TSI #27: The stock market explained

Today I want to focus on the stock market in general. Lots of investors still struggle to fully understand how the market works. I want to make sure that you do. Because then, and only then, can you truly master your money.

I’ve come across lots of financial enthusiasts that are great with analyzing various kinds of investments. But when it comes to understanding the nature of the market, their knowledge is limited. Naturally, that has an effect on the ability to make and keep money. That being said, let me explain what the stock market really is in simple terms.

What is the market actually?

Imagine a marketplace where people go to buy fruit and vegetables. The sellers set their prices and the buyers haggle. The exact same logic applies to the stock market. People that own companies are the sellers and the people that want to own companies are the buyers.

Now imagine a marketplace with millions of transactions. Things would go super slow if everything was manually done. That’s why when you see $AAPL trading at $148 you should know that millions of transactions (and haggling) have set that price.

How big is the stock market?

Before I go too deep, I’d like to devote a few words to the size of the market. Usually that is determined by the so called “market capitalization”. That is nothing else but the price that was set on the marketplace by the buyers and the sellers.

If you rank all the companies by size you’ll get something like this.

Apple, as the largest company in the US, is the company on the far left. Microsoft is second and so on. When you go towards the right, you get smaller and smaller companies.

Here is how companies are classified based on their size:
• Mega-Cap: Larger than $200 billion
• Large-Cap: Larger than $10 billion
• Mid-cap: Larger than $2 billion
• Small-cap: Larger than $300 million
• Micro-cap: Larger than $50 million

Here is a fun fact for you. There are only 24 Mega-cap stocks listed right now. Because they’re so big, they take up 35% of the entire stock market.

Because the human population has the natural tendency to organize, we came up with so called indexes. That might seem like a complicated term. But it’s noting else than a collection of companies. Here are the most important indexes in the United States.

Five famous groups of stocks

• The Dow Jones index only consists of 30 companies. That’s roughly 0.6% of the total stock market.
•  The S&P 500 index tracks 500 of the biggest companies in the stock market. That’s about 10% of all listed companies. But it’s also 80% of the total value.
•  The Nasdaq is actually an exchange where roughly 50% of stocks are traded (usually technology stocks).
•  The Nyse is where the other 50% of stocks are traded.
•  The Total Stock Market index tracks all stocks.

For investors that don’t want to bet on the sector, size, index or exchange, the Total Stock Market is the preferred choice. That way, you have access to the growth of all companies.

So, note down these points and start investing today:

• The stock market acts similarly to a marketplace
• There are fewer large companies but due to their size, they take up the majority of the stock market
• The Total Stock Market index guarantees equal access to the growth of the market