How the stock market works

Prices go up and down all day, but what is actually changing hands behind that number? A stock is a slice of a real company, and the market is just where people trade those slices. Start there and the rest of it stops looking like a casino.

What a stock is

A stock (also called a share or equity) is a small piece of ownership in a company. If a company is split into a million shares and you own one, you own a millionth of the business, including a claim on its future profits. Companies sell shares to raise money to grow; investors buy them hoping the company becomes more valuable over time, or pays them a share of profits as a dividend.

How prices are set

A share price is not fixed by the company. It is set continuously by buyers and sellers on an exchange. If more people want to buy a stock than sell it, the price rises; if more want to sell, it falls. A stock’s price reflects what the market collectively believes the company’s future profits are worth today. That is why prices can move on expectations and news long before anything actually changes at the business.

Indices: the market’s scoreboard

You cannot watch every stock, so investors track indices, baskets of stocks that summarize how a market is doing.

• The S&P 500 tracks 500 large US companies and is the most widely used snapshot of the American market.
• The Nasdaq is heavy with technology firms, so it is watched as a gauge of tech and growth stocks.

When the news says “stocks rose today”, it usually means an index like these went up.

Why the market moves

Three forces drive most of the action:

• Earnings. Companies report profits every quarter. Beating or missing expectations can swing a stock sharply, and big companies can move the whole index.
• Interest rates. When the Federal Reserve changes interest rates, it changes how much future profits are worth today. Higher rates generally pressure stocks; lower rates tend to lift them.
• The economy and sentiment. Growth, inflation, jobs data, and geopolitics all shift how optimistic investors feel, and optimism (or fear) shows up in prices fast.

Bull markets and bear markets

A sustained rise is a bull market; a sustained fall of 20% or more is a bear market. Both are normal parts of the cycle. Over long periods the market has tended to rise, but it can fall hard and stay down for a while, which is why time in the market usually matters more than timing it.

The bottom line

The stock market is a real-time vote on the future value of companies. Follow earnings, interest rates, and the economy, the three things Economicium tracks daily, and the daily swings start to make a lot more sense.