How Does the Stock Market Actually Work?

The stock market is one of those things people talk about all the time, on TV, at bars, and in group chats, but very few people ever bother to explain. Here's the simple version.

A stock is a claim on a company

When someone buys a share of Apple, they've bought a small piece of that company and everything in it: the stores, the patents, the profits. Companies sell these claims to raise money, and the claims then trade between investors on big exchanges like the NYSE and Nasdaq.

That, in short, is what the market is: a place where people buy and sell claims on companies.

When people say "the market went up," they usually mean a specific index like the S&P 500, which rolls the value of its member stocks into a single number. You can see how the major indices are doing on our markets page.

Why prices move

A stock's price moves with the ebb and flow of investors' opinions about what the underlying company is worth. Earnings reports, product launches, interest rates, wars, rumors of wars, and just about anything else can push stocks up or down. In the short term, prices can be downright fickle. A company can report fantastic results, and if investors expected even better, the stock falls anyway. Over longer stretches, though, prices track fundamentals like a company's earning power.

Where the returns come from

There are two sources of return. First, you can sell shares for more than you paid. Second, there are dividends, the portion of profits some companies pay out to shareholders, usually quarterly. Together, these have produced an average return of roughly 10% per year for the US market as a whole, around 7% after inflation. The path there is wildly variable, with some years gaining over 25% and the worst losing more than 20%, but the long-run average has been remarkably durable across more than a century that included the Great Depression and two world wars. Want to see what steady monthly investing at those rates builds into? We've got a calculator for that.

The part nobody can do reliably

Now the humbling part: predicting which individual stocks will rise and fall is notoriously difficult. Even professional money managers, whose entire job is beating the market, mostly fail to do it over time, according to S&P Global's SPIVA scorecard, which has tracked fund-versus-benchmark results for over two decades. Morningstar's annual "Mind the Gap" research adds a second humbling finding: individual investors earn noticeably less than the very funds they hold, because they buy and sell at the wrong times. The problem is worse for casual investors, who tend to concentrate money in a few stocks they know little about.

The good news is that you don't need to time the market or pick winners to earn attractive returns. By buying an index fund, you get exposure to hundreds of stocks at once and collect the return of the whole market. It's practically the default recommendation for individual investors, precisely because so few people, professionals included, consistently beat the average. Most investors are better off owning the market than betting against it.

How to actually do it

It's easier than it seems. Open a brokerage account, which is free and takes about ten minutes. Fund it. Buy a diversified index fund. Then leave it alone through the ups and downs, because what you own has a long track record of rewarding people who stay invested for decades. That's really the secret of stock market investing. You're not buying a lottery ticket or a hunch. You're buying a small claim on hundreds of companies with a long history of steadily producing value.

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This article is for general educational purposes only and does not constitute personal financial, investment, tax, or legal advice. Consult a qualified financial professional before making major financial decisions. See our Disclaimer.