|Photo by Chris Liverani on Unsplash|
If you don’t know much about the stock market, all the confusing stuff you hear on the news can be hard to understand. Words like “earnings movers” and “intraday highs” might not make sense to most people, and that’s okay. If you’re saving for retirement or investing for the long term with mutual funds, you don’t really need to worry about all that complicated stock market stuff.
But if you want to learn how to trade stocks, it’s important to understand the stock market’s basics. You don’t have to be an expert, but having some basic knowledge about how stock trading works will help you get started.
Stock market basics
The stock market is where stocks are bought and sold. There are different exchanges where stocks are listed, like the New York Stock Exchange and the Nasdaq. These exchanges bring together people who want to buy stocks and people who want to sell stocks. They create a market for the shares of these stocks. The exchange keeps track of how many people want to buy or sell a stock, which affects its price.
When you want to trade stocks, you usually do it through a broker. Nowadays, many people use online brokers. You place your trades with the broker, and they handle the transactions with the exchange on your behalf.
The New York Stock Exchange and the Nasdaq have specific trading hours. They are open from 9:30 a.m. to 4 p.m. Eastern Time. Some brokers also offer premarket and after-hours trading sessions, but it depends on the broker you use.
Understanding the stock market
When people talk about the stock market being up or down, they’re usually referring to major market indexes.
A market index is like a tracker that shows how a group of stocks is performing. It can represent the entire market or a specific sector, like technology or retail companies. The most commonly mentioned indexes are the S&P 500, the Nasdaq composite, and the Dow Jones Industrial Average. These indexes are often used as indicators of how well the overall market is doing.
Investors use these indexes to compare the performance of their own investment portfolios. It helps them make decisions about buying or selling stocks. You can even invest in an entire index by buying an index fund or an exchange-traded fund (ETF) that follows a specific index or sector of the market.
Stock trading information
When there’s high inflation or the stock market becomes volatile due to factors like war, supply-chain issues, or rising interest rates, even experienced investors can feel unsettled. It’s generally recommended for most investors to create a diversified portfolio of stocks or stock index funds and hold onto it through both good and bad times.
However, some investors prefer a more active approach and engage in stock trading. Stock trading involves frequently buying and selling stocks, trying to time the market to make a profit.
Stock traders aim to take advantage of short-term market events by selling stocks when the prices are high or buying stocks when they’re low. Some traders are day traders, making multiple trades within a single day, while others are active traders who make a dozen or more trades each month. If you’re interested in specific stocks, you can check out our other posts on the best-performing stocks this year.
Stock traders devote considerable time to research, often spending hours each day following the market. They rely on technical stock analysis, using tools to track a stock’s movements and identify trading opportunities and trends. Many online brokers provide stock trading information, including analyst reports, stock research, and charting tools.
Bull markets vs. bear markets
While neither a bull nor a bear is a creature you’d want to encounter during a hike, in the stock market, the bear has become the symbol of fear. A bear market occurs when stock prices are falling, typically by 20% or more, across the multiple indexes mentioned earlier.
Bull markets and bear markets often alternate, signaling larger economic trends. A bull market indicates investor confidence and economic growth, while a bear market suggests investors are pulling back, indicating potential economic decline.
The good news is that bull markets tend to last longer than bear markets. This is why, in the long term, investing in stocks can help your money grow.
The S&P 500, which includes around 500 major U.S. stocks, entered bear market territory on June 13, 2022. While it has recovered somewhat, it is still down over 15% in the past year.
However, historically, the S&P 500 has returned an average of about 7% annually when accounting for reinvested dividends and adjusting for inflation. This means that if you invested $1,000 30 years ago, you could have around $7,600 today.
Stock market crash vs. correction
A stock market correction occurs when there is a drop of 10% or more in the stock market. On the other hand, a stock market crash refers to a sudden and significant decline in stock prices, like what happened in early 2020 during the COVID-19 pandemic.
Although crashes can signal the start of a bear market, it’s important to remember that bull markets generally last longer than bear markets. This means that stock markets tend to increase in value over time. In 2020, the market rebounded and reached new record highs by August.
If you’re concerned about a market crash, it’s helpful to focus on the long term. During a market decline, it can be unsettling to see the value of your portfolio decrease in real time. However, if you’re investing for the long term, it’s often best to do nothing.
Why? When you sell investments during a downturn, you realize your losses. If you plan to re-enter the market when things are better, you will likely end up paying higher prices and may miss out on the gains from the market’s recovery.
The importance of diversification
As an investor, you can’t avoid bear markets. However, you can reduce the risk that comes from having an undiversified portfolio.
Diversification is crucial to protecting your investments from market setbacks. If you put all your money into a single company, you’re relying solely on its success, which can be easily affected by factors like regulatory issues, poor leadership, or unexpected problems like a food contamination scandal.
To mitigate this company-specific risk, investors practice diversification by combining different types of stocks. This helps balance out potential losses and reduces the risk of one company’s issues negatively impacting your entire portfolio.
However, building a diversified portfolio of individual stocks requires significant time, patience, and research. An alternative approach is to invest in mutual funds, exchange-traded funds (ETFs), or index funds. These funds hold a collection of investments, providing automatic diversification. For example, an S&P 500 index fund aims to mimic the performance of the S&P 500 index by investing in the 500 companies included in that index.
The good news is that you can combine individual stocks and funds within your portfolio. A suggested strategy is to allocate 10% or less of your portfolio to carefully selected individual stocks you believe in while putting the remaining portion into index funds or other diversified funds.