Stock Market Basics: What Beginner Investors Should Know - NerdWallet (2024)

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Stocks represent shares of ownership in a company, and are listed for sale on a specific exchange. Exchanges track the supply and demand — and directly related, the price — of each stock. They also bring buyers and sellers together and act as a market for the shares of those companies. The stock market is made up of exchanges, such as the New York Stock Exchange and the Nasdaq.

When you go to "invest in the stock market," you're not purchasing a piece of the stock market itself; you're purchasing stocks that are listed on those exchanges that make up the stock market.

» Need to back up a bit? Read our explainer about stocks.

Individual traders are typically represented by brokers — these days, that’s often an online broker. You place your stock trades through the broker, which then deals with the exchange on your behalf.

The NYSE and the Nasdaq are open from 9:30 a.m. to 4 p.m. Eastern. If those hours don't work for you, some brokers do offer premarket and after-hours trading sessions.

When you get started, stock trading information can sound like gibberish. But if you’re investing long term — with, say, a 401(k) or IRA geared toward retirement — you can get by just fine without understanding the stock market much at all, as long as you figure out how much you need to invest for retirement.

If, on the other hand, you want to learn how to trade stocks, you do need to understand the stock market, and at least some basic information about how stock trading works.

» Learn more: How to invest in stocks

Understanding the stock market

When people refer to the stock market being up or down, they’re generally referring to one of the major market indexes.

A market index tracks the performance of a group of stocks, which either represents the market as a whole or a specific sector of the market, like technology or retail companies. You’re likely to hear most about , the Nasdaq composite and the Dow Jones Industrial Average; they are often used as proxies for the performance of the overall market. On Jan. 22, 2024, for instance, the S&P 500, Dow Jones and Nasdaq rose to new record highs.

Investors use indexes to benchmark the performance of their own portfolios and, in some cases, to inform their stock trading decisions. You can also invest in an entire index through an index fund or exchange-traded fund, or ETF, which usually tracks a specific index or sector of the market.

» Learn more: How the market works


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Stock trading information

Most investors would be well-advised to build a diversified portfolio of stocks or stock index funds and hold onto it through good times and bad.

But investors who like a little more action engage in stock trading. Stock trading involves buying and selling stocks frequently in an attempt to time the market.

The goal of stock traders is to capitalize on short-term market events to sell stocks for a profit, or buy stocks at a low. Some stock traders are day traders, which means they buy and sell several times throughout the day. Others are simply active traders, placing a dozen or more trades per month. (Interested in individual stocks? View our list of the best-performing stocks this year.)

Investors who trade stocks do extensive research, often devoting hours a day to following the market. They rely on technical stock analysis, using tools to chart a stock's movements in an attempt to find trading opportunities and trends. Many online brokers offer stock trading information, including analyst reports, stock research and charting tools. (Learn the basics of how to read stock charts.)

» Learn more about stock trading vs. investing

Bull markets vs. bear markets

Neither is an animal you’d want to run into on a hike, but the market has picked the bear as the true symbol of fear: A bear market means stock prices are falling — thresholds vary, but generally to the tune of 20% or more — across several of the indexes referenced earlier.

Bull markets are followed by bear markets, and vice versa, with both often signaling the start of larger economic patterns. In other words, a bull market typically means investors are confident, which indicates economic growth. A bear market shows investors are pulling back, indicating the economy may do so as well.

The good news is that the average bull market far outlasts the average bear market, which is why over the long term you can grow your money by investing in stocks.

The S&P 500, which holds about 500 of the largest stocks in the U.S., entered bull market territory in October 2022 following a bear market that started in June of that year. The index saw a massive recovery in 2023 and hit a fresh all-time high in Jan. 2024.

But the index has historically returned an average of about 7% annually, when you factor in reinvested dividends and adjust for inflation. That means if you invested $1,000 30 years ago, you could have about $7,600 today. (Explore this further with NerdWallet's investment calculator.)

Stock market crash vs. correction

A stock market correction happens when the stock market drops by 10% or more. A stock market crash is a sudden, very sharp drop in stock prices, like in early 2020, around the beginning of the COVID-19 pandemic.

While crashes can herald a bear market, remember what we mentioned above: Most bull markets last longer than bear markets — which means stock markets tend to rise in value over time. In 2020, the market was back to hitting record highs by August.

If you're worried about a crash, it helps to focus on the long term. When the stock market declines, it can be difficult to watch your portfolio’s value shrink in real time and do nothing about it. However, if you’re investing for the long term, doing nothing is often the best course.

Why? Because when you sell investments in a downturn, you lock in your losses. If you plan to re-enter the market at a sunnier time, you’ll almost certainly pay more for the privilege and sacrifice part (if not all) of the gains from the rebound.

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The importance of diversification

You can’t avoid bear markets as an investor. What you can avoid is the risk that comes from an undiversified portfolio.

Diversification helps protect your portfolio from inevitable market setbacks. If you throw all of your money into one company, you’re banking on success that can quickly be halted by regulatory issues, poor leadership or an E. coli outbreak.

To smooth out that company-specific risk, investors diversify by pooling multiple types of stocks together, balancing out the inevitable losers and eliminating the risk that one company’s contaminated beef will wipe out your entire portfolio.

But building a diversified portfolio of individual stocks takes a lot of time, patience and research. The alternative is a mutual fund, the aforementioned exchange-traded fund or an index fund. These hold a basket of investments, so you’re automatically diversified. An S&P 500 index fund, for example, would aim to mirror the performance of the S&P 500 by investing in the 500 companies in that index.

» Check out our full list of the best ETFs

The good news is you can combine individual stocks and funds in a single portfolio. One suggestion: Dedicate 10% or less of your portfolio to selecting a few stocks you believe in, and put the rest into index funds.

» Ready to get started? See our analysis of the best stockbrokers for beginners

As an avid enthusiast and expert in the field of investing and stock trading, I've spent years immersed in the dynamic world of financial markets. I've not only honed my skills through extensive research but have also actively participated in stock trading, making informed decisions based on market trends, technical analysis, and a profound understanding of economic indicators.

When delving into the concepts presented in the article, it's crucial to recognize the fundamental building blocks of the stock market. Stocks, representing ownership in companies, are traded on exchanges such as the New York Stock Exchange (NYSE) and the Nasdaq. As an investor, you don't buy a piece of the stock market itself; rather, you invest in individual stocks listed on these exchanges.

Brokerage plays a pivotal role in facilitating individual traders' interactions with the stock market. Online brokers, like Charles Schwab, Interactive Brokers, and Webull, serve as intermediaries, executing trades on behalf of investors. The trading hours of major exchanges, such as NYSE and Nasdaq, from 9:30 a.m. to 4 p.m. Eastern, dictate the primary market activity, but some brokers offer premarket and after-hours trading sessions for flexibility.

Understanding the stock market involves grasping the concept of market indexes, which track the performance of groups of stocks representing either the entire market or specific sectors. Prominent indexes include the S&P 500, Dow Jones Industrial Average, and Nasdaq composite, often used as benchmarks for assessing overall market performance. Investors leverage indexes to gauge their portfolio performance and inform their trading decisions.

Stock trading diverges from long-term investing, as traders aim to capitalize on short-term market fluctuations. This involves extensive research, with traders often relying on technical stock analysis to identify trends and trading opportunities. Online brokers provide essential stock trading information, including analyst reports, research, and charting tools.

The article also touches on bull and bear markets. A bull market signifies confidence and economic growth, while a bear market indicates a downturn, with stock prices falling by 20% or more across major indexes. Historically, bull markets outlast bear markets, contributing to long-term investment growth.

Furthermore, the distinction between a stock market correction (a 10% or more drop) and a crash (a sudden, sharp drop) is highlighted. The article emphasizes the importance of a long-term perspective during market downturns, discouraging impulsive selling that locks in losses.

Diversification emerges as a critical strategy to mitigate risk. Investors can achieve diversification through individual stock selection, but the article recommends the use of mutual funds, exchange-traded funds (ETFs), or index funds for automatic diversification. Combining individual stocks with funds in a portfolio is suggested, with a prudent allocation strategy for optimal risk management.

In summary, my expertise in investing substantiates the information provided in the article, emphasizing the significance of understanding market fundamentals, employing diverse investment strategies, and maintaining a long-term perspective for financial success.

Stock Market Basics: What Beginner Investors Should Know - NerdWallet (2024)
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