as a whole.
Although it takes time to understand the stock market and how it works, once you do, technology has made it easy to be involved with your own financial portfolio. By investing, you can also increase your financial literacy.
Of course, there are risks associated with investing in the stock market. You do need to educate yourself and invest wisely.
How to invest in the Canadian stock market
You’ve done your research on the stock market, and now you're ready to invest. Your first decision is to decide if you’d like to do it yourself as a self-directed investor or work with an advisor. Learn more about your investing options in the article on How to Invest Your Money.
Whether you take the DIY approach or you have a financial advisor help with your investing goals, the more you know the better off you are towards making informed decisions.
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