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Investor's Perspective: What is the stock market and how exactly does it work?

In many cases, there is a common word that comes to mind when the stock market comes up in conversation: fear.

The media does an excellent job of manipulating the emotions of many investors, especially with people who are tracking the ups and downs of the stock market on a daily basis, which can be detrimental to the psychological health of the investor. In other cases, investors tend to shy away from the stock market simply because they do not understand how it works.

Wallstreet professionals are infamous for using complex jargon about the stock market, but in reality, the stock market is not nearly as complicated as it may seem. In this discussion, I am going to breakdown and hopefully dispel some of the common fears of investing. I am also going to explain how the stock market works in plain english so without further delay, let's jump into it!

The stock market explained in Plain English

The stock market is a huge market place where investors gather to trade stocks, bonds, and various other securities with each other. All of this trading action takes place in three major stock exchanges in the U.S: the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX), and the NASDAQ (national association of securities dealers automated quotation system).

I have concluded that the stock market exists for two primary reasons.

1) To enable companies to raise money

2) To enable investors to make money

Reason number one: Companies use the stock market to raise money through what is called an Initial Public Offering (IPO). An IPO is when a company makes an initial offering of partial ownership of their company in exchange for investor's dollars through shares (stocks). This is also what is meant whenever you hear the saying "this company is going public." In other words, instead of searching and "sales-pitching" to individual investors, a company can draw in a massive number of investors by registering with what is formally known as the Securities and Exchange Commission (SEC) so that the company can offer shares of ownership to a select group of investors, otherwise known as investment bankers, through what is also known as the primary market.

At the conclusion of the IPO, the investment bankers will then sell the shares to the general public through what is formally known as the secondary market. Make note that the primary and secondary markets are two separate entities of the stock market itself.

To sum things up, the primary market is where investors (investment bankers) buy stocks directly from the company issuing them, while the secondary market is where investors buy and sell stocks amongst themselves.

Reason number two: Investors use the stock market to make money by buying and selling shares from each other in an attempt to make a profit one way or the other. Investors can be large institutional organizations such as commercial banks, or they can be retail investors such as individuals like you and I. As I stated in reason number one, you do not buy the shares from the issuing company. Instead, you buy them from someone who already owns them in the open market.

I have deduced that most investors fall into one of two categories.

1) Day trading/get rich quick approach

2) Long term/gradual wealth accumulation approach

Day trading/get rich quick approach: Those who fall into this category typically have no desire for investing for the long-term. These individuals believe that they can time the market and accurately predict stock price fluctuations in short spurts. They jump in and out of positions on a daily basis in an attempt to make fast money. They study charts and graphs to identify patterns with the belief that whatever happened in the last 5 minutes of a stock price will dictate what will happen within the next 5 minutes of the stock price movement.

Long term/gradual wealth accumulation approach: Those who fall into this category typically have no desire to risk their hard-earned earnings in an attempt to make fast money. These individuals do not believe in trying to time the market on a minute by minute basis in an attempt to get rich quick. They themselves, and or they hire a trusted professional to carefully select suitable investments on their behalf on the basis of investing for long-term wealth accumulation. These individuals are not only interested in building wealth for themselves, but they are also on a mission to build wealth for the next generation.

This is a selfless approach to investing.

In other words, they usually begin training their children at a young age on how to nourish and grow wealth so that the next generation does not end up becoming broke and penniless.

Common fears of investing and how to overcome them

Fear is an emotion that many investors are very familiar with, especially if you were invested during the 2008 housing market crash. When individual stocks or the value of your entire portfolio drops significantly you may likely be tempted to sell to avoid more losses.

Logically you are probably well aware that it is not always best to sell low.

Logically you are probably well aware that you should weather the storm and hold your position for the long term.

Logically you are probably well aware that as a whole the stock market has performed relatively well historically, although there are many ups and downs along the way to accumulating wealth.

You see, you can be well aware of all of this logical reasoning but fear can still easily trump all logic! Warren Buffett is easily one of the greatest stock market investors ever known to mankind. Arguably, Buffett's greatest strength has been his ability to not allow emotions to dictate his investing tactics.

If you do your research you will quickly see that individuals who have had the most success with investing in the stock market are those who were in it for the long game.

Money that you invest should not be money that is needed to put a down payment on a home next month.

"What this really boils down to is the fear of losing money."

As a result, you leave all of your funds sitting idle in a savings account or a CD (certificate of deposit), (or what I like to call a "certificate of depreciation" due to a CD's inability to keep up with inflation) for years and years with average annual returns of 1% or less, causing you to miss out on an immense amount of potential growth and wealth accumulation. With social security becoming less reliable and pension funds nearly extinct, the reality is that you cannot afford not to invest.

Taking the first step is always the hardest.

But once you get started and begin to understand the art of making your money work for you instead of the other way around, you will be left with asking yourself one question...why didn't I get started much sooner?

Don't waste any more time.

If you valued this article please hit the 'like' button and also share via your Twitter, LinkedIn, Instagram, and Facebook social media platforms. I encourage you to join the conversation or ask questions in the comments section of this post.

Disclaimer: Hudson Wealth Management, LLC (HWM) is a FINRA registered investment adviser firm. Investing in securities involves risks, and there is always the potential of losing money when you invest in securities. Before investing, consider your investment objectives and HWM's fee schedule. The information provided herein is for illustrative purposes only and does not constitute personalized investment advice, recommendations or solicitations to hold, buy or sell any investment or security of any kind. All images and return figures shown are for illustrative purposes only and are not actual customer or model returns. Past performance does not guarantee future results.

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