Intro To The U.S. Stock Market For Beginners

We understand entirely if you don’t know the stock market basics and find CNBC frustrating. Phrases like “earnings movers” and “intraday highs” can be overwhelming to the novice investor. If you’re planning on being a long-term investor and have a retirement portfolio with mutual funds, you don’t have to worry much.

If you want to learn how to trade stocks, you need to know the basics of the market. You also need to understand how stock trading works. Don’t worry too much because that’s exactly what we’re here to simplify.

What Is A Stock?

Let’s start with the basics. Companies issue stocks as a way to raise funds and grow their business. Stocks are security or a share that represents ownership in a company. When you own a single share, you own a fraction of the company.

When investing, stocks can increase wealth and beat or be unaffected by inflation over time. When you own a stock, you share in the company’s profits. Incorporated and public companies sell their stock through an “exchange” like NASDAQ or the NYSE.

Any shareholder can buy shares through stockbrokers – this can be online or through a financial advisor. Stock exchanges have an inventory of each company’s stock, which directly affects the stock price. Stock prices change throughout the day, but shareholders hope the prices go up with the hope of making profits. This does not happen every time or with every company.

The company’s monetary status affects your stock directly. Companies can also lose value or go bankrupt. That’s why it’s essential to do your research before you invest your money in a stock. It also shows you why it’s important not to put all your eggs in one basket and diversify.

If you’re an employee with a 401(k), you might already own stock without realizing it. Most employers invest in mutual funds, which have many company stocks in one place. They also don’t get affected by the market as much as an index or Sensex funds and are therefore a suitable long-term option.

Understanding The Stock Market

When people say that there is an incline or decline in the stock market, they refer to a market index. A market index is what tracks the performance of stock groups. It indicates the health of the entire or section of the market at any given time.

Investors use indices as an indicator of their portfolio performance. The most common indices you’ll hear about are the Dow-Jones Industrial Average, Nasdaq Composite, and S&P 500. These are often used as proxy indicators for the market’s overall performance.

Investors also use indices to make trading decisions. Index funds and exchange-traded funds (ETFs) are good ways to invest in an entire index. You can also use it to track a specific index or sector of the market.

Bull And Bear Markets

While bulls and bears are terrifying to run into on hikes, they mean different things in the stock market. A bear market indicates a dropping (typically 20% or more) index market. A bull market is generally followed by bear markets and vice versa and predicts future economic patterns.

A bull market signifies good luck and economic growth for the investor. A bear market indicates the opposite and causes investors to sell. On the bright side, bull markets tend to last longer and is beneficial for you to grow your money long-term.

The S&P 500 has 500 of the largest U.S. stocks and produces an annual average return of ~7% when investors reinvested dividends, and inflation adjustment is considered. This means that you’d have about $7,600 today if you invested $1,000 30 years ago.

Stock Market Crash vs. Correction

When there is a stock market drop of 10% or above,  what happens is called “a stock market correction.” However, a stock market crash occurred suddenly, like the 1987 crash when stocks dropped by 23% in a day.

If you’re worried that the stock market will crash, focus on the long term. While crashes can cause a bear market, remember that bull markets last longer than bear markets. This means that the stocks will eventually regain value.

Watching your portfolio’s value shrink in real-time and doing nothing about it can be challenging when the stock market falls. However, if you’re investing long-term, doing nothing is often the best course. If you’re thinking about why you should wait years for your stocks to regain value, remember that you lock in your losses when you sell investments in a downturn.

If you choose to exit the market and re-enter at a better time, you might worry about your potential gains or losses. Therefore, to avoid regrets and conservativeness, it is better to stay.

The Importance Of Diversification

As an investor, it’s not possible to avoid bear markets. Therefore, you should focus on risk management. There are many risks when having an undiversified portfolio. Diversification can protect your portfolio from suffering immeasurable losses.

If you invest all your income in one company, your success will be very short-lived as the company can get shut down due to regulatory issues, an outbreak of a disease, or poor leadership. To have a backup, investors invest in many stocks to balance out the losses and eliminate the risk of losing your portfolio.

Building a diversified portfolio takes effort, patience, and research. You could also invest in a mutual fund, the ETF mentioned above, or an index fund. These funds have a basket of investments, simplifying your portfolio diversification. For example, an S&P 500 Index Fund aims to mirror the performance of the S&P 500 by investing in the index of those 500 companies.

However, the good news is that your portfolio can have a combination of individual stocks and funds. Just keep in mind to use less than or equal to 10% of your portfolio to your trusted stocks and the rest in index funds.

The Bottom Line

Indices are crucial to analyze the U.S. equity market. Their movements provide insight into the economic status of a country. It also provides insight into the investor’s risk appetite and investment trends. Understanding the subtleties of their design and structure can be essential to making investment decisions.