What Is the Stock Market?

Investing, Investments
what-is-the-stock-market

The stock market is the world’s meeting place for buyers and sellers of financial securities. Even as trading has become increasingly complex over the centuries, the concept behind the stock market remains pretty simple.

Operating much like an auction house or bazaar, the stock market enables buyers and sellers to negotiate prices and make exchanges. Commonly the product is a stock, which is a unit of partial ownership in the assets of a publicly traded company. In decades past, these transactions likely took place in a physical marketplace, such as the floor of a stock exchange. Today, they most often happen electronically.

But while a vast majority of these transactions are now conducted online through sophisticated exchanges around the globe, the modern stock market’s roots are actually quite humble.

Here’s more on how the stock market began and how it functions today.

History of the stock market

The first stock-like market dates back to the 1500s in Belgium. Back then, the market consisted of brokers and moneylenders meeting to wrangle out deals related to business, government or individual debt.

By the 1600s, the modern incarnations of the stock market began to take root, in response to a boom in Western Europe’s imports from the East Indies and Asia. Investors helped to foot the cost for these risky voyages, receiving stocks and dividends from the companies.

In 1773, the first stock exchange was formed in London — the London Stock Exchange. In the United States, the roots of today’s financial market developed soon after the country’s founding. In 1792, 24 stockbrokers signed the Buttonwood Agreement, which started the New York Stock Exchange Board — what’s known today as the New York Stock Exchange.

For years, the trading floors of stock exchanges around the world were the primary places where the buying and selling of stocks occurred. That all changed with the advent of computers and a new, entirely electronic exchange — Nasdaq — that debuted in 1971. In turn, other exchanges adopted electronic trading.

The appearance of electronic trading revolutionized the stock-buying process, making it cheaper and easier for individual investors to take part. Orders no longer need to be routed to a trader on the floor of a stock exchange for execution; instead, they can be conducted electronically via online brokers. There still are traders on the floors of many exchanges —you’ve probably seen pictures of them wearing funny-looking jackets — but there are far fewer today than in the past.

Stock market versus stock exchanges

People often use “stock market” and “stock exchange” interchangeably. The stock market encompasses all publicly traded stocks available to investors, while exchanges list — or include for trading — a subset of that universe. Other products traded on these exchanges include options, exchange-traded funds (ETFs) and bonds.

There’s a further distinction between the primary and secondary markets. Shares of companies that have filed an initial public offering (IPO), a company’s first offering of stock to the general public, are exchanged on the primary market, mostly by institutional investors, which are large organizations that often make significant investments. Once public, these stocks are available for trading to all types of investors in the secondary market. Stocks can also trade over-the-counter — not on an exchange — through dealer networks.

There were more than 3,600 listed U.S companies in 2016. References to “the stock market” aren’t always explicit about what universe that entails, but they often refer to a benchmark such as the Standard & Poor’s 500 index — a group of 500 prominent U.S. companies that is often used as a proxy for the broader U.S. stock market.

How the stock market works

As at an auction, market participants determine the price for each security. Computer algorithms generally do most of those calculations now, but the basics of trading are the same. Buyers offer a “bid,” or the highest amount they’re willing to pay, which is usually lower than the amount sellers “ask” for in exchange. This difference is called the bid-ask spread. For a trade to occur, a buyer needs to increase his price or a seller needs to decrease hers.

Each of these decisions happens on a stock-by-stock basis, but unrelated stocks often move in tandem because of news, political events, economic reports and other factors. Generally speaking, if someone says “the market’s up today,” it’s a) most likely referring to one of the key gauges like the S&P 500 and b) because buyers were more motivated than sellers.

The major exchanges have a variety of rules in place to limit the severity of single-stock and broad market declines, as well as identifying erroneously executed trades.

In the U.S., the stock market is open Monday through Friday from 9:30 a.m. to 4 p.m. EST, save for holidays.

Want to take part in the market? There are several other things you should know first, and the resources below may help:

Anna-Louise Jackson is a staff writer at NerdWallet, a personal finance website. Email: ajackson@nerdwallet.com. Twitter: @aljax7.