Why You Should Understand The Stock Market
The outcome of the day's stock market garners a lot of media attention. But how does it really work? What is the Dow? Who is the SEC? What does a stock broker do? Events on Wall Street impact Main Street's ability to do everyday business, which trickles right down to the common consumer: you. Read on to discover what happens on Wall Street and why you should a bit about it.
A Stock Market Overview
The stock market is a series of exchanges where the trading of equities (companies' stocks) takes place. Exchanges, entities that bring together buyers and sellers in an organized manner, are where stocks are listed and traded. Globally there are many well-known finance centers such as New York, London, Tokyo and Germany.
In the United States, stocks are traded on exchanges such as the New York Stock Exchange (NYSE), which is located on Wall Street. In addition to the NYSE, there is also the Nasdaq exchange. The Nasdaq originally featured over-the-counter (OTC) securities, but today it lists all types of securities. Stocks can be listed on either exchange if they meet the listing criteria, but in general technology firms tend to be listed on the Nasdaq.
Oversight and Regulation
The Securities and Exchange Commission (SEC) is the regulatory body that is charged with overseeing the stock market. The SEC is a federal agency that is independent of the political party in power. The agency states that its "mission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation." (Learn more about the SEC in Policing The Securities Market: An Overview Of The SEC.)
Types of Securities
There are two general types of securities that are most frequently traded: over-the-counter and listed securities. Over-the-counter securities are traded directly between parties, usually via a dealer network, and are not listed on any exchange, although these securities may be listed on pink sheets. Pink sheet securities often do not meet the requirements for being listed on an exchange and tend to have low float, such as closely held companies or thinly traded stocks. Companies in bankruptcy are typically listed here.
OTC securities do not need to comply with SEC reporting requirements, thus finding credible information on these securities can be difficult. The lack of information makes investing in pink sheet securities similar to investing in private companies - investors need to look closely at the company to ascertain the securities' quality.
Listed securities are those stocks traded on exchanges. These securities need to meet the reporting regulations of the SEC as well as the requirements of the exchanges on which they are listed.
The Players
There are many different players associated with the stock market, including stock brokers, traders, analysts, portfolio managers and bankers. Each has a unique role, but many of the roles are intertwined and depend on each other to make the market run effectively.
Stock brokers, also known as registered representatives in the U.S., are the licensed professionals who buy and sell securities on behalf of investors. The brokers act as intermediaries between the stock exchanges and the investors by buying and selling stocks on the investors' behalf. (Learn more about your broker in Evaluating Your Stock Broker.)
Stock analysts perform research and rate the securities as buy, sell or hold. This research gets disseminated to clients and interested parties to decide whether to buy or sell the stock. Portfolio managers are professionals who manage a portfolio of stocks for clients. These managers get recommendations from analysts and make buy/sell decisions for the portfolio. Mutual fund companies , hedge funds and pension plans use portfolio managers as their investment professionals.
Investment bankers represent companies in various capacities such as private companies that want to go public via an IPO or companies that are involved with pending mergers and acquisitions.
Measurement
Indexes are used to measure changes in the stock market. There are many different indexes and each represents a pool of stocks. The Dow Jones Industrial Average (DJIA) is perhaps the one most commonly reported by news media. The Dow is comprised of the 30 largest stocks in the U.S. and the daily Dow shows how these stocks perform on a given day. The Dow average is a price-weighted average meaning it is based on the price of the stocks.
The S&P 500 is comprised of the 500 largest capitalization stocks traded in the U.S. These two indexes are generally accepted representatives of the overall economy in the U.S. and are the most followed measurements of the U.S. stock market. There are many other indexes that represent mid-sized and small-sized U.S. companies, such as the Russell 2000. (For more on indexes and their function, check out The History Of Stock Market Indexes.)
Conclusion
The stock market is a global marketplace where goods and services are traded in the form of equities. It is an organized market with rules, oversight and various players involved in the movement of equities. Each player is intimately involved with the other players in creating a system that provides an efficient market. The indexes that measure the value of these stocks are widely followed and are a critical data source that Main Street looks to to gauge the current state of the economy. As a financial barometer, the stock market has become an integral and influential part of the financial decision making process for everyone from the average American family to the wealthiest businessman. So, even if you don't invest a cent in stocks, you should still understand how the stock market works.
