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How Does the Stock Market Work?

For new investors, the stock market can seem overwhelming. But thinking about it in the simplest terms can make it a little less daunting.

When you need a prescription, you go to the pharmacy. When you want to buy a stock or mutual fund, you will buy them through the stock market. The stock market is open to essentially anyone and can be accessed through a brokerage account, employee retirement plan, or a robo-advisor.

What Is the Stock Market?

The stock market is where investors go to buy and sell securities. It is comprised of a network of exchanges like the New York Stock Exchange (NYSE) and the Nasdaq.

But the stock exchange goes far beyond the United States. There are stock markets throughout the world include locations in Japan, London, Hong Kong, Shanghai, European Union, and Australia.

When people hear the term “stock market” they likely think of stock market indexes, like the S&P 500 or the Dow Jones Industrial Average. Since it is hard to track every stock available, the different indexes include various sections of the stock market. Their performance is considered a trusted representation of the entire market.

When you hear “the stock market dropped today,” it is typically referring to the stock market index that moved down from the day before. It reflects general market behavior and is an indicator of how the overall U.S. economy is doing.

What Are Public Companies?

There are two definitions of a public company. The first is one that is most common, where corporate entities sell their stock to investors, who then become shareholders in the company.

When a company sells securities to the public, the stockholders become equity owners. Most public companies were started as a private company but go public to gain a pool of funds to finance their operations or projects.

The public shareholders provide the company with capital, and in return, the shareholders receive value in the company and dividends. Public companies are required to hold annual meetings where shareholders vote on new members for the board of directors, formulate new policies, rules, and goals.

The second way a public company can be defined is if the company is required to disclose financial and business information on a regular basis to the public.

A company is subject to public reporting if they sell securities, increase their investor base to a certain size, or voluntarily register with the U.S. Securities and Exchange Commission (SEC).

Private Companies Subject to Public Reporting

Private companies are not required to release their business and financial information to the public, in most instances. However, if a private company merges with a public shell company, they can be subject to public reporting.

Market Participants

The U.S. Securities and Exchange Commission regulates the stock market to “maintain standards for fair, orderly, and efficient markets.” To do this, it regulates market participants. There are eight market participants that the SEC regulates.


There are thousands of broker-dealers throughout the United States. All broker-dealers are required to be registered with a national securities exchange, FINRA (Financial Industry Regulatory Authority), or both.  These market participants buy and sell securities for their own accounts or on the behalf of their clients.

Self-Regulatory Organizations (SROs)

The SEC regulates SROs, which are non-government organizations that can create and enforce professional and industry regulations. The goal of SROs is to protect investors by establishing a standard set of rules, regulations, and procedures that are ethical, equitable, and professional. FINRA is one of the most well-known and largest SRO’s in the securities industry.

Clearing Agencies

A clearing agency is a type of SRO that is not required to register with the SEC. They create and enforce their own rules. The two main types of clearing agencies are clearing corporations and depositories.

Credit Rating Agencies

Before you invest in a company, you should understand its creditworthiness. Credit Rating Agencies provide this information on a company and/or security. They give a grade that can help investors determine which companies are a safe bet to invest their capital, and which are a risk.


Electronic Communications Network (ECNs) are systems that utilize electronic ways to automatically match orders to buy and sell at determined prices for its users. ECNs are required to register as broker-dealers with the SEC. They are subject to the Regulation Alternative Trading System (ATS).

Securities Exchanges

As mentioned above, securities exchanges are where investors buy and sell securities. The SEC currently has fifteen securities exchanges registered.

Investment Advisers

Many beginning investors turn to investment advisors for advice. These people or firms that provide the advice are regulated by the SEC.  

Transfer Agents

A transfer agent is a bank, trust company, or other institution that records changes of ownership in securities. They are responsible for maintaining investors’ financial records, tracking account balances, transferring records, cancelling and issuing certifications, distributing dividends, and more.

Types of Brokerage Accounts

A brokerage account allows you to deposit money and utilize it to buy and sell securities through a brokerage. You will need to open a brokerage account to start building your investment portfolio. There are two types of brokerage accounts.

Cash Accounts

When you open a cash account, you as the investor are required to pay the full amount for the security you purchase. You cannot utilize funds from your broker.

Margin Account

When you open a margin account, the brokerage firm can lend you money to purchase securities. When you buy these securities, they will be used as collateral for the loan. However, it is important to note that you will have interest costs associated with the loan.

Types of Stock Market Orders

When you enter the market as an investor, you will want to understand the basics of stock market orders. A market order is when you make a request, typically through your broker, to buy or sell a security at the best price in the present market. There are four main types of stock market orders.

Market Order

This order is to buy or sell the selected security immediately. When you request to buy or sell the security, you are guaranteed through your order that it will be executed. However, there is no guarantee of the price. Generally, a market order will be executed at or near the sell/buy order, but there is no guarantee.

Limit Order

There are two types of limit orders, buy and sell. A buy limit order is an order to buy a security at or below a specified price. A buy limit order can only be executed at the limit price or lower.

A sell limit order is an order to sell a security at or above a specified price, at limit price or higher. Both types of limit orders are not guaranteed to execute and can only be filed if the market price reaches the limit price.

Stop Order

A stop order is an order to buy or sell stock when the value hits a specified price – the stop price. When this price is reached, a stop order turns into a market order.

Types of Stock Purchases

There are two different stock purchases – long and short. As an investor, if you have a long position it means you bought and own the shares of the stock. You will want to have a “long” position if you expect the stock will increase in value over time.

The opposite is “short” position. This is when an investor does not own the stock or is it borrowed. With a short sale you are hoping that the price of the stock will decrease over time.

If it does, you then can purchase it at the lower price to see a profit. However, if the price rises over time and you buy it back, you will take a loss. This is not something that is recommended for beginning investors.

Execution of Orders

When you place an order to buy or sell stock, it takes more than just a click of the button or a call to your broker. The order is not always filed immediately.

There are various ways that your order can be filed, including some that cause delays. The overall cost of your transaction can be impacted by how and where you order is executed.

Do not be fooled. If you are trading through an online brokerage account, you do not have a direct connection to the securities market. Instead, your order is sent to your broker, who then makes the determination on which market to send it to. Because prices can change rapidly, the price of the stock may vary.

Investing in the Stock Market

If you are looking to grow your wealth, investing in the stock market is a terrific tool. Everyone can do it, from beginners to savvy investors. You can choose to select your own stocks and funds or have an expert guide you. there is an endless number of possibilities to expand your capital.

Continue Your Investments

Now that you understand how the stock market works, utilize it to grow your investment portfolio. As a long-term investor, you can weather market volatility and produce tremendous returns on your investments.

When it comes to navigating the stock market, you do not have to fend for yourself. Working with a robo-advisor service can provide you with a low-cost management for your investments. Almost all major brokerage firms have this service, which will provide you with stock market recommendations.

But if you prefer to dive further and work with a professional who knows the ins and outs of the stock market, a financial advisor might be better suited. They will guide you to investment options that can grow your wealth and be by your side throughout the entire process.