Key Takeaways
- The stock market is an intangible thing that can be a bit difficult to understand.
- There are a lot of factors that affect the stock market, but there are some basics that can help you understand how it works.
There are some concepts that are not intuitive and can be difficult to get our arms around when we first hear of them. For instance, NFTs, memes, and…the stock market. Sometimes we simply don’t know the meaning of something because it’s a completely foreign concept to us and we have no framework for it.
When it comes to the stock market, if you don’t really know how it works, you’re not alone. It’s an intangible thing and there are a lot of moving pieces. But there are some basics that can help shed some light on it, and we’ll review them here.
To start, think of the U.S. stock market very simply as a representation of all the goods and services in the United States. There may be industry leaders, such as Elon Musk or Jeff Bezos, whose products you believe in and want to buy stock in their companies. Think of this as a starting point.
Then we get into why stocks go up and down. Well, you can compare this to the concept of the wisdom of the crowds. To illustrate this, consider those guessing games where there’s a giant jar of marbles and you have to guess how many marbles are in there. Surveys have shown that if you take 1,000 people’s guesses and average them, you’ll come within one percent of the correct number. That’s the wisdom of the crowds and there’s a bit of this going on in the marketplace, where stock pricing comes together in a similar way.
But the real way stock pricing comes together is through the earnings of a company. When you get down to brass tacks and look at the quantitative data, it’s the earnings (in the form of dividend or growth) and how much people are willing to pay for a stock.
There are two parts of a stock – the dividend they pay out and the growth of the stock over time. We saw this during COVID, when a lot of technology took off during that time and there were a lot of earnings and growth.
So why do some stocks move so quickly at times, going up and then coming back down? Well, there’s a simple concept called “buy on the rumor, sell on the news.” For instance, if there’s a rumor that Tesla is doubling their capacity of putting out electric cars, their stock can suddenly shoot up. But then the news may come out that they’re not quite doubling capacity or something else to negate the rumor, and the stock goes down. So there’s some emotion in the way people react to the stock market.
Finally, there’s the economy. If the economy is growing, then generally, the stock market’s going to grow. Why? Because we’re buying more goods and services, and so the companies we buy from are making more money. If they make more money, their stock goes up.
The stock market can be looked at from a number of different angles because there are a lot of factors that go into how it works and what affects it. But hopefully this gives you some background on the basics. Until next time, enjoy.
Gary
If you’d like to read more on this topic, here are a few of Gary’s previous posts that you might enjoy:
