How does the stock market work?

Investing in the stock market can seem complex, and it’s normal to be unsure where to start. Understanding how the stock market works can help you make sense of how shares are bought and sold and what affects their price. This page outlines what the stock market is, how it works, and what to be aware of when investing.

The stock market is a marketplace where people buy and sell shares, or stocks, in companies.  Investors trade shares based on how much they think the company will be worth in the future, hoping to make a profit. There are stock markets all over the world, with some of the bigger ones including America’s New York Stock Exchange and the UK’s London Stock Exchange. Each piece of stock you buy means you own a share of the company you’re buying it from.

The performance of each stock market is often tracked by looking at the value of large indexes. An index contains the top-performing companies within the stock market, examples being the S&P 500 in the US, the FTSE 100 in the UK, and the Nikkei Index in Japan. You might hear news headlines saying, for example, “the FTSE 100 is up 1.2%”. This means the stock market index has moved, not the stock market itself.

There are stock markets all over the world. In the UK, the main stock market is the London Stock Exchange, located in the City of London. Founded in 1801, it lists many of the country’s biggest companies, including HSBC, BP, and Unilever.

The world’s two largest exchanges in terms of market capitalisation are located in the US: The New York Stock Exchange, created in 1792 and located on Wall Street, and the Nasdaq, which was founded in 1971 and focuses on tech companies such as Apple and Facebook.

The Tokyo Stock Exchange in Japan, home to the Nikkei 225 index, is another major market, listing the country’s largest corporations and providing insight into Japan’s economy.

The stock market works similarly to an online marketplace, where people buy and sell shares in companies – known as making trades, or trading on the stock market. One way to picture it is as a continuous online auction: buyers place a bid, or the highest amount they’re willing to pay for stock owned by another investor. The seller, meanwhile, sets asks, which is the lowest price they’ll accept. For trades to occur, a bid must match an ask. 

Sometimes a company needs money to grow or pay off debt. To raise funds, it undergoes a process called an initial public offering (IPO). Once the pricing details and IPO are finalised, the company will set a date to open up its shares to the public. This is known as the primary market, because you’re buying directly from the company.

In the UK, the company lists their shares on the London Stock Exchange during this process. Some investors may be drawn to this option as a way to get in early, but there is some risk as the company’s shares are being sold to the public for the first time.

Once a company’s shares are sold in an IPO, most buying and selling happens between investors on the secondary market. Stock exchanges are secondary markets, so when you purchase a share, you’re buying it from an existing shareholder, not the company itself. 

Once investors buy shares, the prices are based on the supply and demand among investors. If more people want to buy a stock than sell it, the price tends to go up, and vice versa. The prices of shares in the stock market are often set through an auction process in which buyers and sellers place bids on shares.

Prices also change in response to new information that can affect how investors value a business. The company might have released its latest earnings, for example. Wider economic factors such as changes to interest rates can also lead to altered trading activity and, in turn, different prices. This is why share prices can quickly change in a single trading day.

Since it’s difficult to track every single stock, indexes such as the S&P 500 and FTSE 100 represent sections of the stock market and make observing them a little easier.

For example, the FTSE 100 is the share index of the top 100 companies listed on the London Stock Exchange. These 100 companies represent the performance of all the other companies.

Investors can earn returns in two main ways:

• Capital appreciation: The value of shares can rise (appreciate) or fall (depreciate), depending on how well the company is performing and what investors think about its future. The goal is to buy shares for one price and sell them at a higher price, making a profit in the process. In the UK, any profit you make may be subject to capital gains tax, unless you’re using a tax-free vehicle such as the stocks and shares ISA.
• Dividends: These are regular payments that some companies make to shareholders from their profits. Dividends are often paid out once or twice a year, and may be taxable if they’re over the annual dividend allowance.

The stock market is volatile by nature, and several factors can cause this volatility: 

• Economic factors, such as tax and interest rate policies, can influence the market. For example, if the Bank of England raises interest rates, it costs more for companies to borrow money, and they may not grow as quickly. This can lead to investors seeking out safer options, which then may lead to lower stock prices.
• Inflation may impact stock market volatility due to its implications for borrowing and corporate costs. If inflation drops unexpectedly, for example, stock prices might be boosted thanks to the lower costs of borrowing.
• Natural occurrences, such as a weather event, may have ramifications for the stock market. If extreme weather impacts a major oil-producing area, for example, this may suddenly increase oil prices. This can then spike the price of oil-related stocks.
• Political uncertainty is another contributing factor to stock market volatility. Trade deals between major powers can move stock markets up or down. An example is the US' decision to introduce tariffs on countries across the globe in 2025, which caused volatility across markets.
• Global events can make the stock market swing wildly. For example, the COVID-19 pandemic affected stock markets worldwide.

The biggest risk of investing in the stock market is that the value of the stock you own falls significantly. If the company you own stocks in goes bankrupt, you could lose all the money you invested in it.

Markets move up and down all the time. When the market falls sharply, this is known as a market crash, and it can sometimes cause a recession. In the history of the stock market there have been several notable crashes, such as the Wall Street crash of 1929 (‘Black Tuesday’), and the 2008 financial crisis that followed the US housing bubble.

When a stock market decreases by around 20% from its highest price and remains at this level, this is known as a bear market. Bear markets can occur in any asset class and can potentially wipe out years of gains. 

If you’re buying and selling stocks, you need to be comfortable with potential losses. Emotional decision-making can make investors buy (or sell) at the wrong time. Some consider day trading to be risky because it’s impossible to predict exactly what will happen with prices. In contrast to short-term trading, investing in the stock market over the long-term can sometimes reduce risk, but it doesn’t remove the possibility of losing money.

To begin your investment journey, here are six steps you can follow:

There are two ways you can begin investing in the stock market. You can either do it yourself or hire someone to manage your investments for you. If you have specific companies you want to purchase stocks from, then the DIY approach through brokerage accounts may be more suitable for you. However, if you don’t have the confidence or knowledge to choose which stocks you want to purchase, then a robo adviser or a stockbroker might be helpful.

If you’ve chosen the DIY option, you’ll probably be looking to open a brokerage account. An online brokerage account typically offers the fastest and least expensive way to purchase stocks, funds and other investment options.

If you need more support as you start to invest, you might want to hire a robo advisor or take advantage of one of the many online services that can help you set this up. Robo advisors are usually a lower-cost option for investors and can offer streamlined investment advice. They work by using algorithms designed to follow your investment goals.

When you invest in the stock market, you’re essentially choosing between two investment types. Pooled investment vehicles include mutual funds and ETFs, which allow you to purchase shares in different companies in a single transaction. This can be beneficial if you wish to diversify your investments.

If you want to invest in a single company, one option is to purchase individual stocks. Doing so can bring you high returns, but can be risky, as you won’t have any other stocks to fall back on in the event the company you’ve invested in fails.

Once you’ve chosen where you want to invest, you’ll need to set a budget. For individual stocks, the budget you’ll need will depend on how expensive the shares in the company are. If you plan on investing with a fund, you’ll likely need to meet a minimum investment requirement, which can be as much as £1,000. Remember that you should never invest more than you can afford to lose.

Investors have many different strategies when it comes to investing. But most successful investors stick to the basics, which include investing in companies that have room for growth, and being willing to sit tight for a long-term duration. Once you start investing, you might not want to track the performance of your shares as that will just give you a snapshot rather than an overall picture of the growth trajectory.

Once you’ve invested, you’ll need to revisit your portfolio to make sure its performance is in line with your goals. Investors typically do this on an annual basis. You’ll be able to make adjustments, such as making additional investments into other companies if you feel your portfolio is too focused in one area. You could also add geographic diversification by investing in international stocks.

Besides the stock market, there are several other types of financial markets where people and companies trade or invest. These include:

• The bond market: Companies or governments issue bonds to borrow money for financing major projects or investments. In a bond market, investors buy bonds, which are essentially loans, and the company or government will pay back the money with interest within an agreed period.
• Commodities market: This is where companies buy and sell natural resources such as oil, wheat, and gold. Since the prices are unpredictable, a company can sometimes use these markets to lock in prices for future delivery. If the value of those commodities increases, investors can also profit.
• Derivatives market: Derivatives are complex products that base their value on underlying assets, such as stocks or bonds. Commodity futures are an example of a derivative.

Investments in the stock market can go down as well as up, and you could end up with less than you originally invested. If you’re looking to put your money away with less risk, another option is a savings account.

Fixed rate savings accounts provide competitive interest rates from the day you open the account until the end of your agreed fixed term, giving you more predictable returns.