How Does The Stock Market Actually Work? | Beginner Investors

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How Does The Stock Market Actually Work?

You've likely heard to just buy "stocks" because they go up overtime. Buy an index fund like $VFV or $XEQT , wait 30 years and boom, you have millions in retirement. It seems great, but HOW and WHY does this actually work?

Let's break it down so you understand the basics. When someone refers to the "market", most often they're referring to the US market or at least the S&P 500. Now there are many other stock markets from other countries and indices all of which move in different directions, but for the example we'll use the US market.

The S&P 500 is a representation of the 500 largest companies in the US. Investors will tell you to buy an index fund tracking this market and you'll be rich in 30 years. If that's the case how does it actually work?

The S&P 500 is not simply a graph on a screen, it's an index that tracks 500 companies. Each company is also traded individually on a stock exchange. Every business day the companies will be available to buy and sell for investors. Some days they'll go up, somedays they'll go down. The price of each company is affected by many different things like macro news, politics, sectors, and most importantly earnings.

Each company will post what it earns every 3 months, and investors will buy/sell shares of a business based on this information. This happens for every company in the S&P 500 which means investors are trading shares all the time based on the company earnings. The idea of the stock market is that over time most businesses should grow bigger and larger and therefore increase in value. Being able to own all the companies directly allows you to participate in their profits and overtime continue making more money.

This is the basics of how markets work, you buy a large basket of businesses and you share in their profits which theoretically will continue to increase overtime as does the economy. However, this isn't the only factor of how a market moves.

If businesses could just keep going up in price there would be no risk and seemingly infinite money. Stocks carry RISK because there isn't a guarantee of making money. Not every business will succeed or make more money every year. There are also outside influences affecting the market.

Take the war in Iran, recently US stocks started to dip because investors were losing confidence in US companies due to political conflict. This means businesses are expected to give you less returns and therefore investors made the prices go down. Macroeconomics and politics can play a direct part in affecting markets like we saw in April 2025 with tariffs.

Another forgotten piece is that interest rates have a mostly direct correlation to stock prices. Interest rates affect both loaning and saving at a guaranteed rate. A loan with a 4% interest rate does not fluctuate, and a savings account with a 4% interest rate does not fluctuate. This means you won't lose or gain on your principal balance.

Since all businesses operate directly in correlation with interest rates, investors will use that as one factor to determine a company's price. If interest rates go up, it means that most businesses will have loans that are directly affected. Company debt now costs more because the interest rates went up, the business now has to pay more, the business earnings are now lowered because of it, and investors have less confidence because the company starts making less.

This is why in periods where interest rates start to increase, stocks will usually decrease (they have an inverse relationship). There is also a direct result for consumers when interest rates rise or fall. If interest rates suddenly skyrocketed to 10%, that means any sort of fixed income like GICs, Bonds or Treasury Bills will now give you that interest rate in return. If you have the opportunity to guarantee 10% return a year with NO risk of losing capital, why would you invest in stocks?

Since stocks carry risk, buying high interest fixed income is a safer option. Why would you as a consumer risk your money on tech stocks like $AMZN and $NVDA if the banks are offering double digit fixed income? Markets reflect this.

During the early 1970s and 1980s, the interest rate in the US was anywhere from 8-15%. That means your fixed income could generate you 8-15% a year guaranteed. At the same time, the S&P 500 remained relatively flat for 10 years. Why? Because why would you risk losing money in the market when you could guarantee high interest payments.

The same is true for falling interest rates. Lower interest on business debt meaning more earnings, less reason for consumers to save, more spending at businesses which means more profit, and all of that translates to higher appreciation on stock prices.

Without going into too much detail, this is your basic idea of why stock prices go up over time. Remember, a broad market fund will go up over time but not over a short period. There are many periods where different countries will experience losses or gains at any time. Individual stocks also have no guarantee of giving you returns.

If you want a brief summary of what affects the stock market remember this: It's affected by interest rates, macro economics, politics, and company earnings. This will determine the direction of the market.

As always, do your research and happy investing!

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