January 13, 2023
The stock market changed during the pandemic. Flush with government stimulus money and nothing open to spend it on, a flood of retail shareholders entered the market for the first time. And for the first year or two, most have probably logged a good run of success. Markets were up and many individual investors – even noobies – did well.
That’s changed in recent months. The markets have sagged, leaving many new retail shareholders scratching their heads and wondering what went wrong as they struggle through their first market downturn.
Many of the new investors who entered the market in recent years jumped in with little in the way of investor education. As the market rose, they probably didn’t see the need. Now that the market has dropped a bit and given retail investors time to breathe, it is also time for these greenhorn shareholders to brush up on stock market basics. In this Insight, we are going to focus on explaining the stock market, stock exchanges, stock indices and IPOs. We will continue to investigate the basics in future Insights.
Let’s start at the beginning.
Investopedia has a great definition of the stock market: “The stock market provides a venue where companies raise capital by selling shares of stock, or equity, to investors. Stocks give shareholders voting rights as well as a residual claim on corporate earnings in the form of capital gains and dividends.
“Individual and institutional investors come together on stock exchanges to buy and sell shares in a public market. When you buy a share of stock on the stock market, you are not buying it from the company, you are buying it from an existing shareholder. What happens when you sell a stock? You do not sell your shares back to the company, but instead, sell them to another investor on the exchange.”
Stock exchanges are the secondary markets where existing shareholders buy and sell shares of stock they own. The two largest are the New York Stock Exchange and Nasdaq, though there are dozens of markets around the world. Retail shareholders can also look for stocks on over-the-counter or bulletin board exchanges, but should be aware of the risks since they are not regulated as tightly as the larger exchanges.
The general performance of the market can be tracked by following indices that represent the aggregated prices of a group of stocks. Most individual investors know indices like the Dow Jones Industrial Average (DJIA), which tracks the share price of 30 of the largest U.S. corporations. Another well know index is the S&P 500, a market-cap-weighted index of the 500 largest companies in the U.S. Many retail shareholders trade indices through exchange-traded funds (EFTs), which act in the same way as stocks, but track a larger group of assets.
Companies issue shares of their stock – effectively fractional ownership of the company – for a variety of reasons, but the most common is to raise capital. Companies often start small and start to grow, perhaps with small investments from the founders. As the company grows, it may have capital requirements that are larger than the founders or even outside investors (both angel investors and venture capital firms) can afford. That’s when a company may decide to issue shares through what is called an initial public offering (IPO). It is at this point where it becomes a publicly traded company whose stock is bought and sold through the previously mentioned markets.
Now that you have the basics under your belt, it’s time to open a brokerage account, the account where your assets are stored. Brokerage accounts can be as simple as a self-directed standard accounts through one of many brokerage firms like Robinhood and Schwab or designed for a specific purpose – often to avoid taxes – like retirement or to pay for college costs.
Investing is never easy or without risk, but armed with some basic information, retail shareholders can avoid some of the pitfalls that trap those new to the markets.
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