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Everything you Need to Know About the Stock Market

28 June 2019 by National Bank
how does the stock market work

How does the stock market work, why invest, where do you begin and what are the pitfalls to avoid? The questions are endless and the subject is fascinating. Here is an overview to enhance your understanding of the stock market.

What is the stock market?

The stock market, often simply referred to as “the market,” is similar to a public market where buyers and sellers exchange listed securities. Listed securities include stocks, exchange-traded funds, investment funds and other types of securities. Stocks are the most well-known types of securities; the stocks you hold represent your interest in the company’s capital.

Notable markets include the New York Stock Exchange, often referred to as Wall Street, the Toronto Stock Exchange (or TSX) and the NASDAQ, the largest electronic stock exchange in the world.

Stock indexes group a certain number of companies listed on the stock market according to different industry sectors and act as a barometer to follow a market’s evolution. For example, the S&P 500 groups 500 very large American companies. This selection of companies is an excellent representation of the American market and, therefore, its global trend.

Why do companies issue shares?

As a general rule, companies want capital to accelerate their growth. The inflow of new capital from external investors, i.e. shareholders, is often less restrictive than a bank loan. The latter requires results and interest, as well as recurring, regulated payments.

How varied are share prices?

Stock markets are governed by the law of supply and demand. The price of a company’s share normally coincides with its real value, which is established using objective data, not an estimate.

Therefore, if a large number of securities is purchased during the day, share prices tend to increase. This is a sign that investors see the potential returns and growth of the business. On the other hand, if a large number of people are looking to sell their shares, the share value tends to decrease.

You may be investing without even knowing it!

It’s easy to forget, but people who hold RRSPs and TFSAs sometimes invest indirectly in the stock market. These accounts or savings tools are quite often made up of shares. That’s why it’s so important to understand the basics.

Stock-market strategy: Deciding factors

Buy or sell? There are many factors to consider first. However, some fundamental elements always ring tried-and-true, including the financial statements and annual reports that publicly traded companies are required to disclose. This is a good indicator of their financial health.

Analysts and investors often consider hundreds of secondary indicators that can influence a security’s movement, including expert opinions, economic growth, geopolitical considerations, inflation, interest rates and natural disasters.

Returns and emotions

Another thing to consider is mediating your discipline and your patience. Emotion is often a bad advisor, especially considering that stock market fluctuations are generally cyclical.

In periods of market volatility or correction, a significant drop in prices may be followed by an equally significant increase in a matter of 60 days. The way an investor-shareholder behaves during these periods will make a big difference in their returns, both in the short and medium term.

Diversification

Diversifying your assets is another key element for anyone looking to reconcile performance and consistency for a more comfortable retirement, for example. The most common diversification is a combination of Canadian, U.S. and foreign stocks, bonds, term savings and investment funds (such as dividend or natural-resource funds). Your assets will be especially diverse if you also vary the duration of your investments and the industry sectors in which you invest. A potential loss in one asset class could then be more easily offset by a gain in a different one. Above all, diversification must be in line with your investor profile and risk tolerance.

Many people opt for investment funds since they represent a large group of stocks that is monitored closely by a professional portfolio manager. Even with a modest initial investment, this option allows for a better distribution of risks and a certain detachment regarding market investment prices.

No matter how much you invest, it’s recommended that you work with an advisor or planner who can help you grow your wealth and, ultimately, achieve your life goals.

Online brokerage: Control over your investments

An increasingly popular option, online brokerage is great for investors with a good understanding of the market who prefer to manage their own investments. This type of brokerage is cheaper than a traditional brokerage since you are not benefitting from an expert’s advice. This is an autonomous approach to online investing. Simply open an account with an online brokerage firm and use its platform to manage your investment portfolio.

Remember that online brokerage is not for everyone—during a market downturn, constantly consulting your investments can create a high level of stress, among other things.

The stock market is difficult to predict

There are as many theories as there are investors to thoroughly explain the market’s up-and-down fluctuations. Famous investors such as Warren Buffet advocate for simple foundations: understand the company, invest in safe stocks and, above all, think long-term. There are, however, some fundamental errors you should avoid making on the stock market.

Table of market quotes

Every company listed on the stock market has a trading symbol. By entering “National Bank stocks” in a search engine, you can access a graph showing National Bank’s share prices.

From there, you can select different time periods (day, month, year, etc.) to see how the prices have fluctuated and analyze the stock return.

Ready to invest in the stock market?

The stock market is not a lottery. Its indexes generally show convincing annual returns, and if growth is not shown in a perfect diagonal line, don’t worry—it does its work over time.

By making an appointment with your financial advisor, you can get a clear picture of your financial situation, your needs and capabilities, your investor profile and your level of risk tolerance.

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Views expressed in this article are those of the person being interviewed. They do not necessarily reflect the opinions of National Bank or its subsidiaries. For financial or business advice, please consult your National Bank advisor, financial planner or an industry professional (e.g., accountant, tax specialist or lawyer).

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