Rule #1 Finance Blog

With Investor Phil Town

How The Stock Market Works: Basics Everyone Should Know

The stock market is the best wealth creator in the entire world, yet remains a confusing concept for a lot of people. In fact, most people don’t know the stock market basics.

When it comes to investing, many people wonder where to start. It’s difficult to pick a single starting point with so many strategies out there.

That’s why I’m here. To help you get started and launch your investing practice. The best time to start is now.

Today, we’ll cover the basics such as what the stock market is, how the stock market works, and how to invest in the stock market for beginners.

When you understand the stock market basics, you’ll be able to enter the market with the knowledge you need to create incredible wealth. 

Let’s get started.

Stock Market Basics

There are a few things every investor should know before entering the stock market. When you master these basic investment terms and principles, you will be able to make smart investment decisions.

What Is A Stock? 

A stock is a type of security that gives investors (also called “owners” or “stockholders”) a share of ownership in a company. In other words, when you buy a stock in a company i.e. Apple or Amazon, you then own a tiny piece of that company.

When you purchase stock in a company, you can choose to purchase one tiny piece or many tiny pieces. The number of individual stocks you buy is also called your “share” or shares. When the stock price goes up, the value of your shares increases and so does the return on your investment.

In order to buy a company’s stock, it typically has to be publicly traded on a stock exchange, such as the New York Stock Exchange. This brings us to our next stock market basic.

how the stock market works

What is a Stock Market Exchange?

A stock exchange is where public companies list shares of their company for purchase. There are many stock exchanges where one can purchase or sell shares in a company. 

These include the New York Stock Exchange (NYSE), the Nasdaq, over-the-counter markets (OTC), and international stock exchanges. Many of these stock exchanges are linked together electronically.  

History of the New York Stock Exchange

Among the various major stock exchanges, the New York Stock Exchange is the most famous and the largest home of stock trading. Many of the largest companies in the world choose to list their shares on the New York Stock Exchange. 

It has a long-standing reputation, officially dating back to 1792, but with a history going back as far as the 1600s. Over the course of centuries, the NYSE has established itself as a trusted marketplace for people to buy and sell stock. While it’s not the only exchange, it is the most notable. 

People can’t just walk up to the New York Stock Exchange on Wall Street and buy or sell shares, though. When a stock is actually purchased or sold by the average person, it is done so through a brokerage.   

What Is A Brokerage? 

A brokerage is a middle man between buyers and sellers of individual stocks, index funds, exchange-traded funds, and mutual funds. Every individual investor needs to go through a brokerage or stockbroker to purchase stock. 

You can either partner with a broker who will engage in buying and selling activities on your behalf in accordance with your goals for a fee, or you can use an online brokerage firm and do all the buying and selling yourself.

I encourage you to learn how to invest your money on your own and open up a brokerage account with an online broker to

What is the Stock Market?

The stock market is not actually a physical place of any kind, like the New York Stock Exchange. 

Rather, it represents a vast network of economic transactions where buyers and sellers trade stocks with one another. Generally speaking, most people use the term “stock market” to refer to the total collection of various markets and exchanges where these activities take place. 

It’s also important to note that the stock market is not the economy, but it does affect the economy

When people refer to the stock market going up or down, they are often referring to one of the major stock market indices such as the Dow Jones Industrial Average, referred to as “The Dow”, or the S&P 500. 

These stock market indices track a large number of the top companies traded on a stock exchange. A broad market index, such as the S&P 500 or the Dow is a good representation of how the stock market is trending as a whole. 

How stock prices across the major stock indices are trending over some time is often an indication of how the economy is doing at a given time.

How The Stock Market Works

Now that you know what a stock and stock exchange is, what the stock market is, and what a brokerage is, let’s discuss how they all work together.

Companies List on an Exchange 

As I mentioned above, to buy stock in a company it has to be a publicly-traded company that is listed on a stock exchange. 

Companies decide to go public for a variety of reasons. One of these reasons is to raise money. When they initially go public, through an Initial Public Offering of shares, or IPO, companies raise money from institutional investors who want to purchase shares. 

Publicly traded companies can then use this money to work on projects such as new products, expanding operations, hiring, etc. Going public also affords companies the ability to attract top talent with stock options and provide current employees with equity.

How Stock Prices are Set

When a company goes public its initial stock price is set by a bank based on the company’s value and demand from institutional investors. However, the price is then influenced by a variety of factors.

Supply and Demand

After a company is public, its stock price is set by basic supply and demand. The more individual investors who want to purchase a piece of the company, the higher its stock price goes and vice versa. 

Investors buy stocks when they think the company’s share price will increase and sell stocks when they think the company’s share price will go down. 

Understanding the Market Cycle

Now, the prices of publicly traded companies are influenced by more than just supply and demand. 

World events, fear, greed, and economic factors, such as interest rates also drive the market. And the market tends to go up and down in cycles. When it’s up, it’s called a “bull market” and when it’s down, it’s called a “bear market.”

Watch this video to learn more about how stocks work and how stock prices are determined:

Why You Should Invest in the Stock Market

Now, you’re probably wondering, “can you make money in stocks?” 

Great question. 

how the stock market works

When you own a piece of a company, you benefit from its success and profit when they profit. If you choose to invest in great companies, you can experience a great return on your investments and make a great deal of money.

Build Wealth

Over the long run, investing in the stock market produces the best returns of any investment. 

Better than bonds, better than gold, and even better than real estate. This can be an incredible way to build wealth not only for you but also for the generations to come

Create Passive Income

Additionally, investing in the stock market can offer you a way to create passive income. 

Ultimately, passive income is what enables you to afford the same lifestyle with little to no additional effort. 

For most of us, working for the rest of our lives isn’t feasible, so we need to create passive income (AKA invest) in order to retire. The sooner you invest, the more wealth you can build and passive income you can create—plus the earlier you can retire

All this is only true, though, IF you invest the right way.

How To Invest in The Stock Market

Learning to invest is like learning to speak a new language. When you first start out, it can be a challenge. First, you need to learn the basics of the language. Then you need to practice the language. Eventually, you can speak a new language well—the same is true with investing. 

And you’re well on your way to learning the basics of the language. In fact, you’re already on step 3 of my investing plan for beginners

Before you move on to the next step, do these few things to set yourself up for success.

Set Goals

First, answer the question, “Why am I investing?” Do you want to set yourself up for retirement, create passive income, or work toward a future home or college fund?  

Knowing your “why” will help you understand your timeline for making returns, determine the type of stocks that make the most sense for you, and help you make wiser investment decisions as you go. 

Determine Your Risk Tolerance

Next, determine your risk tolerance. If you’re young and have plenty of time to ride the stock market waves, you may be more risk-tolerant or you may not have a lot of money to lose and so, you’re less risk-tolerant. 

If you’re nearing retirement, on the other hand, and will need supplemental income soon, you may be a bit more risk-averse, or you may want to be more aggressive given your shorter timeframe.   

Regardless of your age, you can invest in the stock market with little money and still reap the rewards. And if you’re just getting started, that’s what I suggest. 

Develop a Strategy

Now, you wouldn’t walk into the Superbowl without a game plan or a big debate without a speech, and you shouldn’t start investing in the stock market without a strategy. 

There are a lot of investment strategies out there but the key to success in the stock market is simple: buy wonderful businesses and buy them when they’re on sale. This is the strategy we teach at Rule #1 Investing and the strategy you can count on to deliver incredible returns. 

I don’t want you to miss this —

Central to the Rule #1 investing strategy, and the reason it works, is only investing in WONDERFUL businesses. 

To determine whether or not a business is “wonderful” and worth considering investing in, we rely on four components. Ask yourself these questions before buying a company’s stock:

  1. Do I understand the business and the industry it is in? 
  2. Does the business have staying power? 
  3. Does the CEO have talent and integrity?  
  4. What is the true value of the business? 

To help you learn how to answer these questions, I’ve put together a guide on how to pick stocks. Read this and you can learn how to invest in accordance with this strategy too. 

How To Buy Stocks

When you’re confident in your investment strategy and have selected a few wonderful companies you would like to own a piece of, it’s time to learn how to buy those shares

Open a Brokerage Account

For starters, you’ll need a brokerage account. As I mentioned above, the best way to invest is to do so on your own. Most professional investors (we’re talking 96%) don’t beat the market. 

You’re better off learning how to invest on your own and making trades through a brokerage account.  


Wait for the Right Time to Buy…

Now, just because you’re armed with a brokerage account and a list of wonderful companies, doesn’t mean it’s time to invest. 

The Rule #1 strategy only works if you buy those businesses when they are ON SALE. So wait until the stock price reflects half of the intrinsic value before you buy! 

… And Know When to Sell

While Rule #1 Investing is a long-term investment strategy, there will come a time to sell and hopefully profit from your smart investment decisions. If the stock price has met its intrinsic value, or the story has changed, it may be time to sell.

how the stock market works

Start Today

The best part of learning to invest is that once you learn to do it, you can do it for the rest of your life.

So, what are you waiting for? 

Now, that you know the basics, you’re ready to get started! Attend my next investing webinar and learn from me directly. It’s completely free and will help guide you as you begin this journey. 

Now… go play.

How the Stock Market Works
Article Name
How the Stock Market Works
Every serious trader needs a solid understanding of how the stock market works. Phil Town covers what you need to know before you start investing.
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Rule One Investing
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