Understanding the stock market

If, like most Canadians, you own shares of an equity mutual fund or exchange-traded fund, have an employer pension plan, or contribute to the Canada Pension Plan (CPP), you already invest in the stock market, if only indirectly. However, if growth is your long-term investing objective, you’ll likely want to allocate a portion of your portfolio to stocks. Managing your own portfolio of individual stocks means that you have to pick the stocks, do your research, and buy and sell stocks on your own.

We know investing in the stock market can be a bit intimidating, with new systems and terminology to navigate. That’s where some know-how and the right tools come in handy.

What is a stock?

Companies sell stocks (also known as “equities” and “shares”) in order to raise money to run their business, to fund growth and expansion, or upgrade their equipment and technology. The portion of the company’s balance sheet that is funded by shareholders is called shareholders’ equity.

In exchange for providing the money, you (the shareholder) receive an ownership stake in the company, which includes a claim to its future earnings. The first time a company issues shares to investors is called an initial public offering (IPO). After that initial sale to the public, the shares can easily be traded—bought and sold—among investors. Stock exchanges and brokerages exist to facilitate those transactions and maintain an efficient, fast, accurate and cost-effective market for stocks and related securities.

Stock markets are often seen as a representation of economic health. More than that, they can be an important way for public companies to raise capital to run their businesses, and for investors to build wealth.

What is the stock market?

The stock market is a marketplace system where stocks and other related investments are bought and sold (also known as “traded”). The stock market is made up of a number of “stock exchanges”, secondary markets where sellers of a stock can connect with buyers of a stock.

What is a stock exchange?

A stock exchange is a centralized marketplace for stocks, where sellers of a stock can connect with buyers of a stock. An exchange tracks trade orders, which determine the stock’s price. Examples of some key stock exchanges include the Toronto Stock Exchange (TSX), New York Stock Exchange (NYSE), London Stock Exchange (LSE), Hong Kong Stock Exchange, Tokyo Stock Exchange (TSE) and the Nasdaq.

How is the stock market regulated?

In Canada, stock markets are regulated by the Canadian Securities Administrators (CSA), the umbrella organization of provincial and territorial securities regulators. Their job is to coordinate and harmonize regulation of Canadian capital markets, and to deliver regulatory programs across the country. However, it is the responsibility of the individual provincial and territorial regulators to field complaints about securities violations and enforce regulations in their region.

What is a stock index?

When discussing stock market performance, analysts and market commentators are usually citing the performance of a stock index, which measures the performance of a group or basket of stocks that are intended to represent the performance of either a stock market, exchange or a smaller area (industry, segment).

Stock indices can be used as a benchmark to help investors and analysts compare the performance of an individual stock against its industry, peer group or the wider market. Some of the more widely known indices include the Dow Jones Industrial Average, which measures the performance of 30 major companies listed on U.S. stock exchanges, and the S&P 500 Index, which measures the performance of the 500 largest public companies in the U.S. Other prominent indices include:

• S&P/TSX Composite Index – measures the performance of Canadian stocks, comprising approximately 250 companies.
• Nasdaq Composite Index – measures the performance of over 3,000 companies listed on the Nasdaq exchange.
• MSCI EAFE Index – measures the performance of 21 indices in Europe, Australasia and the Far East.

What is traded on the stock market?

Generally, the “stock market” refers to markets and exchanges where equity shares and related securities are traded. Other types of assets trade on their own markets, including those for commodities, foreign currencies, derivatives, and cryptocurrencies. You cannot purchase bonds on the stock market, nor can you purchase a mutual fund. Bonds are bought and sold through a bond broker or directly from the issuer.

Why do stock markets go up and down?

Stock markets rise and fall as the value of the companies’ shares included in each stock exchange go up and down. An individual company’s stock price is set by supply and demand from buyers and sellers.

The price that buyers and sellers are willing to pay for a company’s stock is dictated by a wide variety of things, including the value of its assets, level of debt, creditworthiness, location, brand and reputation.

The more optimistic (“bullish”) investors feel about a company’s potential to grow its earnings, the more they are willing to pay for a share of those future earnings. But when investors feel pessimistic (“bearish”) about a company’s prospects, the stock price falls.

If the company performs well, the value of its stock tends to increase. If the company doesn’t do well, if its earnings or profits decline, the value of its stock tends to decrease. Like all investments, stocks entail risk. If the company’s share price declines below the price you paid to purchase its shares, and you then sell the stock, you’ll realize a loss on your investment.

However, external factors can also affect the value of a company’s stock. These include geopolitical events, regulatory change, interest rates, currency rates, or simply investors’ opinions or sentiment about the company, its industry, or the financial markets in general.