You may have heard that stock investing can be a wonderful long-term method to build money. Undoubtedly, it is true. Do you actually understand how does stock market work ? Do you understand the distinctions between a stock market and a stock exchange or stock index? Have you ever heard of a stock?
You are not alone if you give a negative response to any of them. The fundamentals of stock markets, stock exchanges, and stock indices are summarised here.
So what is a stock market?
Investors can trade a variety of financial assets on the stock market, including shares, bonds, and derivatives. The stock exchange serves as a middleman for the purchase and sale of shares.
The Bombay Stock Exchange (BSE) and National Stock Exchange are the two main stock exchanges in India (NSE). Additionally, a primary market exists where businesses can list their shares for the first time. Following that, the shares are traded again on the secondary market.
How does the stock market work? Understand the basic terminologies.
Participants: The stock exchange offers a trading floor for financial goods. Before trading, brokers, traders, and investors must register with SEBI and the exchange (BSE, NSE, or regional exchanges), as well as the companies (listing their shares).
Securities and Exchange Board of India (SEBI): SEBI is the market regulator whose main duty is to guarantee that the Indian stock market operates smoothly and transparently, allowing average investors to invest without concern. Exchanges, businesses, brokerages, and other participants must all adhere to the rules established by SEBI.
Stockbrokers: Members of exchanges are stockbrokers. They are the middlemen who, in exchange for fees, carry out the buy- and sell-order instructions from investors. Investors must trade through broking houses or brokers in the Indian system, who serve as facilitators.
Investors and traders: Investors and traders are the two main categories of market participants. Investors purchase stock in a company with the intention of holding it for the long term and earning money from it. In contrast to investors, traders engage in the buying and selling of stocks.
Company success, possibilities for long-term growth, dividend payments, and other similar aspects drive investor behaviour. Contrarily, price changes as well as supply and demand considerations have an impact on traders.
Stock Exchanges, stock markets, and stock indexes
Here, three separate phrases with overlapping and frequently misleading meanings are used:
Stock market: The act of investors purchasing and selling stocks to one another through the stock market.
Stock exchange: the actual middleman, such as the New York Stock Exchange, that connects buyers and sellers (NYSE).
Stock index: A metric that tracks the performance of a group of stocks by expressing them numerically.
Demand and Supply in the Stock Market
Another fascinating illustration of the rules of supply and demand in action in the real world is the stock market. There must always be a buyer and a seller in a stock transaction. The stock price will trend upward if there are more buyers than sellers of a certain stock due to the unchangeable rules of supply and demand. On the other hand, if there are more sellers than buyers of the stock, the price will move lower.
The spread between a stock’s bid price and its ask price or offer price, also known as the bid-ask or bid-offer spread, indicates the difference between the highest price a buyer is ready to pay for a stock and the lowest price a seller is willing to sell it for.
When a seller accepts the bid price or a buyer accepts the asking price, a trade transaction is completed. If there are more buyers than sellers, they might be willing to increase their offers to buy the stock. As a result, sellers will increase their asking prices, driving up the cost. If there are more sellers than buyers, sellers might be willing to accept lower offers for the stock, and buyers might do the same, driving the price down.
An Introduction to the Indian Stock Market
You should consider the amount of dividend income this company distributes before buying shares. What are the pillars of this business? How does this business continually enhance its performance? Another thing to think about is how expensive or inexpensive this stock is right now.
When you begin trading on the stock market, there are a lot of things for a beginner to learn and do. Here, we’ll go through the fundamental ideas and procedures involved in purchasing and selling shares.
Share traders are those who buy and sell shares. They acquire the right to own the business’s assets and profits for a predetermined period of time when they buy.
They receive dividend payments throughout this time from the company’s earnings.
Three categories of shareholders exist:
1) Face Value: These owners purchase their shares at face value, which is the price the corporation gave them for, with no consideration for the future.
2) Direct Benefit: These shareholders receive perks such as coupons that offer extra dividends above and above their face value or other incentives like an annual meeting with senior managers where they can express their views in person.
3) Growth Option: These investors receive dividends as well, but they also receive extra perks including the chance to take part in a brand-new programme called the Guaranteed Growth Plan. They will vote on the clients who will get a bigger cut of the company’s income under this scheme.
Understanding the stock market’s price structure
Demand and supply considerations affect the price of stocks on the market. Part of a company’s share price is determined by its market capitalization, which is the sum of the stock price times the number of outstanding shares. The market’s current asking price is determined by the most recent sale price. Consider that the previous closing price of 100 shares of firm XYZ was Rs 40, and you wish to purchase them. The share is worth (40*100), or Rs. 4,000, in fair market value.
The discounted cash flow approach is a different way to determine the fair price. According to the notion, the fair price is equal to the sum of all future dividend payments, discounted at present value.
The network of exchanges, broking firms, and brokers that make up the stock market acts as a middleman between businesses and investors. Initial Public Offerings, or IPOs, are used to list companies in the market before investors can buy their shares. A company’s market capitalization can be determined by an initial public offering (IPO), and investors can choose shares to purchase from distinct lists of large-cap, middle-cap, and small-cap companies on the stock markets.
In addition, stock exchanges have indices. The Nifty and Sensex are different indices used by the Indian exchanges NSE and BSE. Based on market volume and share popularity, these indices are made up of the best large-cap firms. These indicators are followed by average investors to determine market direction.
The bid-ask spread is yet another crucial term to understand when discussing how the stock market operates. The term “bid” describes the amount that buyers are prepared to offer for an underlying, which is frequently less than the seller’s “ask” price. The bid-ask spread refers to the difference between the two prices. For a transaction to take place, the seller must lower the ask price and the buyer must raise the bid price.
Trading on Stock Exchange
The shares of stock that corporations issue can be traded in the secondary market once they are listed on stock exchanges. Stockbrokers and brokerage firms, who operate as the go-between for investors and the stock exchange, handle the buying and selling of the stocks that are listed on the exchanges.
Your buy order for shares is forwarded by your broker to the stock exchange. For the same share, the stock exchange looks for a sell order.
A price is agreed upon to complete the transaction once a seller and a buyer have been identified. Following that, your broker will receive notification from the stock exchange that your order has been confirmed.
The broker then transmits this message to you. All of this occurs instantly and in a matter of seconds.
The stock exchange also verifies the information of the purchasers and sellers of shares in the interim to make sure neither party defaults.
The actual ownership transfer of shares from sellers to buyers is then made possible by this. The settlement cycle is what is referred to here.
The process of settling stock trades used to take weeks. However, this has recently been shortened to T+2 days.
For example, if you buy a stock today, the credit will be available by the end of the day.
The stock exchange also makes sure that the settlement process honors stock trades.
The stock market loses its integrity if the settlement cycle doesn’t occur in T+2 days, since trades may not be upheld.
Stockbrokers use a special code given to each investor to identify their clients.
A contract note, which includes information about the transaction such as the time and date of the stock trade, is given to the investor by the stockbroker after the investor completes the transaction.
Investors are also required to pay brokerage fees, stamp duty, and securities transaction tax in addition to the purchase price of a stock.
In a sale transaction, these expenses are deducted from the sale proceeds before the investor receives the balance.
There are numerous organisations/parties participating in the communication chain at the broker and stock exchange levels, including the brokerage order department and exchange floor traders.
What happens when you purchase stock?
The purchasing and selling of stocks by investors must be done through a broker. In a sense, a broker is just a company that is authorised to trade stocks on a stock exchange. A broker could be a real person whom you instruct on what to buy and sell. The entire transaction is typically processed electronically by an online stock broker, such as TD Ameritrade or Fidelity.
Here is a brief explanation of what happens when you purchase a stock:
- You specify the stock you wish to purchase as well as the number of shares you desire to your broker (or input online).
- Your broker transmits your order to the exchange, and a market maker sells you shares at the current market price.
- The shares are then delivered to your account.
In India, how many stock exchanges are there?
In India, there are two important stock exchanges. they are:
Bombay Stock Exchange
The Bombay Stock Exchange is the oldest in Asia and was founded in 1875. In terms of transactions, it is ranked 10th internationally. In November 2022, there were 5295 publicly traded businesses, and the market capitalization of the BSE (total shares x market price) was over 3.5 trillion dollars. The top 30 equities on the BSE are included in the Sensex, which tracks the performance of the BSE. As of right now, the Sensex is at 63,000.
National Stock Exchange
The National Stock Exchange, or NSE, was established in 1992 to compete with the BSE’s monopoly. The NSE is the ninth-largest stock exchange in the world according to market capitalization, which is $3.4 trillion. The NSE’s performance is used by investors all over the world to gauge the state of the Indian stock market.
Worldwide stock markets have a high degree of correlation, so when the BSE declines, other significant global indices also experience declines.
Regulation of the Indian Stock Markets
The Securities and Exchange Board of India is responsible for regulating and monitoring the stock markets in India. The SEBI Act of 1992 established SEBI as a distinct legal entity with the authority to examine stock exchanges. The inspections examine the market’s activities, the organisational structure, and various facets of administrative oversight. SEBI’s primary responsibilities include the following:
- establishing a just and fair market for investors to develop in
- adherence to the regulations established by the Securities Contracts (Regulation) Act (SC(R) Act), 1956, by the exchange organisation, its system, and its methods
- Make that the SEBI’s recommendations and instructions are followed
- Verify that the exchange has adhered to all requirements and, if necessary, extended the funding made under Section 4 of the SC(R) Act of 1956.
The stock market’s myths
Myth 1: Investing in stocks is gambling
People often feel that trading is a bet in which you either win or lose.
Investing is more akin to science than art because it requires thorough research into the technical and fundamental aspects of the assets, as well as the market’s current trends and the company’s growth potential.
Myth 2: Previous performances predict future results
Investors take ratings or the stock’s past performance into consideration when making an investment choice.
Investment choices are made based on the company’s prospects, not only on past trends. Some of the key macroeconomic factors that have a significant impact on stock performance are the interest rate, GDP, exchange rate, etc. Investors must also take into account quarterly results, the intensity of the rivalry, production costs, the introduction of a new product, changes in top management, etc.
Myth 3: Stocks that decline eventually rise or vice versa
Most people think that a stock that is declining will eventually rise. Similar to this, they avoid purchasing equities that are at all-time highs because they anticipate a quick decline in value.
Investors should investigate the causes of a stock’s decline. Is the collapse merely the result of market sentiment, which may change, or is it the result of some major occurrence that could have a negative impact on the company’s finances? Furthermore, a stock’s recent rapid increase does not always preclude further gains.
Myth 4: You must invest a lot of money in order to be successful.
The investors just need to practise discipline and thorough investigation, in actuality. Regularly making little investments over a long period of time can unleash the power of compounding and turn regular investors into millionaires.
Myth 5: To be successful, you must engage in a lot of trading.
The belief that they will need to trade frequently in order to generate excellent profits is another factor that discourages potential investors from making investments.
In actuality, quality transactions outperform quantity trades. If you don’t complete your research, you can make a lot of trades and not get the results you want. However, if you invest after conducting careful research and make great deals, you might earn good returns.
Myth 6: It is wise and secure to trade stocks with low P/E (Price-to-Earnings) ratios
Whether a stock is overvalued or undervalued can be determined using the price-to-earnings ratio (P/E). According to conventional knowledge, the better the bargain, the lower the price in relation to earnings (P/E ratio).
The stock’s low price may have a valid justification. The company’s growth prospects, operating revenue, product launch (if any), debt structure, peer comparison, management, etc. must all be taken into account.
How Does Inflation Affect the Stock Market?
When consumer prices rise, it’s referred to as “inflation.” This can happen when there is an abundance of money or a dearth of products for sale. As a result of more money entering the market and faster job growth, inflation may occasionally result in higher share prices. However, these consequences are unpredictable. Higher input costs, however, might also limit business profits by limiting earnings. In general, during periods of high inflation, value equities tend to outperform growth companies.
You may become a better investor by understanding the fundamentals of the stock market and how does stock market work?. Your ability to buy and sell your investments at any time will become clear to you. Additionally, you’ll comprehend that prices are determined by supply and demand rather than only by the core principles of a firm, and that the market functions like an auction system.
1. Why is the stock exchange necessary?
A stock exchange performs a number of crucial tasks. As follows:
- Cheap Financing for Businesses: Companies can acquire cheap capital through the stock market.
- Investors have access to liquidity at all times and can buy and sell commodities and shares at the current market value.
- Investor Wealth Creation: When investors purchase a strong stock and hold it for an extended period of time, they generate wealth. Holding a stock for ten years or longer has advantages such as income from dividends, growth through bonus and right shares, and wealth accumulation due to increased market value.
2. How Can You Invest in the Stock Markets?
You must use a broker to invest in stocks; you cannot do it directly. The first step is to open a trading account and a Demat account with a bank or a brokerage company. Money transfers from your bank to the Demat account when you make a buy order. When you sell a share, the money is deposited in your bank account.
3. When Must You Submit a Share Application?
You must apply for shares if you wish to purchase them; you might or might not get all the shares you request. Shares are issued through an IPO.
4. Which two major stock exchanges are available for investing in shares?
With the help of the BSE and the NSE, you can buy shares in India.
5. How do new traders use the stock market?
Six steps to stock investing-
- Determine your stock market investment strategy.
- Select a trading account.
- Find out the distinction between investing in stocks and funds.
- Create a budget for your stock market investment.
- Put your attention towards long-term investing.
- Manage your stock portfolio.
6. How can you profit from stocks?
Invest and hold. Long-term investors often use the saying, “Time in the market beats timing the market.” Reinvest your dividends, choose the best investment account, and choose funds over individual stocks.
7. What stock market is the largest in the world?
NASDAQ: The New York Stock Exchange
As of December 2022, the New York Stock Exchange’s equity market capitalisation was around 23 trillion USD, making it the largest stock exchange in the world. The NASDAQ, the Shanghai Stock Exchange, and the Euronext were the next three markets.