Understanding Stock Market: How it Works & Its Functions
29 May, 2024
All About Stock Markets and its working
The stock market in India is a financial platform where various publicly listed companies’ shares are bought and sold. Regulated by the Securities and Exchange Board of India (SEBI), the Indian stock market plays an important role in channelling savings into productive investments and contributing to the nation’s economic growth. In simple terms a stock market or also called as share market is a marketplace where buyers and sellers meet to trade i.e. buy and sell shares.
The main purpose of a stock market is to facilitate the movement of funds (capital) from the savers (investors) to the borrowers (companies) through Stock Exchange platforms.
There are around Nine Stock Exchanges in India out of which the primary stock exchanges in India are the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE), where trading occurs electronically. Investors, ranging from individuals to institutional entities, can participate in the stock market with the aim of capitalising on market fluctuations to generate returns. The other exchanges are Multi – Commodity Exchange (MCX); National Commodity and Derivatives Exchange (NCDEX); India International Exchange (INX); NSE IFSC; Indian Commodity Exchange (ICEX); Calcutta Stock Exchange (CSE) and Metropolitan Stock Exchange (MSE).
Understanding the Stock Market
There are two types of Stock Markets:
Primary Market - where companies raise capital for the very first time. The process of issuing shares to the general public for the first time is known as an Initial Public Offering, or IPO. The Primary market includes major players viz Merchant Bankers, Mutual Funds, Financial Institutions, Foreign Institutional Investors (FIIs) and Individual Investors
Secondary Market - Once the shares are issued in the primary market, they are traded i.e. bought and sold in the secondary market via a stock exchange. The major players in secondary market include stock exchanges, stock-brokers (who are members of the stock exchanges), the mutual funds, financial institutions, foreign institutional investors (FIIs), and individual investors.
The shares of a company represent ownership in those companies, granting you, as an investor, a stake in their profits and losses. The stock market serves as a platform for companies to raise capital by issuing shares to the public. You, as an investor, on the other hand, would typically participate with the goal of growing your wealth through capital appreciation and dividends.
It is important that you analyse the factors like company performance, global events, and investor sentiment that influence stock market fluctuations to make informed decisions. While the stock market offers opportunities for substantial gains, it also comes with inherent risks due to market volatility.
The stock market operates on the principles of supply and demand, which determine the prices of stocks. If there is high demand for a particular stock, its price rises, and vice versa.
Key Participants in the Stock Market:
SEBI – The Securities and Exchange Board of India, is the market regulator and is in charge of monitoring the stockbrokers and stock exchanges to protect the interest of investors. The main aim of the SEBI is to protect the rights of the investors in the Stock Market
Investors – These are the Individuals or Entities who buy and / or sell the shares of the publicly listed companies either in the primary market or the secondary market
Depositories – India has currently 2 listed Depositories who regulate the working of Demat account which the Investors are required to Open
Stock Brokers – These are Clearing members who maintain Trading accounts of the clients to enable the investor to participate in trade of securities through Stock Exchanges
Clearing Corporations – Clearing Corporation/House is an entity responsible for clearing and settlement of trades done by clearing members on a recognised stock exchange. A Clearing Corporation / Clearing House of a stock exchange is admitted to the depository system for clearing and settlement of securities traded on their respective stock exchanges
How Stock Market Works
Understanding how the stock market works is essential for anyone seeking to engage in investment activities.
The Participants
The participants include SEBI, the stock exchanges that is BSE and NSE, the stockbrokers, the traders (daily traders and long-term traders) and the investors. Do note the investors who also trade need to set up a Demat and Trading Account before they begin their trading journey.
IPO
When a company decides to go public, it issues shares to the public through an Initial Public Offering (IPO). The initial requirement for the company to be listed in the stock exchange is to file a draft offer document with SEBI. With specific details and regulatory norms in place, these shares represent ownership stakes, and investors who buy them become shareholders.
Distribution
The company issues and allots the shares to the investors who had applied for the IPO. It is a computerised process; hence not all the investors would get the shares. The shares are then listed in the stock market, and the investor has the option to sell their newly allotted shares, and another investor has the opportunity to buy these shares.
Stockbrokers
The intermediary or the middlemen are individuals or broking agencies registered with SEBI and the Stock Exchanges that assist the investor in buying and selling shares through the stock market. Your Demat and Trading Account is set up with your stockbroker who executes the deal for you, upon confirmation of your order the stockbroker sends you the contract cum transaction bill report.
Order Processing
This is the final step when the broker places an order or trade on behalf of the investor on the specific exchange. The executed trade order is settled, which is the process where the buyer receives the shares and sellers receive their monies.
What is Stock Market Volatility?
Investing in Stock Market is subject to certain risks which can also be termed as ‘Market Volatility.’
Stock market volatility is defined as the rapid and unpredictable fluctuations in the prices of stocks and securities that are traded within a financial market. It signifies the extent of price variability over a specific period, often reflecting sudden shifts in supply and demand dynamics, investor sentiment, economic indicators, and external events.
High volatility is characterised by sharp price swings, creating opportunities for substantial gains but also exposing you as an investor to increased risks. Low volatility, on the other hand, indicates relatively stable price movements. Volatility is often measured using statistical tools like standard deviation. While it can create chances for profitable trades, it can also lead to significant losses if not managed effectively. Traders and investors use various strategies, such as diversification, hedging, and technical analysis, to navigate and mitigate the impact of market volatility on their portfolios.
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Disclaimer: *The information provided in this article is generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. You are recommended to obtain specific professional advice from before you take any/refrain from any action. Investments are subject to changes in tax laws. Please contact a professional consultant for an exact calculation of your liabilities.
