How does the stock market work?

22 August 2022 by National Bank
how does the stock market work

Investing in the stock market may seem complicated and best left to a few people with a specialized background in finance. However, many of us are already investing in the stock market without knowing it, for example through a pension fund. In order to better understand how it works, here’s a quick guide on how to invest in the stock market.

What do you need to know before investing in the stock market?

What is the stock market?

What we call the “stock market” or the “market” are physical or digital spaces where people buy and sell securities, such as stocks. It’s kind of like a massive shopping centre where financial assets are bought and sold.

These spaces – stock markets – simplify exchanges and ensure a framework for them in order to reduce risks.

Some examples of stock markets you might know: 

  • The New York Stock Exchange (NYSE). Often referred to as “Wall Street,” this is one of the best-known stock markets. This is the world’s largest stock market (including shares in many U.S. companies).
  • The Nasdaq. The world’s second largest stock exchange (behind the NYSE) and the largest electronic market.
  • The Toronto Stock Exchange (TSX). Canada’s largest stock exchange. It includes many shares in major Canadian companies.

What are publicly traded securities?

Securities are financial assets (that represent a financial value). When the security is listed on a stock exchange – meaning it can be bought and sold there – it is said to be publicly traded.

Listed securities can include:

→ The vocabulary used to talk about the stock market can sometimes be confusion. Read our article to help understand it all: “Your guide to investments: Read before investing”.

Stocks are no doubt the best-known securities. These are shares in companies. This means that someone who holds shares in a company owns a portion of their capital.

What causes stock prices to fluctuate?

You may hear people talk about a share price that had gained or lost value. That means the price of the share went up or down.

To explain variations in share prices, you need to revisit a (very) important law in economics: the law of supply and demand. And this also applies to stock markets.  Here’s how it works:

  • The more a share is bought, the more its price will tend to go up. This is a sign that people who want to invest in the stock market believe in the return and growth potential of the share (or the company that issued it).
  • Inversely, if a greater number of people are looking to sell a share, its value will tend to decrease.

Good to know: the term quote is sometimes used to talk about the price of a share.

What are the main terms to know when talking about stocks?

There are many indicators related to stocks and stock markets. Here are a few of them:

  • Bid: the maximum price a buyer is prepared to pay for a security, like a stock. This is also what the seller will receive when they sell it to the highest bidder.
  • Ask: the minimum price a seller is prepared to accept to part with a security. That means this is what a buyer will pay to acquire it.
  • Last: the last price at which the share was traded. You’ll often see this number when you consult apps, stock tables or stock market news.

How can you predict what will happen on the stock market and with stock prices?

It’s impossible to perfectly predict prices and performances of individual shares if you want to invest in the stock market.

That being said, there are a number of factors available to us to help analyze a stock, its potential return or the risk it represents.

8 important factors:

1. Fundamental elements.
When investing in the stock market, analysts and investors will assess the financial results and annual reports that publicly traded companies are required to release. This is a major indicator of a company’s health.

2. Volatility.
The volatility of a stock depends on fluctuations in its value over a given period.

If a share’s price is stable, its volatility is low. Conversely, if the price goes up and down substantially and quickly, the share is considered volatile. Generally, the higher volatility is, the riskier the share is.

3. Interest rates.
Rising interest rates (and by extension borrowing costs) can reduce development and performance of a company. Consequence: this can bring down the value of their shares.

Investors with loans (such as a variable-rate mortgage) also see their purchasing power reduced after an interest rate increase. Consequence: this drives down demand on markets.

4. Inflation and economic growth.
When inflation rises, the cost of living rises, and the purchasing power of businesses and investors goes down. This situation slows economic growth and brings down demand on markets – which can exert downward pressure on share prices.

Good to know: in Canada, interest rates are primarily based on the Bank of Canada’s policy rate (link to outside site).

5. The liquidity of a stock.
How easily it can be sold.

  • A stock for which there is little demand - which is relatively illiquid - will be more difficult to sell when you want to, especially for a large volume.
  • Conversely, a stock for which there is a great deal of demand will be very liquid.

6. Geopolitical risk.
The relations between countries have a major impact on what happens in many industries. For example, if they turn hostile, some companies may see their growth slow, and the value of their shares impacted.

7. Exchange rate.
When you buy or sell foreign shares, the exchange rate can have an influence on the return of your investments.

Example: if the Canadian dollar goes down, the return of your foreign shares could go up.

8. Natural disasters, pandemics, etc.

What tools are there for viewing and tracking stock prices?

Stock price charts

Every company listed on a stock exchange has a stock symbol. For example, National Bank’s symbol is NA.

You could put “National Bank stock” (link to an outside site) into a search engine and view share price charts.

These allow investors to select various periods (day, month, year) to view price changes and analyze the market return over a given period.

A multitude of online tools

There are also numerous tools and brokerage platforms in order to help you:

  • Track the market
  • Observe changes in share prices
  • Analyze the return on your investments
  • Buy and sell securities

 Are you interested in different stock market strategies? Consult our article: "How should you invest your money?

Crystal ball tip
It is extremely complex, if not impossible, to predict stock markets. There are as many theories as there are investors to explain upward or downward movements. Famous investors like Warren Buffet favour relatively simple rules to invest in the stock market: understand the company, invest in safe values and especially, focus on the long term.

What is a stock index?

Stock indexes combine a certain number of publicly traded companies. Certain indexes are specific to market sectors like health care or precious metals. Others have a broader spectrum and combine many types of different companies.

Some examples of well-known stock indexes:

  • S&P 500. This index combines 500 very large U.S. companies. This basket of companies is relatively representative of the U.S. market and its trends.
  • Nasdaq 100. It represents the largest 100 non-financial companies listed on the Nasdaq exchange.
  • Dow Jones Industrial Average. It combines 30 major U.S. firms. The Dow Jones is one of the most tracked indexes.

How to invest in the stock market

Good to know: index funds are exchange-traded funds (ETFs) that attempt to reproduce the return of a specific stock index.

How to get ready to invest in the stock market

Investing in the stock market is not just for experts. When you buy stocks, ETFs or options, you’re investing in the stock market.

But before getting started, there is still a process that must be followed.

First think about:

Should you invest in the stock market with help from specialists or by yourself?

Investing in the stock market with the help of advisors from a brokerage firm or a financial institution provides you with peace of mind and convenience.

Important points:

  • You will generally have to pay brokerage fees (management fees and commission) for each transaction.
  • Your broker will take care of opening your accounts and buying or selling securities for you, based on your strategy and needs.
  • To have access to a broker, your investments need to be relatively high.
  • If you have a more modest portfolio, your financial advisor can assist you and point you toward mutual funds that include stocks, for example.

Self-directed investing allows you to be in control of your investments. In this case, you:

  • Are responsible for your portfolio
  • Carry out your own transactions
  • Can use simplified direct brokerage platforms (these applications are generally free)
  • Save on certain fees, like brokage fees

→ Interested in self-directed investing? Check out our article on the subject

Keep in mind that although stock markets do not increase in a perfectly straight line, they do the job over time. Ready to invest in the stock market? Take the first step yourself using our direct brokerage platform or feel free to contact an advisor.

Discover our self-directed investing platform

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