How the Stock Market Works

A share of stock is a small piece of ownership in a company. When you own shares, you have a claim on part of the company's assets and future profits, and usually a vote on certain corporate matters. The stock market is the network of exchanges and trading venues where those shares change hands.

Primary and secondary markets

Companies raise money by selling new shares to investors, most visibly through an initial public offering (IPO). That first sale happens in the primary market, and the money goes to the company. After that, investors trade the shares among themselves in the secondary market. Almost all everyday trading is secondary: when you buy a share, you are buying it from another investor, not from the company.

Exchanges, brokers and market makers

Stock exchanges such as the New York Stock Exchange and Nasdaq list shares and run systems that match buy and sell orders. Individual investors do not trade on an exchange directly. They place orders through a broker-dealer, which routes each order to an exchange, a market maker or another trading venue. Market makers stand ready to buy and sell particular stocks, which helps keep trading continuous.

Every stock has two prices at any moment: the bid, the highest price a buyer is offering, and the ask, the lowest price a seller will accept. The gap between them is the spread. Heavily traded stocks tend to have narrow spreads, while thinly traded stocks can have wide ones.

Common order types

  • Market order: buy or sell right away at the best available price. It usually fills quickly, but the price is not guaranteed and can differ from the last quote in a fast market.
  • Limit order: buy or sell only at a set price or better. You control the price, but the order may never fill.
  • Stop order: becomes a market order once the stock trades at a chosen stop price. It is often used to limit losses, but in a sharp move the fill can be well below the stop.
  • Stop-limit order: becomes a limit order at the stop price, which caps the price but risks not filling at all.

Why prices move

A stock price is simply the most recent price at which a buyer and a seller agreed to trade. Prices move as investors change their views on a company's future earnings, interest rates, the economy and the level of risk they are willing to take. In the short run, prices can swing on news, rumors and emotion. Over long periods, they tend to follow the growth of the underlying business more closely.

Market indexes

An index tracks the value of a basket of stocks to show how a market or segment is doing. Three are quoted most often in the United States:

  • The S&P 500, which follows about 500 large U.S. companies and is weighted by market value.
  • The Dow Jones Industrial Average, which follows 30 large U.S. companies and is weighted by share price.
  • The Nasdaq Composite, which includes most stocks listed on the Nasdaq exchange and leans toward technology companies.

You cannot buy an index directly, but index funds and ETFs are built to track them.

Trading hours and settlement

The major U.S. exchanges hold regular trading sessions from 9:30 a.m. to 4:00 p.m. Eastern time on business days. Many brokers also offer pre-market and after-hours trading, where volume is usually lighter and prices can be more volatile.

When you buy or sell, the trade is not final until it settles, meaning cash and shares actually change hands. Most U.S. stock trades now settle one business day after the trade date, a cycle known as T+1.

Who oversees the market

The U.S. Securities and Exchange Commission (SEC) enforces federal securities laws and requires public companies to file regular financial reports. FINRA, a self-regulatory organization overseen by the SEC, writes and enforces rules for broker-dealers and licenses their representatives. Exchanges also police trading on their own platforms. If a brokerage firm fails, the Securities Investor Protection Corporation (SIPC) works to return customers' missing cash and securities, within limits, but it does not protect against market losses.

Next, compare the main ways to own stocks in Stocks vs ETFs vs Mutual Funds.

Sources

Educational information. This page explains general concepts and is not investment, tax or legal advice. Rules, limits and fees are set by regulators and firms and can change, so confirm the details with the official sources listed before you act.
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