What is the Stock Market
The stock market refers to the collection of markets and exchanges where the activities of buying, selling and creating of shares of publicly held companies take place. Such activities are done through institutionalized formal exchanges or Over-The-Counter (OTC) marketplaces.
There can be multiple stock trading venues in a country or region which allow transactions in stocks or other forms of securities. You may hear another term of a stock exchange, both are used interchangeably.
The stock market provides a secure and regulated environment where market participants can trade shares and other financial instruments with low risk. These markets operate under a defined set of rules stated by a regulator. The stock market acts as a primary market and secondary market.
NYSE, NASDAQ, LSE, DAX, and ASX exchanges
There are many forms of the stock market, all based around the world. There are 60 ‘major’ exchanges but some of the tops are the New York Stock exchange (NYSE), the NASDAQ Stock exchange (NASDAQ), London Stock Exchange (LSE), Deutsche Borse AG (DAX) and Australian Securities Exchange (ASX) to name a few.
Here is a list of the top 25 by market capitalization. Click here.
There are 16 stock exchanges in the world that have a market capitalization of over $1 trillion USD each. These exchanges account for 87% of global market capitalization in 2015.
For the UK we have the London Stock exchange, as of March 2021 the total market value of the companies trading on the LSE was valued at £3.8 trillion. Originally founded in 1801 making the LSE one of the oldest stock exchanges in the world.
A stock exchange shouldn’t be confused with Indexes or indices.
The NYSE has 3 which include the Dow Jones Industrial average (known as DJIA or DOW), Standard and Poor’s 500 (S&P 500) and NYSE composite (NYA).
Over-The-Counter – OTC
Compared to the centralized markets of major stock exchanges, OTC markets are decentralized in which market participants trade stocks, commodities, currencies and other instruments directly between two parties without a central exchange or broker.
Unlike major stock exchanges, the Over-The-Counter market does not have a physical location, instead, instruments are traded electronically. OTC markets are much less transparent than exchanges and are also subject to fewer regulations. Because of how the OTC market operates liquidity may come at a premium (spread between the buy and sell price).
History of the stock market
The market always goes up
Historically the market always goes up, or at least recovers in MOST cases.
The stock market makes money 77% of the time.
Over the last 10 years, the S&P 500 has returned an annual average of 13.6%.
If you missed out on the best 10 days, from trying to time the market, your return would fall to 4.5%. Miss the best 20 days? Just 2%. Miss the best 30 days? Now you’ve lost money and made a negative return.
As we can see here with the S&P 500 that since 1984 the market has trended upwards. On this graph dips in the markets cannot even be seen. We can see the noticeable drops in the market are 2002 and 2008. Not even the recent market correction in March of 2020 can be really seen on this long-term graph.
Taking a look at the FTSE 350 we can see very similar events to the S&P 500 with the markets recovering since such drops.
The events around 2002-2003 were many events from the dot-com bubble of 2000 through to the market downturn of 2002. from 2007 to 2008 we had the Chinese stock bubble, the United States bear market and the financial crisis. in 2020 we had the stock market crash where the S&P 500 dropped 34%.
There are many economical events which occur around the world at any one time, and these affect the stock market but looking at these charts, historical performance has shown the market has recovered.
Here you can find a list of market crashes and bear markets.
Dips, corrections & recessions
When talking about investing we hear investors talk about “buying the dip”, this is a very common piece of advice but to new investors, this can be an unfamiliar phrase. Buying the tip is another form of timing the market, where you try to predict how the market will move in the future and try to buy near the bottom (the dip).
When we hear investors talk about a dip this is normally a short-term downward trend of an investment such as an individual stock, a specific index or the market as a whole.
When it comes to corrections and recessions it comes a bit different than dips which can occur regularly, depending on how volatile the stock market is.
Since 1920 the S&P 500 index has on average recorded a 5% pullback (dip) three times a year, a 10% correction every 16 months and a 20% plunge every 7 years. A correction on average lasts 43 days.
Trying to anticipate such dips, corrections, bear markets and so on can be stressful. Not only can you lose sleep second guessing if you have missed the bottom or if such an event is in motion but you can lose out on gains. Remember timing the market rarely works over the long term, which is why many investors choose to cost average.
Cost averaging allows you to take advantage of a rallying stock market (bull) or average down on investments when the market is trending down (bear).
Most people lose by trying to move their money around to participate in the ups and avoid the downs, as you can see in the statistics written above in ‘The market always goes up.
Japanese Nikkei stock market index (the exception)
Though above we can see examples of how the stock market goes up there has been one exception, to this I present the Japanese Nikkei index.
Over the last 20 years, if you invested since 1991 and held till now, you would have only just seen a positive return.
That’s a long period of time with no true return but this does not show the true extent of the drop from all-time highs. In 1989 the index hit its peak around October at a record 38,915.87.
Though such a thing can be scary we also can note that this does not include dividend reinvestments nor averaging into a position. This is simply to showcase that it’s possible that markets don’t see a positive over a long period of time. When investing actions such as averaging down and dividend reinvestment can help give better returns as long as the underlying investment is still solid.
Now you know what the stock market is, you may wish to start investing. If you are about to start your investment journey, make sure you check out our guide on how to get started investing.