June 07, 2021

For many people the stock market is a mystery. We see the numbers reported every day and when the market has big gains or losses it is headline news. But what do these numbers mean and why are they sometimes so volatile? It seems like the stock market’s behavior is totally random and this leads many to believe that investing in stocks is just gambling and if you invest in stocks you have to just hope and pray you make money.

Let’s look at the basics, just as a supermarket is a place you go to buy different food items, the stock market is a place you go to buy individual stocks. A stock is one share of a company like the local company, Buckle, Inc. If you buy one share of the Buckle you are an owner in the company. The company takes the money they make and reinvests some of it back into growing their business and some of it they give to their shareholders in the form of a dividend.  If the company does well and makes money the value of your share of Buckle Inc. increases plus you get the dividend.

You have to remember that the stock market is a market of stocks like Buckle Inc. There are roughly 6000 individual stocks listed on U.S. exchanges, some of them make money some don’t, some are fast growing companies some are not. Some of them will never make money.

When most people say “the stock market” they are talking about the Dow Jones Industrial Average (DJIA). This is the most widely quoted stock market average there is, yet there are only 30 individual stocks in this average to tell us how the entire stock market of 6000 stocks is behaving. It can tell you generally what investors are doing that day so that’s why it gets reported so much.

America is still a capitalist country where private entities own the means of service and production. Those 6000 public companies plus all of the private ones propel the U.S. economy. The DJIA was at the 1,469 level in the year 1915, around 8,000 in 1965 and stands at 34,500 today. If you believe in the capitalist system and that America will continue to produce and grow you have to believe American companies will grow, and if you own stock in those companies your investment will grow.

So, it makes sense that the stock market went up in a straight line for the last 106 years from 1469 to 34,500 and investors made money and lived happily ever after. Well, it might have if all of us human investors didn’t get in the way. As we know the market can take some wild swings up or down because we act in a very human (and predictable) ways. We get very excited during good economic times. When there is a bull market, we look in the rear-view mirror and think things are so good they just have to continue. Then we look at our neighbor and think, that guy is making money and I’m smarter than that guy, I need to get in. So rather than being rational and looking at the actual value of companies we all follow the herd and eventually go over the cliff. At other times, like last year, people get scared thinking it’s the end of the world and just start indiscriminately selling stocks. 

The stock market is not mysterious, if you want to make money in stocks you must believe in the promise of America, stay invested for the long term and ignore the short-term swings. If you understand this you can use investors emotions to your advantage. When everyone else is panicking you can step in and buy bargains and when people are euphoric and values are high you can take a little money out of the stock market.