Stock market basics: how it works, in plain English

1. What a stock is

A stock (or share) is a small slice of ownership in a company. Own one share of a company that has issued one million shares, and you own one millionth of it — of its stores, its brand, its profits.

Big companies do exactly the same thing, just with billions of dollars. The first time a company sells shares to the public is called an IPO (initial public offering). After that, the shares trade between investors every day — on an exchange.

2. How the stock market works: TSX, NYSE, Nasdaq

A stock exchange is a marketplace where shares are bought and sold. The main ones you'll hear about:

• TSX — the Toronto Stock Exchange, Canada's main market: banks, railways, energy, Shopify.
• NYSE — the New York Stock Exchange, the biggest in the world: Coca-Cola, Visa, Walmart.
• Nasdaq — also in New York, home of most tech giants: Apple, Microsoft, Nvidia, Amazon.

You don't walk onto the exchange floor. You use a broker — today, an app — that sends your order to the exchange. Every company has a short code called a ticker: RY for Royal Bank, SHOP for Shopify, AAPL for Apple.

What makes a price move? Only one thing: more people wanting to buy than to sell (price goes up), or the opposite (price goes down). And what makes people want to buy? Expectations about future profits. Good news about sales, a new product, lower interest rates — up. A bad quarter, a lawsuit, a recession scare — down. The market is a giant, never-ending vote on what every company is worth.

Markets are open on business days, 9:30 am to 4:00 pm Eastern time — Montreal time.

3. Indexes: what "the market is up" means

Nobody can follow 4,000 companies at once, so we use indexes: a basket of companies whose average price we track as one number.

• S&P 500 — 500 of the largest US companies. When the news says "the market", it usually means this.
• S&P/TSX Composite — about 220 of the largest Canadian companies.
• Nasdaq-100 — the 100 largest non-financial companies on the Nasdaq, mostly tech.
• Dow Jones — 30 big American companies; the oldest, most famous — and least useful — index.

"The S&P 500 rose 1 % today" simply means that, on average, those 500 companies are worth 1 % more than yesterday.

4. ETFs and dividends

Here's the good news: you don't have to pick companies. An ETF (exchange-traded fund) is a basket of shares — often an entire index — that trades like a single stock. Buy one share of an S&P 500 ETF and you own a tiny slice of all 500 companies, instantly.

ETFs are cheap. Their yearly fee (the MER, management expense ratio) is often 0.05 % to 0.25 %, versus around 2 % for many traditional mutual funds. That difference sounds small; over 30 years it's the difference between keeping your money and giving away almost half of it.

A dividend is a piece of the profits a company sends to its shareholders, usually every three months. Canadian banks, for example, have paid dividends for more than a century. Reinvesting dividends — using them to buy more shares — is compound interest in action (remember lesson 1?).

5. Bull markets, bear markets

A bull market is a long rise (the bull throws you up with its horns). A bear market is a fall of 20 % or more from the top (the bear swipes down). Both are normal. Since 1950, the S&P 500 has gone through roughly a dozen bear markets — and recovered from every single one to reach new highs.

6. Diversification: never one basket

One company can go to zero. In 2000, Nortel was the most valuable company in Canada, worth about a third of the entire TSX. Nine years later it was bankrupt. People who had their savings in Nortel lost them. People who owned the whole index barely noticed within a few years.

That is diversification: spreading your money across many companies, industries and countries so that no single failure can hurt you much. An index ETF gives you that in one click — which is why it's the first investment most professionals recommend, including to their own kids.

7. Investing for the long term

The stock market is unpredictable over a day, a month, even a year. Over 10, 20, 30 years, it has been remarkably reliable: the S&P 500 has averaged roughly 10 % a year since the 1950s (before inflation, with dividends), through wars, crashes and pandemics.

The catch is that you have to stay. Many of the market's best days come right after its worst days, so investors who sell in a panic miss the rebound. The old saying is true: it's time in the market, not timing the market.