How the stock market works

Investing offers a way to potentially grow your money in a different way from savings. Many common investments involve the stock marketStock market The collection of markets and exchanges where stocks, bonds and other securities are issued or traded.+ read full definition. Learn more about how this works.

What is the stock market?

Investing involves using your money to buy assets that may later show a return. In other words, people make investments in the expectation that their money will increase in value. Many investments, though not all, involve the stockStock An investment that gives you part ownership or shares in a company. Often provides voting rights in some business decisions.+ read full definition market. Real estateEstate The total sum of money and property you leave behind when you die.+ read full definition is an example of a potential investmentInvestment An item of value you buy to get income or to grow in value.+ read full definition that is purchased outside of the stock market.

A lot of investing happens through buying and selling stock, also called shares. Companies raise capital from investors by issuing and selling shares through the stock market. Buying shares allows investors to own part of the company.  Investors could make a profit if the value of the shares they purchase goes up.

The stock market brings together people who want to sell stock with those who want to buy stock.

Two types of markets

When a company first makes shares of their private company available to the public, this is called an initial public offering. This is often called going public. This type of activity is the primary marketPrimary market The market where securities are offered to investors for the first time. The money from the sale of the securities goes directly to the company. For example, buying a company’s stocks from a company it hires to sell them (the underwriter).+ read full definition.

Any further buying or selling of the company’s shares — often called trading — is considered the secondary marketSecondary market The market where securities are resold by other investors, not the company that issued them. The money from trades goes to the selling dealers or investors, rather than directly to the company that issued the shares (which is the primary market).+ read full definition. These types of transactions are done through marketplaces, such as exchanges.

Stock exchanges

The stock market does not refer to one specific place, but to several marketplaces where stocks are bought and sold. A stock exchangeStock exchange A market in which securities are bought and sold.+ read full definition is an organized market in which an investor, through their dealer, can tradeTrade The process where one person or party buys an investment from another.+ read full definition securities in a publicly visible manner, under rules that apply to everyone who uses that exchange.

In the past, stockbrokers used to meet to buy and sell stock in a physical location. They would send trade instructions to the trade floor and traders would execute the trades in person. All stock trades are now done electronically.

You may already be familiar with some stock exchanges in Canada and the world, including:

  • Toronto Stock Exchange (TSX)Toronto Stock Exchange (TSX) Canada’s largest stock exchange, North America’s third largest stock exchange, and the sixth largest in the world.+ read full definition
  • National Association of Securities Dealers Automated Quotations (NASDAQNasdaq the National Association of Securities Dealers Automated Quotation System. NASDAQ is a computerized system that provides price quotes for securities traded over-the-counter. An American stock exchange and the second-largest exchange in the world by market capitalization, behind the New York Stock Exchange.+ read full definition)
  • New York Stock ExchangeNew York Stock Exchange An American stock exchange, and the world’s largest stock exchange by market capitalization. The exchange trades stocks for some 2,800 companies.+ read full definition (NYSENYSE See New York Stock Exchange.+ read full definition)
  • London Stock Exchange (LSE)

Learn more about how and where stocks are traded.

If you’re considering investing in a company, do some research to make sure it is a good fit for your investment goals. Learn more about where to get information on a company before investing.

Why invest in the stock market

Investing in the stock market means that the value of your investments can go up over time, as the companies grow their business and as the economy grows. Investments can potentially give higher rates of return than the rate of inflationInflation A rise in the cost of goods and services over a set period of time. This means a dollar can buy fewer goods over time. In most cases, inflation is measured by the Consumer Price Index.+ read full definition.

However, this also means there is potential for the investment to go down in value, depending on the economy and the type of investment. When you investInvest To use money for the purpose of making more money by making an investment. Often involves risk.+ read full definition, you are exposed to a number of different types of risk.

You can make money in the stock market if you sell your investments at a higher price than what you paid for them, or by receiving dividends.

Investing in the stock market can be done in different ways. Buying stocks can be done through an investment firm, or through an online adviser. Or, you can invest in funds — mutual funds or exchange-traded funds (ETFs) — which are composed of many different stocks or other investments such as bonds.

Both saving and investing are important. Investing can help you reach different types of goals than saving. Learn more about saving versus investing.

How the stock market is tracked

You have likely heard news reports referring to the stock market being “up” or “down” on a certain day. When people talk about the market this way, they are usually referring to an index. An indexIndex A benchmark or yardstick that lets you measure the performance of a stock market, part of a stock market or a single investment. Examples: S&P/TSX, S&P/TSX Canadian Bond Index.+ read full definition is a collection of securities that represents the performance of a portion of the market.

Some examples of indices are:

  • S&P/TSX Composite index — the Canadian equitiesEquities Another word for investments in the stock market.+ read full definition market. This index contains stocks of the largest companies on the Toronto Stock Exchange
  • S&P 500 — the U.S. Equities market. This index contains stocks of 500 large companies with common shares listed on the New York Stock Exchange or the NASDAQ Stock Market.

Other indices may track specific types of investments, such as bonds, or specific industries, such as the energy sectorSector A part of the economy where businesses provide the same or related products or services. May also refer to a group.+ read full definition. Indices like these give investors a general idea of whether trades within these markets are experiencing upward or downward momentum.

You can invest in the stock market in different ways. Deciding whether to be an active or passive investor is a key decision to make as you get started.

What makes the stock market go up or down

The stock market fluctuates. This means investments can also fluctuate in value day to day. This is often called volatility. An extended period of growth moving towards a peak is often called a bull marketBull market A strong market where stock prices rise and investor confidence grows. Often tied to economic recovery or an economic boom, as well as investor optimism.+ read full definition. And an extended period of decline is a called a bear market.

Bear and bull market swings can be hard to predict. Keep in mind that the stock market is composed of many different companies, industries and investors. As a result, there are several factors that can cause the market to fluctuate, including:

  • Industry performance
  • Company performance
  • Investor sentiment about a specific company or industry
  • Broader economic factors including interest rates, economic outlook, or inflation

Many different types of investments are traded on the stock market as well, each with slightly different levels of risk, and different kinds of exposure to different industries. This means that how much your investments go up or down along with the market’s fluctuations will depend on the composition of your portfolioPortfolio All the different investments that an individual or organization holds. May include stocks, bonds and mutual funds.+ read full definition.

Getting started with investing

If you’re interested in investing, be sure to also consider your financial goals and the level of risk that is right for you. You can also work with an advisor to build your portfolio and your investing plan. If you’re not sure whether you’re ready to invest, try our Investor Readiness Quiz.

Key points:

1. Investing often involves putting your money into the stock market in some way. Some investments, such as real estate, are purchased outside of the stock market.
2. Buying and selling stock happens on marketplaces, such as stock exchanges. Exchanges bring together investors and companies who issue their shares on the market.
3. Your investments can go up in value, but they can also go down.
4. You can invest in the market by buying stocks, bonds, or by buying funds which are composed of many different stocks or other securities.
5. The stock market can fluctuate up or down based on many different economic factors.

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