What’s “The Market”? Understanding the Stock Market and How it Works
If you’re casually scrolling through social media or checking the news, you’re going to hear a lot about “the market.”
And no, this isn’t your local farmer’s market or grocery store. It’s the name people typically give for the stock market, or where people buy and sell stocks.
If you’re interested in growing your wealth, preparing for retirement, or generally increasing your financial literacy, it’s important to understand the stock market. I dove deeper into this topic on episode 56 of The Canadian Money Roadmap because I know it’s something a lot of people have questions about.
Plus, the financial media is always out there fear mongering and making things confusing for the average investor. So, let’s get back to basics and talk about “the market”: what it is, some basic definitions, and what you need to pay attention to.
Stock Market 101: Basic Definitions
We refer to “the market” all the time, but what is it, really? Is the stock market a real place, like the other markets we shop at?
Some basic definitions can help clarify some details:
The market: The term typically used to refer to the stock market, which is where stocks are bought and sold.
Market: An economic term for a group of buyers and sellers. The market, then, is a concept rather than a physical space.
Exchange: This is a tangible, “real” market where stocks are bought and sold. Popular exchanges for the stock market include the New York Stock Exchange (NYSE) and the Toronto Stock Exchange (TSX). While there is a physical location to these exchanges, most transactions today are digital.
IPO (Initial Public Offering): The process a company completes to be listed on a stock exchange. They make shares available for investors to buy to raise capital for their company.
Primary market: The market in which shares are sold for the first time (i.e., during an IPO), primarily to institutions and investment banks.
Secondary market: The market in which shares are subsequently sold. For example, after investment banks and large institutions like pension funds purchase the initial shares of a company during an IPO, they can re-sell them to individual investors like you or me in the secondary market.
Market capitalization: A measurement of what a company is worth in real time. It’s simply the number of shares that exist multiplied by the share price.
Index: A hypothetical grouping of companies which tracks the average performance in that group.
How the Stock Market Works
To understand how the stock market works, let’s put all these terms together with a real-life example.
One company I’m personally interested in is Rivian, an electric car company. They’ve got some really cool technology and ideas, but haven’t brought many cars to the market yet. To keep growing as a company, they need money.
And, because they have cool ideas and technology, many investors are willing to fund their growth by investing in their shares.
Here’s how it happened:
Rivian went through an IPO on the Nasdaq exchange in November 2021.
Rivian sold 153 million shares of their company for $78 a piece, resulting in $12 billion raised in this initial primary market.
That $12 billion goes to Rivian to fund their operations.
The demand in the secondary market for Rivian’s shares was high, causing their stock price to increase from $78 per share to $100 on the first day of trading.
This increase in price indicates an increase in Rivian’s market cap.
One thing to note here is that after the initial IPO that raised $12 billion, Rivian as a company doesn’t see any money from a sale at a higher share price. After the IPO, shares are traded between investors instead of between an investor and the company itself.
The laws of supply and demand are at play in secondary markets. If someone wants to own Rivian shares because they value the company, they’re willing to pay more—demand goes up, price goes up.
As investors take in new information and buy and sell accordingly, the prices constantly go up and down. But this doesn’t necessarily mean that a company is objectively doing better or worse. Rather, it’s a reflection of how people subjectively value them on that day and what they’re willing to pay for the shares.
Stock Market Indices to Watch
It’s very difficult to track the performance of every individual company every day. To make the market simpler, indexes were created to track large groups of companies all at once and the average performance within that group.
Rivian, for example, is just one of tens of thousands of publicly traded companies around the world. Whether they have a good or bad day doesn’t tell us much about what the market as a whole is doing.
Indexes capture a broader cross section of industries or types of companies and give you a clearer picture of how that part of the market is performing. Some common indices include:
S&P 500: The 500 largest companies in the USA.
TSX 60: The 60 largest companies in Canada.
FTSE 100: The 100 largest companies in the UK.
Nikkei 225: The 225 largest companies in Japan.
These examples are country-based, but an index can also be made around specific industries such as oil and gas or technology. Other types of indexes might track investment styles like dividends, growth, momentum, or low volatility.
Within most indexes, companies are weighted based on their market cap. So, big companies like Apple make up 7% of the S&P 500 index, whereas Costco makes up just 0.7%. That means Apple’s movement in the index makes a bigger difference than Costco’s. Big players move the needle more and can drive the whole index up or down.
Okay, so what’s the point here—what do investors need to know about indexes? Which ones should you be paying attention to? The general advice is this: don’t worry as much about what index to look at, but know what story they’re telling and how it relates to your investment strategy and goals.
Here are a few things to remember when you’re considering what to watch:
Financial news: Be mindful of what you consume. Their goal is to freak people out to get them to come back and keep reading their ads. So, take everything with a grain of salt and make sure you read financial news with a critical lens. Remember that the media doesn’t understand you or your investment goals.
A Diversified Portfolio: Having a globally diversified portfolio can help hedge against the extreme volatility of any individual stock. As a result, the news surrounding a specific index or individual stock might not always be relevant for your situation.
Ignore the Dow Jones: This is one of the most famous indices, but I really think it’s not worth looking at! Have a listen to the podcast episode for a few reasons why I think paying attention to this index is a waste of your time.
Ultimately, the indices that are important to you are the ones that align with your investment strategy. And if you don’t have an investment strategy—that’s your first step!
If you’re still in the, “what is the stock market all about?” phase, take some time to do your research, learn about it, and consider working with a professional to build an investment strategy.
You can go listen to episode 56 of The Canadian Money Roadmap podcast to learn more about the market and how it works.
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Evan Neufeld is a CERTIFIED FINANCIAL PLANNER® professional in Saskatoon, Saskatchewan and offers both investing and fee-only financial planning services.
*Disclaimer: Any numbers or rates of returns are used for illustration purposes only and should not be taken as fact. Note that the information in this article is current to the time of writing but is not guaranteed as up-to-date past then.
This article and accompanying podcast do not constitute personal financial advice. Evan Neufeld is a CERTIFIED FINANCIAL PLANNER professional in Saskatoon, Saskatchewan, and provides this Canadian personal finance content for educational purposes to the public.