What is the stock market and how does it work?

The stock market is where shares are bought and sold by investors, and issued in the first place by public companies. It takes in many different aspects of investing, including stock exchanges, indices, and individual stocks, and allows for multiple approaches from you as an investor.

Connor Campbell Published on 20 August 2021.
What is the stock market and how does it work?

Even if you are completely new to investing, you’ve probably heard of the stock market.

However, it is not the most exact phrase. It is often used interchangeably to describe a variety of different aspects of investing, which can be confusing.

So what is the stock market? And how does the stock market work? Below we answer those questions, as well as providing a primer on investing in stocks for beginners.

» MORE: Investing guide and how to get started

What is the stock market?

At the highest level, the stock market refers to the collection of global exchanges and markets where shares of public companies are not only bought and sold, but issued as well.

What is a stock exchange?

If you have ever seen pictures from Wall Street of men in suits shouting and waving as they stand beside banks of computers, then you will have seen a stock exchange – the New York Stock Exchange (NYSE).

It is both a physical location where trading occurs – though nowadays most trading is done online – and the facility through which trading can occur.

Most major economies have a stock exchange. Alongside the NYSE – which, by market cap, is the largest exchange in the world – other stock exchanges include the NASDAQ, the Frankfurt Stock Exchange, and the London Stock Exchange.

» MORE: What is market cap?

For a company to be part of a stock exchange, they first need to be listed on the exchange via an IPO, or initial public offering.

Once listed, it is possible for investors to then buy and sell shares in a company through the exchange.

What is happening in the stock market today?

The term ‘stock market’ is not just used to discuss the mechanisms that allow trading to occur, but generally what is actually being traded.

On a day-to-day basis, people will talk about the stock market being up or down, or that it has moved higher or lower.

This usually refers to collections of stocks, known as indices, and how their price has changed. These indices will be made up of stocks in a way that reflects whatever it is they are tracking, typically an exchange itself. The ‘price’ of an index is therefore influenced by the movement of these individual stocks.

Notable examples of indices include the FTSE 100, Dow Jones, S&P 500 and the DAX, which each represent different selections of stocks from around the globe.

What is the UK stock market?

There are two aspects of trading that are colloquially referred to as the ‘UK stock market’.

First is the London Stock Exchange (LSE). It is one of the oldest exchanges in the world and is predominantly comprised of two markets:

  • The Main Market is home to more than 1,000 of the globe’s biggest companies.
  • The Alternative Investment Market (AIM) contains smaller, less-developed companies.

The other major part of what is referred to as the UK stock market is its indices. These include the FTSE 100 Index and FTSE 250 Index.

The FTSE 100 is an index made up of the 100 companies with the largest market cap on the LSE Main Market. This includes household names such as BP, Shell, AstraZeneca, ITV and Barclays.

The FTSE 250 is the next 250 companies listed on the Main Market as ordered by market cap, that are not found on the FTSE 100. This also contains recognisable, if more domestic, firms such as easyJet, Aston Martin and Greggs.

» MORE: What is a public limited company?

How does the stock market work?

There are two major ways to approach the stock market: the primary market and the secondary market.

What is the primary market?

The primary market is where companies initially issue shares, via an IPO, equity placement or rights issue, to investors.

You could almost think of the primary market like a new car dealership — it is where you would buy stocks and shares before anyone else has owned them.

Although the primary market is dominated by institutional investors, retail investors can still get involved.

For example, you could subscribe to a company’s IPO, meaning you would be able to buy the newly issued stock at the same time and price as institutional investors.

It should be noted that while shares issued on the primary market are ‘new’, this does not make them more valuable than shares and stocks sold on the secondary market. The price of stocks and shares are primarily influenced by supply and demand.

What is the secondary market?

The secondary market is what most people would understand as investing in the stock market.

This is where stocks and shares — as well as other investment products such as bonds, options and futures — are bought and sold between both retail and institutional investors, rather than purchased straight from the issuer, i.e. the company, itself.

The fluctuating price of stocks and shares on the secondary market is determined by a number of factors, including:

  • supply and demand
  • the financial performance of the company in question
  • wider economic data
  • political events and headlines.

What is stock market volatility?

Volatility is a measure of how much, and how quickly, the price of a stock, index or other financial asset can change.

A stock or index is said to be volatile when its price significantly moves up and/or down over a short period of time. The more volatile a stock, the riskier it is as an investment.

Volatility is not necessarily a bad thing, but rather a regular feature of the stock market landscape.

Sometimes, an individual stock will become volatile for reasons associated with that company in particular.

At other times, geopolitical events, especially those of great uncertainty such as Brexit or the COVID-19 pandemic, will cause dramatic volatility for specific indices, or even the stock market as a whole.

What is a stock market bubble?

A bubble is when the price of an asset rapidly rises, taking it beyond what would be seen as its intrinsic or true value (i.e. a value arrived at by ‘objective calculation’ rather than just current market price).

That bubble will burst when investors are no longer willing to buy the asset at such a high price en masse, often leading to a market crash.

When people use the term stock market bubble they refer to the belief that the prices of shares of companies and the market as a whole are overpriced compared to the so-called ‘intrinsic value’.

There is no one catalyst for a bubble. They tend to be characterised, however, by speculation, the suspension of disbelief in the face of negative fundamental analysis, and often an influx of inexperienced investors looking to jump on a trend.

When does the stock market open?

Due to the fact the stock market is not a single market, but several interconnected markets, there is no set opening or closing time.

However, for that same reason, a market will be open somewhere around the world at any given moment.

The table below shows the core session opening and closing times, in GMT, for the major stock markets.

Stock Exchange Indices Opening (GMT) Closing (GMT)
Tokyo Stock Exchange Nikkei 225 00:00 06:00
Shanghai Stock Exchange SSE Composite, SSE 50 01:30 07:00
Hong Kong Stock Exchange Hang Seng Index 01:30 08:00
Frankfurt Stock Exchange DAX, MDAX, SDAX 08:00 16:30
London Stock Exchange FTSE 100, FTSE 250 08:00 16:30
New York Stock Exchange Dow Jones Industrial Average, S&P 500 14:30 21:00
NASDAQ NASDAQ Composite, Nasdaq-100, S&P 500 14:30 21:00

How to invest in the stock market

There are a few different ways you can start investing in the stock market, each with their own benefits and disadvantages.

Before investing in the stock market, it is important to do your research and find the best form of investing for your financial situation.

Brokerage account

An online brokerage account will allow you to buy and sell stocks yourself, and will often include a connected stock trading app.

A managed brokerage account, on the other hand, will come with an investment manager who designs your portfolio and makes the investments on your behalf.

Robo-adviser account

This is an automated form of managed brokerage account.

You will be able to set the parameters of your investing goals, including your tolerance for risk and time horizon, and will then be offered a number of ready-made portfolios to invest in.

» MORE: What is a robo-adviser account?

Workplace pension

Contributing to your workplace pension is a form of investing in the stock market.

The money you and your employer put into your workplace pension will be invested into funds which are made up of individual stocks, or the stocks themselves directly. These investments will potentially help your money grow long-term.

» MORE: Workplace pensions explained

Stocks and shares ISA

As with choosing between an online or managed brokerage account, a stocks and shares ISA allows you to either take a DIY approach and pick your own investments or select a ‘ready-made’ option, where a professional will make the choices for you.

You won’t pay tax on any income or capital gains your investments make in a stocks and shares ISA.

» MORE: Stocks and shares ISAs explained

WARNING: We cannot tell you if any form of investing is right for you. Depending on your choice of investment your capital can be at risk and you may get back less than originally paid in.

Image source: Getty Images

About the author:

Connor is a writer and spokesperson for NerdWallet. Previously at Spreadex, his market commentary has been quoted in the likes of the BBC, The Guardian, Evening Standard, Reuters and The Independent. Read more

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