Investing

How the stock market works — here's everything you need to know

Twenty/20

The stock market is where buyers and sellers connect to exchange investments. Like an auction house, it's a place where market participants can come together to determine prices and make trades.

As the name suggests, the stock market was historically the primary place to trade individual stocks, or shares of ownership in a publicly traded company. Today, it has increasingly become a place where other investments are also bought and sold, including exchange-traded funds (ETFs) that track a basket of assets like stocks, bonds, or commodities.

When people talk about the U.S. stock market, they're often using it as shorthand for major market benchmarks like the S&P 500, Dow Jones Industrial Average, or the Nasdaq Composite.

Here's everything you need to know about how the stock market works.

How the market works: Matching buyers and sellers

There's not just one stock market. Trading activity occurs through a variety of different exchanges, like the New York Stock Exchange or the Nasdaq.

You may have a mental image of people working on Wall Street and making funny hand signals or shouting orders to execute trades. But today, the primary way to trade stocks is electronically. These exchanges serve the important function of bringing together traders who want to buy or sell the same security in what's known as the secondary market.

Stock exchanges track the supply and demand — the amount that buyers and sellers want to execute — which helps determine the price at which securities ultimately trade. Computer algorithms determine those levels for the most part.

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Buyers offer a bid, or the highest amount they're willing to pay for shares in a company. Sellers make an ask, which is the lowest amount they're willing to accept. The difference is known as the bid-ask spread — and these prices can jump around a lot during the day.

Trades are executed in the stock market when either the buyer or seller budges from their respective bid and ask levels to agree on a price, and that's determined by supply and demand. If there's more demand among those traders buying a stock, then its price will go up. When there's more demand to sell, the price will go down.

In the U.S., the regular trading hours for the stock market are from 9:30 a.m. to 4 p.m. Eastern time on nonholiday weekdays — and bells ring at those times to signify the opening or closing of the trading day. During trading hours, you can easily check stock prices for any security that trades throughout the day (including individual stocks and ETFs). In addition, you can check the levels at which the major indexes are trading throughout the day, and how much they're up or down from the previous day.

How to invest in stocks

There are a number of different ways to invest in stocks, some of which will make you feel more connected to the process than others. Regardless, you need an account for executing these trades.

If you have a workplace retirement plan, like a 401(k), you're most likely already investing in the stock market. When you set up your 401(k), you'll have the option to pick from a preselected mix of investments, typically mutual funds that track broad market indexes like the S&P 500.

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Don't have a 401(k)? There are other ways to invest in stocks, including through an IRA, by opening an online brokerage account, or signing up with one of the growing number of robo-advisors.

No matter which route you take to invest in the stock market, the company that oversees your account will serve as the go-between with the exchange, routing your orders to buy shares of individual stocks, ETFs, or other securities for execution.

How to make the stock market work for you

Investing in the stock market is easier, and cheaper, than ever. That's great news for investors, but it's important to go in with a long-term perspective: Experts generally recommend investing in stocks with money that you won't need within the next five years or so.

In addition, it's important to consider how you're investing in the stock market. Buying individual stocks can be risky, since they can experience sharp fluctuations.

Investing in the broader market, especially with a buy-and-hold strategy, is safer. It's also simple, thanks to the index funds that now rule the market. These funds allow investors to buy a lot of assets, most commonly stocks, all at once. As an added bonus, they don't require you to be an investing expert, they typically carry lower fees, and they're an easy way to add diversification to your portfolio.

Other ways to add diversification to your portfolio include buying shares of companies of different sizes, investing in international stocks, ensuring you have a mix of growth and value stocks, and having a healthy allocation to bonds in your portfolio, depending on your age.

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That said, you need to be prepared to ride out short-term bouts of market bumpiness, like the late 2018 slump that saw major U.S. indexes fall nearly 20%. However, the stock market has always recovered. If you keep adding money to your portfolio regularly, you can take advantage of dips to get stocks at lower prices.

Finally, look at the market's proven history for returning value to patient investors. The long-term historical average annualized return for the U.S. stock market is almost 10%. If you'd invested $500 in the Dow 10 years ago, for example, that would be worth more than $1,700 today.

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All investments involve risk, including loss of principal. The contents presented herein are provided for general investment education and informational purposes only and do not constitute an offer to sell or a solicitation to buy any specific securities or engage in any particular investment strategy. Acorns is not engaged in rendering any tax, legal, or accounting advice. Please consult with a qualified professional for this type of advice.

Any references to past performance, regarding financial markets or otherwise, do not indicate or guarantee future results. Forward-looking statements, including without limitations investment outcomes and projections, are hypothetical and educational in nature. The results of any hypothetical projections can and may differ from actual investment results had the strategies been deployed in actual securities accounts. It is not possible to invest directly in an index.

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