Stock market 101
E*TRADE from Morgan Stanley in collaboration with Morgan Stanley Wealth Management
11/30/21Summary: The stock market is the cornerstone of investing. Before getting started, it’s a good idea to get familiar with the basics, including market indexes, the different types of stocks, and the factors that can affect a stock’s market value.
“The market is down. The market is up.” No doubt you’ve heard these phrases before, but what do they actually mean?
A financial “market” consists of people buying and selling (also referred to as trading) certain assets or valuables. There are many different types of markets: a wheat market, a car market, a market for commodities like gold, and, of course, a stock market.
The stock market itself is made up of several exchanges. An exchange is a central location where investors can buy and sell securities in a regulated environment. Most stocks in the United States are traded on two exchanges: the New York Stock Exchange (NYSE) and the NASDAQ Stock Market. Exchanges can be in a physical location, also known as “floor-based” where industry professionals can do trading in person, or computer-based, meaning that all trading is done electronically. The NASDAQ is a computer-based trading system, while the NYSE, formerly floor-based, is now a mix of both floor-based and electronic trading.
Stock indexes
When it comes to the stock market, financial professionals and investors love looking for clues and patterns to help uncover opportunities. Market trends are important because they can give investors a heads up about what might happen next and influence decisions about when to buy or sell certain securities. To help them track the performance of specific categories, such as a particular industry or company size, the concept of an “index” was created. An index represents a group of securities and acts as a performance benchmark for other similar investments. While it is not possible to invest directly in an index, there are funds that attempt to recreate the returns of a particular index.
| Index name | What it reflects | # of securities | Serves as… |
|---|---|---|---|
| Dow Jones Industrial Average1 | Very large, well-established US companies | 30 | An indicator of overall market trends |
| Standard & Poor’s (S&P) 5002 | US companies with capitalization of at least $3 billion | 500 | An indicator of the strength or weakness of the larger US economy, business growth, and consumer confidence |
| Russell 20003 | Small-cap stocks | 2,000 | A benchmark for smaller US companies |
| NASDAQ4 | All stocks that are traded on the NASDAQ stock market, the second largest stock market in the world | More than 3,000 | An indicator of how the information technology sector is performing |
What exactly is a stock?
Companies sell stocks to investors to raise money. When you buy a stock, you are buying a piece of a company (also known as a “share”). Your ownership is calculated by dividing the number of shares you own as an investor by the total number of shares outstanding. For example, if a company issues 5,000 shares and you own 500, you technically own 10% of the company. The value of that ownership stake is based on the stock price, which can go up and down throughout the course of the trading day.
As a stock owner, you are able to participate in the growth of a company, including its future earnings and the potential for its shares to appreciate in value. Of course, that also means you may share in its losses. Another benefit of investing in stocks is that you may be eligible to receive dividends. A dividend is a payout from a company to its shareholders. Whether or not companies pay dividends and how frequently they do so is up to the discretion of the company.
It's important to be aware of concentration risk, since investing a significant portion of assets in one type of security, sector, or industry may expose portfolios to greater volatility.
Types of stocks
There are several classifications for stocks that are often used to describe general traits about the issuing companies. It’s important to recognize the differences between each type as well as how each can affect a portfolio’s performance. Stocks of large, established companies will have a different risk-return profile than smaller technology start-ups that recently went public, for example. The table below outlines various classifications that are common market lingo.
| Classification | Description | Example |
|---|---|---|
| Growth stocks | Growth stocks are stocks of companies whose earnings are expected to grow at a faster rate than the industry average. Growth stocks typically do not pay dividends because the company would prefer to reinvest earnings into research and development or other projects. | Technology companies are a common example, but investors can find growth stocks in any industry |
| Value stocks | Value stocks are stocks that tend to trade at a discount to their intrinsic value. Their valuation is also priced lower than broader market or similar companies in their industry. | Often found in established industries like energy, financial services, and pharmaceuticals |
| Income stocks | Income stocks are stocks of companies that pay regular, often higher than average, dividends. In general, income stocks have lower levels of volatility than the overall stock market. | Telecoms, real estate investment trusts (REITs), and utility companies including electric and natural gas companies |
| Cyclical stocks | A cyclical stock’s price moves in sync with ups and downs in the business cycle or overall economy. Cyclical stocks typically include companies that sell discretionary items that consumers can afford to buy more of in a booming economy (e.g., technology, luxury goods), but will cut back on during a recession. | Many retail companies and automotive companies |
| Defensive stocks | Defensive stocks, also called non-cyclical stocks, are stocks of companies whose business performance and sales are either unaffected by or not highly correlated with changes in the business cycle. As their name suggests, defensive stocks may help defend portfolios from losses during uncertain times because they tend to be less vulnerable to economic downturns. | Includes utility companies and healthcare companies |
| Penny stocks | The term “penny stock” generally refers to a stock that trades at less than $5 per share. They are considered high-risk and have low trading volumes. | Small, growing companies with limited resources and no track record. Can include companies that have filed for Chapter 11. |
Market value and pricing
The value of a stock can go up or down throughout the course of the day. This market value (equivalent to the price of the stock) is influenced by several factors:
- How profitable the company is
- How quickly the company is growing
- The amount of debt the company carries
- Changes that impact the prospects for future profitability (e.g., a product launch, a new CEO, or a regulatory change)
- Interest rates
- Industry developments
- Uncertainty in the geopolitical climate
Remember that one factor sets the actual price of a stock: the most recent trade, which reflects the opinions of one buyer and one seller about the stock’s value.
The source of this Morgan Stanley article, Cut the Bull—the Bear Basics of Investing, is a chapter in The Playbook: Your Guide to Life and Money, originally published in January 2019. Learn more about the Playbook and other resources available to help you navigate various life milestones.
- Dow Jones Industrial Average is a price-weighted index of the 30 stocks and serves as a measure of the US market, covering such diverse industries as financial services, technology, retail, entertainment and consumer goods. An investment cannot be made directly in a market index.
- S&P 500® Index is an unmanaged, market value-weighted index of 500 stocks generally representative of the broad stock market. An investment cannot be made directly in a market index.
- Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represents approximately 11% of the total market capitalization of the Russell 3000 Index. An investment cannot be made directly in a market index.
- NASDAQ Composite Index is a market-value-weighted index of all NASDAQ domestic and non-US based common stocks listed on the NASDAQ stock market. An investment cannot be made directly in a market index.
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