Understanding how the stock market works won't give you a superior advantage over other traders, but it will help you understand what is taking place when you buy and sell stocks and how that affects such things as price.
Stocks are traded on an exchange. You may have heard of the NASDAQ or New York Stock Exchange. There are exchanges all over the world. It is at these exchanges that traders can meet to buy and sell shares of stock and other securities, like bonds. In the not too distant past the exchanges would be flooded with traders yelling and signaling as they made trades. This still takes place today, but there is also a much greater presence of online, or virtual, trading.
The price of a stock changes daily and if it's a very active stock you can watch the price change every few seconds. The economic law of supply and demand is what causes this price movement. If there are more buyers than sellers then there is a high demand for the stock, thus the price will rise. However, if sellers are flooding the market with shares, but no one wants to buy, then the prices will fall. The concept of supply and demand is easy to grasp. What is more difficult to understanding are the people that create the supply and demand. What makes investors like one stock, but dislike another? Why does this attitude change over time?
The stock price is an indicator of what investors believe a company is worth. Remember, this is from the investor's perspective so it might not be correct. You must also remember that investors have beliefs about the future prospects for a company. If they believe it will perform well in the future they will build that expectation into the current price, resulting in a higher price per share.
Are Markets Efficient?
This simple question can spark a great deal of debate between investors. The Efficient Market Hypothesis (EMH) claims that the price of a stock, or any other asset, reflects all available information about that asset. The EMH lays out three possible forms of efficiency that the market can take. The weak form suggests that the price of stocks and other assets already contain all past information that is publicly available. The semi-strong formsuggests that prices contain all past publicly available information and that they update to reflect new information. Finally, the strong form believes everything in the semi-strong form and adds that prices even reflect hidden, or insider, information. Which form you choose to believe is a personal choice and will affect how you decide to trade.
Can You Beat the Market?
You certainly should not begin trading with the expectation that you will beat the market. There are many variables at play that are beyond your control. Even the best investors, those being paid millions each year, will have some down years. Enter the market with a strategy and a plan to minimize losses while trying to maximize gains. This is much easier said than done and developing your strategy will take time and lots of research. When you start out investing, remember the old adage, "If something sounds too good to be true, it probably is". It seems that many people, especially online, know the "secrets" to beating the market. Approach their advice with extreme caution at best.