The stock market represents one of the fundamental pillars of the global financial system, offering individual and institutional investors the opportunity to participate in the ownership and growth of companies. For beginners, understanding its mechanisms is essential. In this guide, we will explore the basics of the stock market, investment strategies, and factors that influence its dynamics.
What is the stock market?
The stock market, a dynamic arena where the financial strategies of investors from around the world converge, stands as a crucial ecosystem in the global economy. In this environment, participants have the opportunity to buy and sell a variety of financial instruments, with shares of public companies being the most prominent asset. According to the most recent data from the World Bank, in 2023, the aggregate value of the global stock market reached a figure of 138 trillion dollars, reflecting a constant average annual growth of 7% over the last decade.
These shares, which represent a tangible portion of ownership in the issuing companies, are actively traded on various stock exchanges around the world, serving as vehicles for investment and wealth creation. However, the stock market is not limited to stocks alone; it also comprises a wide range of other financial instruments, including bonds, mutual funds and derivatives, each offering its own dynamics and investment opportunities. This diversity of options provides investors with a range of possibilities to tailor their strategies according to their financial objectives and risk tolerance. Taken together, the stock market represents a vital component of the global economic system, facilitating the efficient allocation of capital and fostering growth and innovation around the world.
Participants and Roles
The stock market, as one of the fundamental pillars of the global financial system, has a variety of participants that play specific and complementary roles. These participants include individual investors, financial institutions, stockbrokers and listed companies, each contributing in a unique way to market dynamics and liquidity.
Individual investors, who represent a significant portion of the market, provide diversity and liquidity through their decisions to buy and sell stocks. Although their participation can be influenced by emotional and personal factors, their presence is crucial for price formation and market efficiency.
On the other hand, financial institutions, such as pension funds and investment funds, are key players in the stock market, representing a substantial part of the total transaction volume. With more structured and long-term investment strategies, these institutions contribute to the stability and depth of the market, providing a large part of the invested capital.
According to the Securities Industry and Financial Markets Association (SIFMA) 2023 report, individual investors accounted for 25% of the total trading volume in the US stock markets, while financial institutions accounted for 75%. This volume distribution reflects the mix of investment perspectives and strategies among different market participants.
Stockbrokers, on the other hand, act as intermediaries between investors and the market, facilitating the purchase and sale of securities. Their role is essential to ensure the efficiency and rapid execution of operations, providing advisory services and access to market liquidity.
Finally, listed companies issue and manage their shares on the stock market, allowing investors to acquire equity stakes in the company and benefit from its financial performance. Listing on the stock exchange provides companies with access to capital to finance growth and expansion projects while giving them visibility and transparency in the financial market.
Together, these participants play an interconnected and complementary role in the dynamics of the stock market, contributing to its efficient functioning and long-term economic development.
Investment Strategies
In the dynamic world of the stock market, there are various investment strategies designed to suit different risk profiles and financial objectives. Each investor must carefully evaluate their risk tolerance, investment horizon and specific financial goals to choose the strategy that best suits their needs.
Long Term Investment
Long-term investing is a strategy that involves buying and holding securities for an extended period of time, typically several years or even decades. Investors who adopt this strategy intend to take advantage of the long-term growth of the stock market and the power of compound interest.
An illustrative example of the benefits of long-term investing can be seen in the historical performance of the S&P 500 index. According to data collected from Statista and Macrotrends, the average annualized return of the S&P 500 over the past 50 years has been approximately 10.76%, including reinvestment of dividends.
The above shows that compared to years like 2018 and 2019, which were prior to the pandemic, mortgage loan rates have increased by almost 5%. However, 2024 closed with an inflation of 9.28%. Additionally, analysts predict that for 2024, inflation will close the year at 6% and that by 2025, the economy will be close to the bank’s target, which is 3%, which means that the economy is cooling down and that the Banco de la Republica may begin to lower the interest rate (TIBR: Banco de la Republica intervention rate).
Given the above, let’s suppose that an investor decides to invest $10,000 in an index fund that replicates the S&P 500. If they hold this investment for 50 years, with an average annual return of 10%, at the end of the period, they will have more than $1 million.
Day Trading
“Day trading is a short-term investment strategy in which traders buy and sell securities within the same trading day, with the intent of making quick profits by taking advantage of intraday price movements. This strategy requires detailed technical analysis, a deep understanding of price patterns, and an ability to make quick decisions.” (Investopedia, 2024).
For example, let’s say a day trader buys 100 shares of a company at $50 per share at the beginning of the day and sells those shares later in the day at $51 per share. The profit on this trade would be $100 (100 shares x $1 profit per share).
Short Selling
“Short selling is a strategy used by investors who expect the price of an asset to decline. Instead of buying low and selling high, investors first sell the borrowed asset and then buy it back at a lower price, making a profit on the difference.” (Charles Schwab, 2024)
For example, an investor who believes a company’s stock price will fall may short 100 shares at $50 per share. If the stock price falls to $40 per share, the investor can buy back all 100 shares at that price, making a profit of $1,000 (100 shares x ($50 – $40) profit per share).
It is critical to understand that in the vast world of investing, there is no one-size-fits-all strategy that fits all needs and situations. The suitability of an investment strategy varies considerably depending on each investor’s individual circumstances, financial goals, and risk tolerance. Each person has a unique set of financial circumstances, which may include factors such as age, income level, investment time horizon, and financial obligations, among others.
Factors that Influence the Market
The stock market is a dynamic ecosystem influenced by a variety of interrelated factors that can significantly affect the direction and volatility of financial asset prices. One of the most prominent factors is corporate earnings reports, which can have both an immediate and long-term impact on a company’s stock price.
For example, when a company announces quarterly earnings that beat market expectations, its stock is likely to experience a rise in price due to the perception of strong performance and future growth potential. Conversely, if a company reports unexpected losses, its stock is likely to experience a fall in price as investors adjust their performance expectations.
In addition, political events can have a significant impact on the direction of the stock market. For example, presidential elections, referendums on important policies, and geopolitical tensions can create uncertainty for investors and cause volatility in financial markets.
A recent example of this was the Brexit referendum in the United Kingdom in 2016, which caused a sharp drop in global stock markets due to uncertainty about the country’s economic and political future.
Likewise, changes in government policies can have profound effects on the stock market. For example, the implementation of expansionary fiscal policies, such as tax cuts or increases in government spending, can boost economic growth and increase investor confidence, which can result in higher stock prices.
On the other hand, restrictive policies, such as interest rate increases or tighter regulations, can slow economic growth and negatively affect stock market performance.
According to the World Bank, around 60% of stock market volatility in developed countries is attributed to external factors such as those mentioned above. This statistic underscores the importance of investors understanding and closely monitoring these factors in order to make informed investment decisions and mitigate risk in their portfolios.
Conclusion
The stock market offers a universe of opportunities for investors, but it also involves inherent risks. This guide has outlined the basics of the stock market, from its definition to investment strategies and influencing factors.
It is essential for beginners to conduct thorough research and seek professional advice before making investment decisions. With knowledge and prudence, beginners can enter the world of the stock market with confidence and preparation.
