how does the stock market work simple explanation

How the Stock Market Works — Simple Explanation

This article answers how does the stock market work simple explanation in clear, plain language for beginners. You will learn what a stock is, how shares are issued and traded, who the main participants are, what moves prices, and simple steps to start participating — with neutral facts and practical tips (including how Bitget can serve as a trading venue and custody option).

Short guide: the stock market is the collection of exchanges and trading venues where publicly listed companies’ shares are issued and exchanged between investors. Its primary purpose is to connect companies that need capital with investors seeking returns.

Basic concepts

What is a stock?

A stock (also called a share or equity) represents a unit of ownership in a company. Owning stock gives you a claim on a slice of the company’s assets and earnings. There are common and preferred shares:

• Common shares: the most typical stock type. Common shareholders usually have voting rights (for board elections and major corporate decisions) and may receive dividends when the company distributes profits.
• Preferred shares: combine features of equity and fixed-income. Preferred shareholders often have priority over common shareholders for dividend payments and assets on liquidation, but usually have limited or no voting rights.

A company’s market capitalization (market cap) is the current share price multiplied by the number of outstanding shares — a simple, widely used size metric.

Why companies issue stock

Companies issue stock primarily to raise capital without taking on debt. There are two common ways a company raises equity:

• Initial Public Offering (IPO): the first sale of shares to the public. An IPO creates a public market for the company’s shares and helps raise funds for growth, acquisitions, or to pay down debt.
• Secondary offerings: when an already public company issues additional shares to raise more capital.

Issuing equity dilutes existing ownership but avoids fixed interest payments that come with borrowing.

Primary vs. secondary markets

• Primary market: where new shares are created and sold by the issuing company (e.g., IPOs, direct listings, or follow-on offerings). Proceeds go to the company (or selling shareholders in some cases).
• Secondary market: where existing shares trade between investors. The company is typically not directly involved and doesn’t receive proceeds from secondary trades. The secondary market provides liquidity and continuous price discovery.

Understanding the difference helps explain why companies go public and why investors can buy or sell shares at market prices.

How trading happens

Stock exchanges and trading venues

Stocks trade on organized exchanges and alternative venues. Organized exchanges (examples: NYSE, NASDAQ, TSX) provide rules, listing standards, and visible order books. Alternative trading venues include over-the-counter (OTC) markets and private trading venues known as dark pools.

Modern markets are mostly electronic; matching engines route and match buy and sell orders. Market operators set listing requirements, trading rules and ensure fair access for brokers and participants.

When choosing where to trade, many retail investors use regulated brokerages or trading platforms. For users seeking a unified crypto and traditional asset experience, Bitget offers brokerage and custody services tailored to retail and advanced traders.

Orders, bids, asks and the bid–ask spread

• Order: an instruction to buy or sell a stock.
• Bid: the highest price a buyer is willing to pay.
• Ask (offer): the lowest price a seller is willing to accept.
• Bid–ask spread: the difference between bid and ask. Narrow spreads indicate more liquid markets; wider spreads can mean lower liquidity and higher trading friction.

Common order types:

• Market order: buys or sells immediately at the best available price. Useful for fast execution but price is not guaranteed.
• Limit order: sets a maximum (for buys) or minimum (for sells) price. Execution occurs only at the specified price or better.
• Stop order / stop-loss: an order that triggers a market or limit order once the stock reaches a specified price.

Knowing order types helps manage execution risk and slippage.

Market makers and liquidity providers

Market makers and designated dealers provide continuous quotes (bids and asks) for certain stocks and facilitate trading by stepping in to buy or sell when there is an imbalance. Their activities narrow spreads and improve liquidity, which benefits all market participants by lowering trading costs and supporting smoother price discovery.

In some venues, electronic liquidity providers (algorithms) now perform a similar role, quoting prices across many securities.

Order matching and settlement

• Order matching: when a buy order and a sell order meet at a compatible price, a trade executes. Trade execution details are then reported to the market and participants.
• Trade reporting: exchanges and reporting services publish executed prices and volumes to ensure transparency.
• Settlement: the process of transferring securities and cash between buyer and seller. For most U.S. equities, the standard settlement cycle is trade date plus two business days (T+2). Settlement rules vary by jurisdiction and instrument.

As of 2024-06-01, according to the U.S. Securities and Exchange Commission (SEC), T+2 remains the standard settlement cycle for most U.S. securities, with shortening efforts ongoing in some markets.

Price formation and drivers

Supply and demand

At its core, stock prices reflect supply and demand. If more investors want to buy a stock than sell it, the price tends to rise. If more want to sell than buy, the price falls. Order flow, the size of orders, and available liquidity determine how big a price change will be for a given imbalance.

Large institutional orders can move prices significantly; execution strategies (like slicing large orders or using dark pools) aim to reduce market impact.

Company fundamentals and news

Company-specific data influence investor expectations and, thus, prices. Important drivers include:

• Earnings and revenue results
• Guidance and management commentary
• New products or contracts
• Mergers, acquisitions, or divestitures
• Corporate governance changes
• Regulatory actions affecting the company

Breaking news, earnings surprises and trend changes can all cause rapid price moves as investors update forward expectations.

Macro factors and market sentiment

Broader economic and political conditions affect many stocks simultaneously. Key macro drivers include:

• Interest rates: higher rates often reduce the present value of future earnings and can pressure high-growth stocks.
• Inflation: persistent inflation can erode profit margins and change policy expectations.
• Economic indicators: GDP growth, unemployment, and consumer spending influence corporate profits.
• Geopolitics and unexpected events: disruptions or uncertainty can raise volatility.

Market sentiment — the collective mood of investors — can amplify trends or trigger reversals. Sentiment is influenced by news flow, technical market signals, and behavioral patterns.

Market structure and participants

Retail investors

Retail investors are individual households and small account holders who access markets via brokers or trading apps. Technological advances (mobile apps, fractional shares, commission-free trading) have increased retail participation and lowered minimums.

Retail orders are important for many stocks, particularly smaller-cap names, and can influence short-term volatility.

Institutional investors

Institutional investors — mutual funds, pension funds, insurance companies, hedge funds, and asset managers — control a large portion of market capital. Their trading decisions, portfolio rebalancing and research-driven strategies often dominate volume and can drive larger price moves.

Institutions also offer products for retail investors (mutual funds, ETFs) that aggregate many investors’ capital.

Brokers, exchanges, and regulators

• Brokers: provide market access, custody, order routing and often research or tools. When choosing a broker, consider fees, order execution quality, custody safety, and available account features. Bitget provides brokerage and custody services suited to traders looking for an integrated platform.
• Exchanges: set listing standards, provide order books and trade reporting.
• Regulators: agencies like the U.S. SEC set rules to protect investors, maintain fair markets and require disclosure. They oversee market conduct, listing rules and enforcement actions when necessary.

Measures and benchmarks

Stock indices

Indices (e.g., the S&P 500, Dow Jones Industrial Average, NASDAQ Composite) aggregate selected stocks to measure market performance. Indices are useful benchmarks for passive funds and for gauging overall market direction.

Indices differ by construction: price-weighted, market-cap-weighted, or equal-weighted, each affecting how constituent moves impact the index.

Market capitalization and liquidity measures

• Market capitalization: current share price × outstanding shares.
• Free float: the number of shares available for public trading (excluding locked shares held by insiders or founders).
• Volume: number of shares traded in a period — higher volume suggests better liquidity.

Liquidity indicators like average daily volume and bid-ask spreads help investors choose how and when to trade.

Volatility measures

Volatility measures the size of price swings. Standard deviation of returns and implied volatility (derived from option prices) are common. The VIX index is a widely watched gauge of implied volatility for U.S. equities and often acts as a fear or stress indicator in markets.

Investor returns and risks

Ways to earn returns (capital gains, dividends)

• Capital gains: profits realized by selling a stock at a higher price than purchase price.
• Dividends: a company’s cash distributions to shareholders. Not all companies pay dividends; many growth firms reinvest profits instead.

Total return combines both price appreciation and dividends received over time.

Types of risk (market, company, liquidity, regulatory)

• Market risk: broad market declines that affect many stocks.
• Company (idiosyncratic) risk: firm-specific adverse events, such as management failures or product issues.
• Liquidity risk: inability to buy or sell quickly at a fair price.
• Regulatory and legal risk: changes in laws or enforcement affecting operations.

Diversification across sectors, geographies and asset classes is a common mitigation strategy; it reduces exposure to any single company or event but does not eliminate market risk.

Long-term investing vs. trading

• Long-term investing: buy-and-hold strategies focus on fundamentals and compounding over years or decades. Investors may tolerate short-term volatility for longer-term growth.
• Trading/speculation: short-term buying and selling to capture price moves. Trading often requires active risk management, analysis of liquidity and tighter cost controls.

Each approach has different time commitments, tax treatments and risk profiles.

How to participate (simple steps)

Choosing a brokerage account

1. Pick a regulated broker: check licensing, custody practices and user reviews.
2. Open and verify your account: submit identity documents and fulfill KYC requirements.
3. Fund the account: transfer fiat or supported assets according to the broker’s processes.
4. Understand fees and order types: commissions, spreads, withdrawal fees, and margin terms matter.

For users who want an integrated platform with fiat on-ramps, custody and advanced order types, Bitget provides regulated brokerage services and a secure Bitget Wallet for custody.

Buying stocks vs. funds (ETFs / mutual funds)

• Individual stocks: offer targeted exposure to a company but carry company-specific risk.
• ETFs / mutual funds: provide instant diversification across many securities. ETFs trade intraday like stocks; mutual funds price at end-of-day.

Beginners often start with low-cost, broad-market ETFs to gain diversified exposure while learning stock selection.

Basic investing practices

• Dollar-cost averaging: invest regular amounts over time to reduce the impact of timing.
• Diversification: spread investments across sectors and asset classes.
• Research: read company filings, analyst reports and reputable educational resources.
• Cost awareness: mind trading fees, expense ratios, and tax consequences.

Market rules, timing and technical details

Trading hours and after-hours trading

Regular trading hours for major U.S. exchanges are typically 9:30 a.m. to 4:00 p.m. Eastern Time. Many venues also offer pre-market and after-market sessions with lower liquidity and wider spreads. Trading outside regular hours carries higher execution risk.

Circuit breakers and halts

Circuit breakers pause trading when markets move sharply to allow participants time to digest information and slow panic selling. Exchanges may halt individual stocks for news pending, volatility, or regulatory reasons.

These mechanisms aim to protect orderly markets and ensure fair access.

Taxes and reporting

Tax rules for capital gains and dividends vary by country and individual circumstances. Keep accurate records of trades, dividends and corporate actions. Consult tax professionals or local authorities for jurisdiction-specific guidance.

As of 2024-06-01, regulatory guidance in many jurisdictions requires brokers to provide year-end statements and, in some cases, tax reporting forms to clients — check your broker’s reporting practices.

Comparing traditional stock markets and crypto markets (brief)

Key differences

• Regulation: traditional stock markets are highly regulated with disclosure rules and investor protections; crypto markets have varying regulatory regimes.
• Settlement: many stock trades settle on a trade-date+standard (e.g., T+2); some crypto assets settle instantly on-chain, while centralized platforms manage custody off-chain.
• Trading hours: stock exchanges have set hours with limited after-hours; many crypto venues operate 24/7.
• Custody and custody risk: stocks are typically held by regulated custodians or broker-dealers; crypto custody models include on-chain wallets and centralized custodians.
• Valuation and volatility: crypto assets often show higher short-term volatility and rely on different fundamental drivers.

Where they overlap

Both systems facilitate price discovery, require liquidity providers, rely on exchanges or trading venues, and depend on retail and institutional participants. For investors interested in both asset types, platforms like Bitget can offer consolidated access and custody solutions across asset classes.

Common questions (FAQ)

"Can I lose all my money?"

Yes — particularly if you concentrate your portfolio in a single company that goes bankrupt. Diversification lowers this risk. For individual stocks, company failure can mean total loss; for diversified funds, losses are typically spread across many holdings.

"How much money do I need to start?"

Minimums vary. Many brokers offer fractional shares, letting investors buy portions of expensive stocks. Low-cost ETFs allow diversified exposure with small amounts. Consider fees, which can be proportionally higher for very small accounts.

"Are markets predictable?"

Short-term price movements are difficult to predict reliably. Markets incorporate new information continuously. Over long periods, fundamentals like earnings growth and reinvested dividends have driven returns, but past performance is not a guarantee of the future.

Further reading and resources

Introductory guides and sites

Use reputable educational sites and investor-education pages to deepen understanding. Good starting points include Investopedia, The Motley Fool, Wealthsimple and national investor education pages.

Regulatory and official sources

Read materials from securities regulators for authoritative guidance about market rules, investor protections and ongoing regulatory updates. For U.S. investors, the SEC provides a broad set of investor education pages.

References

Sources used to compile this article include educational guides and explainers from Investopedia, Wealthsimple, The Motley Fool, GetSmarterAboutMoney, Scotia iTRADE, National Bank investor education pages, and explanatory videos (e.g., "How The Stock Market Works (very simple explanation)").

As of 2024-06-01, according to the U.S. Securities and Exchange Commission (SEC), the standard settlement cycle for most U.S. securities is T+2. As of 2024-06-01, educational guides from multiple investor-education sites continue to emphasize diversification, understanding fees and the differences between primary and secondary markets.

Notes and scope limitations

This article focuses on public equity markets (stocks) and basics for beginners. It intentionally treats crypto markets only in a comparative section. Local tax, regulatory details and platform-specific procedures vary by jurisdiction and should be verified with local authorities or a qualified advisor.

Further exploration: if you want to try trading or custody services, learn about Bitget’s brokerage solutions and Bitget Wallet for custody and account management. Explore step-by-step guides on account setup, funding and safe custody practices with regulated providers.