What Is the Stock Market?

Thoughts of the stock market conjure images of wealth—fancy suits, fast cars, lavish mansions—and images of destitution from its crashes, including the Great Depression and financial crisis. There are TV channels devoted to it; Reddit message boards that confound markets; thousands of books, magazines and websites that write about it.

But what is the stock market and how does the stock market work?

The stock market is the collection of exchanges where investors buy and sell stocks issued by publicly held companies.

You might be wondering what, exactly, are these stocks that are traded on the market?

Stocks are an investment that represent an ownership share of a company. This entitles the stockholder—the person or institution that buys these shares of a company—to a proportion of the corporation’s assets and profits equal to the amount of owned stock.

Corporations issue stock to raise funds to operate their businesses, including investment in research, product development and hiring. They do so through an initial public offering, or IPO. For shareholders, the stock market lets them invest their capital and, historically, earn rates of return higher than savings accounts or government bonds.

Investors buy these issued shares because they believe that the company will profit or grow in the short or long term. Such growth can lead to share price appreciation and dividend payments, or profits that a corporation directly returns to shareholders. If the share price goes up, the investor can later sell their position and pocket the difference between the sold and purchased price. If the company pays out profits in the form of dividends, the investor continues to own shares in the company and can reinvest the received dividends to expand their holdings.

There are two primary types of stocks: preferred and common. Preferred shareholders do not have voting rights but have priority over company income. Common shareholders do have voting rights but are last in line for company assets, behind creditors, bondholders and preferred shareholders.

The stock market works by offering a centralized and public place where various investors can meet to exchange shares in companies they hold or wish to hold. While some institutional investors have access to private marketplaces such as “dark pools,” stock exchanges are open to everyone and let individual investors place buy or sell orders on specific stocks, typically through a broker.

Investors trade stocks on these exchanges to efficiently deploy their capital. What that means exactly varies for each person. Some may believe that the next tech gadget will sweep through the country and earn its maker billions of dollars. Those investors will scoop up shares of that specific company on the expectation of future earnings. Other investors may trade a variety of stocks in a particular industry, or which align with a specific factor approach. Many will take a relatively passive approach to the stock market and buy pools of stock in the form of mutual funds or exchange-traded funds (ETFs) that largely track overall market performance, a less risky approach that generally limits commissions, time and tax burden.

The stock market, though, can be risky regardless of your investing approach. Investors can lose money—lots of money—in the stock market. During bear markets, more investors are selling than buying stocks, pushing down overall levels and resulting in a general loss of money for those who own stocks. Investments in individual companies can also lose money if that company sees sales decline or, more dramatically, goes bankrupt, at which point its stock is essentially valueless.

Conversely, when companies grow, beat expectations and increase their profitability, investors generally make money from rising share prices. That’s because demand for a given stock increases with the expectation or assumption of future earnings growth or profit that could be redistributed to shareholders.

Historically, the stock market rises, but there are periods of intense market downturns that may panic investors into selling their holdings at a substantial loss or which may challenge retired investors. That’s why it’s important to manage asset allocation and plan for such contingencies, knowing how you will react to market movement and not deviating from your set course of action.

Overall, the stock market is a centralized way for investors to buy or sell shares that a company has offered for purchase. Its liquidity facilitates transactions in a transparent and regulated way, letting investors deploy their capital with confidence and the hope of a large financial windfall.