What Is A Stock Market?

This will be an unusual insight into the role and function of the stock market. Normally you will get a definition of what a stock market is supposed to be.

You will also learn some history and stuff but let me share with you from an investors point of view what a stock market is.

What Is The Stock Market?

Before we move on to that special point of view...let me be clear and tell you what is the stock market?

We are referring to the US stock market isn't it? 

Or are you looking for information about the UK stock market or Malaysian stock market or Japanese stock market?

Well, it doesn't matter because the stock market is actually made up of a collection of many many companies that represent the economy of a country.

The companies in this list are some of the biggest and most profitable companies in the country. They are carefully chosen from the thousands of companies and they reflect different segments of the economy.

For example, the United States' stock market is synonymous with Dow Jones Industrial Average. Sometimes people refer the stock market as the S&P 500 companies.

These are 500 of the most well known and influential companies in the United States.

In The United States The Stock Market Is The S&P 500, Dow Jones And The Nasdaq Composite

I do not think there is a clear definition of what a stock market is...

Let me explain.

If you ask someone on the street what they think a stock market is...they will probably tell you...oh its the Dow Jones.

Later if you ask another person what a stock market is...they will tell you...oh...its all the stocks that you can buy or sell in the exchanges.

And if you happen to spot someone who is into techs, they will probably tell you that the stock market is the Nasdaq and stocks like Apple are on their mind.

So what is the correct answer?

There is no definitive answer.

But for our purposes and for the purpose of determining the economy of such a big and powerful nation such as the United States of America, we need more than one index to tell us about what is happening to the stock market.

There are 3 popular indexes in the US stock market:

  1. The Dow Jones Industrial Average
  2. The S&P 500 Index
  3. The Nasdaq Composite Index

The most popular by far that laypeople know and will usually talk about is the Dow Jones Industrial Average. The Dow Jones has a long history.

It is one of the oldest indexes in the world that is still in use. Today it has 30 components which are some of the biggest and most powerful and influential companies in the United States.

Over the decades, the component of the Dow Jones Industrial Average has changed. The change is made when they decide to kick out one company because it is not relevant anymore to reflect the state of the economy.

Another company that is more relevant is added to replace the irrelevant company.

The company that is being added is usually a company that is growing in power and influence as the years go by. That is why the Dow Jones has a biased of going higher in the long run.

If you keep on replacing components in the Dow Jones with a more influential and growing company, then you are actually putting a bigger company in the place of a company that is losing its influence.

In the long run, the Dow Jones is the survival of the fittest. Only the most powerful and influential company in the United States get to be in this exclusive club.

Two companies that were once nothing has been added to this exclusive club.

They are Apple and Microsoft.

If you were in the 1960s you would not even have heard about these 2 tech giants. But today their products have a far and wide reach across the United States and all over the world.

The 30 Components Of The Dow Jones Industrial Average - Is It Enough?

The Dow Jones Industrial Average has come a long way since its inception.

Today there are 30 components in the Dow Jones.

30 companies might sound a lot of companies but in reality taking 30 companies to represent the entire stock market of the United States and some say they can be misleading. Some say they do not reflect the whole picture of the economy of the United States.

But over the years, the Dow Jones has still been able to tell us about the state of the economy.

If the Dow goes up, then it means the US economy is growing. On the other hand, when the Dow Jones goes down, it means that the US economy is contracting.

The Dow Jones is made up of stock such as Apple, Boeing, American Express, Coca Cola, JP Morgan, Home Depot, Verizon, Wal Mart.

Well these are big names and big companies that employ a lot and a lot of people in the United States alone.

Which is why despite its small exclusive club members, they are still able to reflect the economy of the United States. And when people refer to the Dow Jones as the stock market, they are actually still correct.

Using The Chart Of The Dow Jones To See The State Of The Stock Market And US Economy

Ok, since we now know that the Dow Jones Industrial Average represents the stock market as well as the US economy, we can actually use the chart of the Dow Jones to determine whether:

  • The stock market is going up or down
  • The economy is growing or contracting

Its wonderful isn't it to be able to see whether the US economy is growing or not just by looking at a chart.

Yes, charts can be very simple and useful for analysis purposes.

If you want to find out more about stock charts and how useful they are, check this article out. What Are Stock Charts And Why You Need To Use Them.

Let's go through the chart above and see what we can learn.

The chart above is the monthly Japanese Candlestick Chart of the Dow Jones Industrial Average. Each bar on the chart represents one month of trading. 

Green bars mean the market went up for the month while red bars show us that the market went down for that month.

The red lines and blue lines are the 20 period moving average and the 50 period moving average. Its a simple trend following tool that one can use to follow the trend of the Dow Jones.

We wont go into the details of the moving average and how to use it. But generally if the Dow Jones is above the 20 MA and 50 MA, it means the Dow Jones is healthy and good and in an uptrend.

So as you can see, the period around 2007 to 2009 was where the Dow Jones fell by a lot.

This told us that the stock market was in a bear market and the US economy was not good.

After 2009, the Dow Jones begin to climb up steadily and it has been going up ever since. The long term uptrend for the Dow Jones is still up.

This tells us during this period, the US stock market is in a bull market. The economy had also improved and the US experienced and economic boom that is still going on.

Sure there are ups and downs along the way but the US stock market and US economy is still bullish from a long term point of view.

What Really Moves The Stock Market?

I think at this point you may have this question...

If the stock market goes up and down each day, what is it that really moves the stock market?

What is it that moves stock prices?

In order to answer this question properly, you need to understand the future. What I mean is you cannot look at the past to give the stock market a value. You need to look at the future.

Imagine this...two kids are being asked what they want to do in the future.

The first kids answers, I want to be a doctor.

The second kid answers, I want to be a garbage collector.

Well, what do you see in the future of these two kids. Immediately you will attach a bright future for the kid who wants to be a doctor. If you would give a price tag to the kid's ambition you will probably say...well perhaps he can be worth $20 Million.

On the other hand, you would probably say $200,000 for the garbage collector's entire life's earning potential.

Whose stock is up and whose stock is worthless?

The kids who wants to be a doctor would have a higher value isn't it?

But now let's turn the story a little bit...

Imagine now that the kid who wants to be a garbage collector actually started a business that helps entire cities to collect their garbage. He started with one city and then expanded his operations to  50 other cities. 

His company charges the city by the amount of trash he helps to disposes. Turns out that each month, every city pays his company $500,000 for the dirty work of disposing off their trash properly.

Okay...

That is a bit like stocks. 

A lousy company that seems to have no future but actually turns out to have a brilliant business plan can be worth millions if not billions.

Its take vision to invest in a company like that. Sometimes you can't see the future that clearly but you have the guts to invest in the company because you believe in its potential.

So the answer to the question of WHAT REALLY MOVES THE STOCK MARKET is this...

  • Future prospects

If the entire US economy is expected to grow double digits next year, the stock market will shoot up to reflect that value. On the other hand if the entire US economy is expected to enter recession because of bad policies or war then the stock market will go down.

Even before the war happen or the effects are seen in the public, the market will price them in. 

Therefore, investors who did their homework will immediately sell their stock in anticipation of a war. If everyone is throwing away their stocks, the entire market will collapse.

Sometimes we can rephrase the FUTURE PROSPECTS into NEWS.

Good news for the stock market will lift the stock market. While bad news will help sink the markets.

Good news for a stock will help to lift the price of that company's stock. While bad news will help to sink the stock's price.

A good example is when the FDA finds flaw in a pharmaceutical company's product. There could be massive recalls and bans for that product. If the company's product makes up a big percentage of its profit, then it will affect its bottom line in the next few months to years.

Therefore, investors will quickly dump the shares of the company.

Those massive selling will help to push the price of the stock down. 

Do keep in mind that the recall and ban has not happened yet. There is only an inquiry by the FDA and that is enough to help sink the price of the company's shares.

News That Moves The Stock Market

Today there is a vast array of news that can move the stock market. Good news are news that help to send the market higher. Bad news are news that help to send the market lower.

Some good news that help to send the market higher are:

  • A certain presidential candidate has won the US Presidential election
  • Certain policies of the government that affect the economy (ex...reduce taxes)
  • Trade deals that benefit the country
  • Interest rates are not increased
  • Unemployment rates are low
  • Job reports are very good

Some bad news that will affect the stock market negatively are:

  • Rumor of war or actual war that is about to happen
  • Some hostile country causing instability in certain regions in the world
  • Trade wars that affect two countries ability to profit
  • Increase in tax rate for companies
  • Policies of the government that try to please the public but reign in companies' ability to do business and make profit
  • High unemployment rates in the country
  • Job reports that are not good
  • A rise in interest rates that put a burden on company's borrowing

Sometimes what seems to be good news can have the opposite effect. Good news that are only good news if they are within the expectations of analysts.

For those who are new to the stock market, you may be surprised to hear some good news and then see the stock market sell off.

A good example is this...

The government reports that last month they created 50,000 jobs. Wow! 50,000 jobs is quite a lot. Don't you think that is good news? 

50,000 people have the ability to earn a living and help feed their families.

Well, if economists and analysts are expecting a job increase of 100,000 then a 50,000 new jobs is below expectations. In fact its 50% less than what they expect.

What does that mean?

It might mean that the economy is slowing down. The reason that businesses are only creating 50,000 jobs instead of 100,000 jobs tells us they do not need that many employees.

So when you read a piece of good news in the future...

ALWAYS read it in light of the EXPECTATION.

If you find it hard to understand just picture this...

Your 8 year old son want to have the latest Iphone as his birthday present. Thinking that such a young kid should not be pampered, you and your wife just got him last year's model which is cheaper.

Guess what happens when your son gets his new (old) Iphone? LOL

He will burst into tears of throw a tantrum because his expectations are not met. What seems to be good news (a nice birthday present) is bad news to him.

A Place To Buy A Piece Of A Company

The stock market is a place where you can go to purchase shares of a company that you wish to invest in. You can do that through an online broker.

Many brokers today offer the savvy investor who have an internet connection to purchase shares on their own. If you want to learn which is the best broker I recommend, read The best stock broker with great reliability and best commissions

Let's say you are interested in buying Apple shares. You heard its a great company with great management. It also has great products that you love. You think it may double in price in the next 5 years.

You can own a piece of this company by buying the shares of Apple in the stock market. Simple as that.

A Place To Raise Money For Companies

The stock market is a great place for young companies to raise money. When a stock is listed for the first time on the stock exchanges, it is called an IPO. IPO stands for Initial Public Offering.

IPO is a great way for a company to seek the necessary funds to fund the many ventures that the company will get into. Let's say a private company needs to raise $5 Billion.

They can get a loan but a better way and more prestigious way is to IPO the company. Today, an IPO not only raises money, it raises the prestige of the company and its founder when it is listed on the stock market.

Think Microsoft, Google and Facebook.

You can read about The Biggest IPOs In US History Here

A Place To Share Risk And Build Wealth

The stock market is the perfect place to share risk in a company. Not all companies that are founded are stable and prosper all the time. Many new companies go into risky businesses.

If the company grows, then they stand to make money. But for every big success there are another 10 that goes bust. The people who list their company on the stock market are smart people who want to share the risk with the public.

In return for cash and a piece of the risk, investors seek growth in the stock price.

If the company does well, then the investors are richly rewarded. They are rewarded with a higher share price. Its not uncommon to hear small investors who bought $50,000 worth of shares ending up with $10 million worth of stock after 10 years.

I think a few charts will be able to illustrate how magnificent picking the right companies to invest could be.

The chart above shows the stock chart of Nike, which is the well known shoe company started by Phil Knight. Back in the 1980s, you could have bought a share of Nike for as low as 0.15$.

If you were one of those fortunate investors who bought in the 80s and held on to it, your share is worth $57.86 today. A mere investment of just $10,000 would balloon to $3,857,333 in today's dollars.

Let's take another well known stock today. The chart above is the chart of Facebook. Facebook IPO at around $42 and it dropped to as low at $17.55.

If you had bought this stock in the low $20s or $30s, your investment would have quadrupled today. Not bad for 4 years of investing in this stock.

The next great stock I want to share with you is Amazon. In the late 90s you could have invested in this stock for $1.30. If you have bought this stock, $10,000 would have turned into 6.5 Million!

The stock market is the greatest wealth producing machine in the world. Its no wonder that young entrepreneurs today like to start a company, grow it and list it in the stock market!

A Place Where You Can Earn A Living By Swing Trading

If you are not one of those who like to put money into stocks and hold them for years, the stock market does offer you an opportunity to make money through swing trading.

Swing trading has become more and more popular in recent times.

Especially with the era of the internet, lots of people are able to teach themselves how to swing trade as well as buy and sell stocks for themselves. 

Gone are the days when you need a broker to buy stocks for you. Those days, you will phone up your broker and buy the stock. The commission is quite high as well.

Therefore, you will need to wait for the stock to appreciate by a lot before you can sell with a nice profit. You also need to trade in bigger portions as the big commissions will eat into your profits.

What is swing trading?

Well, the market moves in swings at times. Going from overbought to oversold. Sometimes it breaks out higher. A swing trader aims to capture the movements of the market or a particular stock.

These movements can last from a few days to a few weeks.

Therefore, a swing trader will buy a stock and then hold it for a few days to a few weeks. 

It is very rare for the swing trader to hold stocks for more than a month.

For example, a swing trader sees that Apple's stock is setting a very nice swing trading setup.

Apple's stock has declined to the rising 20 MA. Therefore, the trader thinks that Apple is likely to bounce off the 20 MA and go up for a few days to a few weeks.

The trader then enters Apple and hold the stock for 2 weeks before selling it.

That is the beauty of swing trading.

You do not need to look at the market for the whole day. That will be day trading and not suitable for most people. On the other hand, the swing trader does not need to stay in a stock for months and months.

There are always a swing trading opportunity.

In fact you can find swing trading opportunities every day, if you have the skills and know where to look.

That is the beauty of the stock market.

Those who have learned how to swing trade will be able to reap profits from the stock market every week.

The Stock Market Is A Good Place To Diversify Your Investments

Let's face it...sooner or later in life you might be thinking of investing in something. 

As a grown up you have responsibilities. One of them is to manage your money well. Whether it is for your own self or for your own family, you really need to start thinking about investing in something.

Some stuff you can invest in are:

  • Properties
  • Stocks
  • Gold
  • Bonds
  • Bitcoins

Okay the last one is quite popular today with young people.

There are quite a lot of things you can invest in. But if you only stick with one type...say...you only invest in properties then you are going to be hit hard if something happens to the property market.

A falling housing market is extremely difficult to get rid of your property. You might end up losing a lot because nobody will buy from you at a high price.

Traditionally stocks have gone up by about 7-9% a year. Depending on what period you check the average gains of the S&P 500.

The stock market acts as a hedge against inflation.

If you invest in properties, it takes time to sell off your investments if you need the cash. On the other hand, if you have stocks, you can easily sell them to raise cash when you need the money. 

You can sell it the next day when the stock market opens.

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