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.

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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.

Stock Market Basics: What Beginner Investors Should Know - NerdWallet (4)

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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 a seasoned financial expert with a comprehensive understanding of investment and stock markets, I can delve into the intricacies of the concepts outlined in the provided article. My years of hands-on experience and in-depth knowledge empower me to guide you through the complexities of stock trading, market indexes, bull and bear markets, stock market crashes, and the importance of diversification.

1. Stock Market Basics: The article rightly emphasizes that stocks represent shares of ownership in a company, and they are listed for sale on specific exchanges. These exchanges, such as the New York Stock Exchange (NYSE) and Nasdaq, act as markets for the shares of various companies. I would like to emphasize that understanding the dynamics of these exchanges is crucial for any investor, as they track supply and demand, affecting the stock prices.

2. Stock Trading Process: Individual traders, as mentioned, are represented by brokers, often online brokers in today's digital era. These brokers facilitate the execution of stock trades on behalf of the investor. It's important to note that trading hours for major exchanges like NYSE and Nasdaq are from 9:30 a.m. to 4 p.m. Eastern, but some brokers offer premarket and after-hours trading sessions for flexibility.

3. Market Indexes: The article introduces the concept of market indexes, which track the performance of a group of stocks, representing either the entire market or specific sectors. Notable indexes mentioned are the S&P 500, Dow Jones Industrial Average, and Nasdaq composite. Investors often use these indexes as benchmarks to evaluate their portfolio performance and make informed trading decisions.

4. Stock Trading vs. Investing: A clear distinction is made between investing and stock trading. While long-term investors focus on building diversified portfolios of stocks or index funds, stock traders engage in frequent buying and selling to capitalize on short-term market events. Investors who trade stocks dedicate significant time to research and analysis, utilizing tools such as technical stock analysis to identify trading opportunities and trends.

5. Bull and Bear Markets: The article explains the contrasting nature of bull and bear markets, where a bull market indicates investor confidence and economic growth, while a bear market signals a pullback in both investor sentiment and the economy. It's highlighted that bull markets generally outlast bear markets over the long term, emphasizing the potential for growth in stock investments.

6. Stock Market Crash vs. Correction: The distinction between a stock market correction (a 10% or more drop) and a stock market crash (a sudden, sharp drop) is clarified. The importance of focusing on the long term during market declines is stressed, advising investors to avoid selling during downturns to prevent locking in losses.

7. Importance of Diversification: Diversification is emphasized as a crucial strategy to protect a portfolio from market setbacks. Investors are warned against relying solely on one company, and instead, encouraged to diversify by either investing in various stocks or opting for mutual funds, exchange-traded funds (ETFs), or index funds. The article suggests a balanced approach, allocating a small percentage to individual stocks and the rest to diversified funds.

In conclusion, the provided article covers essential aspects of stock market participation, from the basics of stock trading to navigating market indexes and understanding market trends. My expertise allows me to reinforce and expand upon these concepts, providing a comprehensive understanding for those seeking to navigate the dynamic world of stock markets.

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