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How does the stock market work?

What’s behind one of the most-watched economic outlook numbers?

Photo of someone reviewing stock market charts.
4 min read |

If you’re like a lot of people, you may not pay much attention to daily economic indicators like gross domestic product or industrial production.

But one measure that probably influences how you think and feel about the economy? The stock market. Its ups (and conversely its downs), especially over the last few years, are often seen as a bellwether for our collective financial futures and the economic outlook.

Understanding more about how the stock market works may help you better manage what you do when you read news headlines.

Here are some basics.

What’s a stock market anyway?

Dow Jones, S&P, NASDAQ: Those are perhaps the most famous of our country’s stock market numbers. “Put simply, a stock market aggregates buyers and sellers of shares of company stocks,” says Heather Winston, assistant director of financial advice and planning at Principal®. “Indexes, sometimes called indices, are designed from a group of stocks or bonds that represent a specific part of a broader market.”

The Dow Jones Industrial Average (DJIA), for example, is a weighted average of the stock prices of 30 United States-based companies. The companies that make up the Dow change constantly, and so does their weight in the Dow's index. (Weight is based on a company's market share. In a weighted index, some companies have more market share, so have more value in that index.) The Dow going up in one month just means that the average stock prices of those companies in that average went up.

In fact, the DJIA isn’t even the only index with “Dow” in its name. The Dow Jones Transportation Index refers to 20 transportation sector companies such as trucking and airlines. Domestic indexes include the Russell 1000 and the Wilshire 5000. Japan has the Nikkei and Germany has the DAX—the international list goes on and on. “They’re all just different ways of slicing and dicing investment opportunities around the world and here in the U.S.,” Winston says.

Stock market vocab cheat sheet

Stock Ownership claim of a company (private or public)
Stock market or exchange Collection of public stock buyers and sellers such as the New York Stock Exchange (NYSE)
Stock index A measurement of a collection of public stocks (the DJIA, for example)
Investment fund (mutual fund, exchange-traded fund, etc.) A group that pools resources to invest in things like stocks or stock indexes

Why do individual company stock prices change?

At any point in time, some companies are on an upswing and some are on a downswing. Within a stock index, you’ll find a similar dichotomy in companies—some doing well, some having a tougher go.

Because an index has a little of this and a little of that, it’s likely diversified in some way. The opportunity for growth is spread around.

The 11 S&P 500 Sectors*

Illustration showing the 11 S&P 500 sectors.

Will the stock market always go up?

From day-to-day, markets go up or down in the same way that economies, from year-to-year, tend to operate in cycles. That’s why financial professionals focus on consistent investing in your future, particularly your retirement, over time. Read more about how staying invested may help you in the long run.

Quick, daily moves in (and out) of investments and savings plans can disrupt overall financial goals. “The stock market won’t always go up and to the right, but none of us can predict when trends will change course,” Winston says.

Your retirement savings, which are typically invested in various funds and indexes that are bought and sold on stock markets, may be impacted by big swings. But over time and through history, those swings tend to even out.

That’s why slowly and steadily building your retirement savings—even deferring 1% more every year—can make a real impact.

“Take a long-term approach,” Winston says. “That’s the one way to help ensure that you, as an individual, have the most potential to grow your savings and achieve your goals.”

Illustration stating that approximately 4,000 companies are publicly traded in the U.S.
Illustration stating that the average daily three-month trading volume on the NYSE is 1 billion.

What the experts know about the markets

Sometimes the markets shrug when the news is good (or bad). That’s because the professionals who manage funds and indexes that are bought and sold on those markets spend all day, every day, looking at the health and welfare of those companies and sectors. They don’t track data just in days or weeks, but in months and the year—and further. That’s their job.

So, individual investing in a stock or fund can be difficult. Unless you have loads of time, knowledge, and inclination, it’s hard to know what’s really going on in a stock market—and just as challenging to know everything about the health of companies and sectors.

“As individuals we don’t have much impact on the market because we invest in small quantities,” Winston says. “It’s really professional trading where large blocks of shares are being bought and sold that typically moves markets.”

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