What exactly is the Stock Market? How Does the Stock Market Work?

I have often heard the Quote “An Investment In knowledge pays the best Interest” so why don’t we spend some time to know about the equity market which pays the best interest among all the asset classes. Learning the Equity Market is exciting, Interesting and well rewarding. It’s good that you are keen to learn more about the Stock Market, believe it !! you are not that late at all, the Market will always be there and will always give you plenty of opportunities to develop your wealth over time. 

Before we move ahead and discuss further Just for your knowledge Secondary Market, Equity Market, Cash Market/ Segment are a few other names to denote the Stock Market, so going forward in the articles or even in news you might hear these names, just remember they are all the same.

We all have a strong desire to grow our wealth as fast as and as much as we could. People were always on the lookout for methods to grow their savings safely and Bank FD’s, Chit Funds, Gold, Realestate are the common methods that come into our mind first to grow our wealth. Let’s keep real estate investment apart at the moment as the capital requirement for such an investment option is often high, which may not be suitable for all. Our Parents and elderly ones used and still continue to use FD and Chit Funds as a tool to grow their wealth and it is giving returns of nearly 5% – 8% of their Investment value, and they are happy about it. But the sad thing is that the Purchasing power of our currency is decreasing periodically in accordance with the increasing inflation rate ( 4.9% as of Dec 2020), and these things are eating out the  5% -8% returns which we are getting from FD’s and leaves us mere 1% – 2% annual return on our Hard earned money effectively. So nowadays we have to find safe investment opportunities which could beat the inflation and provide us with a decent % of returns, such opportunities will help to grow our wealth.

What Is Stock market?

In order to create wealth and beat inflation equity investments plays a major role. What is the Equity stock market?  The stock market is not a single entity’s story. It consists of multiple participants and each one of it is equally important. An equity or stock market is a place where the stocks or shares or publicly listed companies are traded. As usual trade, it involves two parties, a buyer and a seller. What are publicly listed companies? Some businesses after their first stage of maturity in order to get further expanded needs humongous capital and to raise that capital they do an initial public offering(IPO) of their business and through the process of initial public offering it will get listed in the stock market where investors will be able to buy their shares to generate the required capital. We will try to give a bit more details of a company getting listed in the stock market, so as to give a better understanding and to point out that all the companies which we see around us are not listed in the stock market as they didn’t meet the requirements set by SEBI (Securities and Exchange Board of India) to get listed under the stock market.

What is Initial Public Offering (IPO) ?? How Does a Company Get Listed in the Stock market?

Here we will tell you briefly the transition of a company from Pvt Ltd to Listed. Suppose you have a business idea and you plan to set up a company. Companies act of India sets up guidelines and requirements to be followed to establish a company in India. With two partners and by meeting basic business requirements you could set up a Pvt Ltd company in India. To raise funds for further growth of a Pvt Ltd company they can take Loans, Issue Debenture, Sell shares of the Company, and by a few other means. Pvt Ltd companies can have only up to a maximum of 200 shareholders for the company as per Act. So if you want to raise further capital from the public then you should convert it into a Public Ltd company, such companies will mention “Ltd” with their name Eg. Reliance Industries Ltd, and they could raise more money from the public for business operations by selling shares of the companies. Throughout the growth journey of the company mentioned here the company shares are transferred hands outside the stock market, where the company shares and securities are issued to the public based on the management decision and governing regulations. Do note that only a Public Ltd company can be listed in the stock market, but all Public ltd companies are not listed on the stock market. So when a Public Ltd Company plans to raise funds on a larger scale for business operations from the general public like you and me, they approach SEBI to get the Company Listed on the Stock market so that the general public can invest in the company by purchase of shares. When the company meets SEBI criteria to get listed, they proceed with the process of Initial Public Offering (IPO) where either the Owners/Promoters of the company sell a portion of their shares or issue new shares which will be traded on the stock exchange. The number of shares of a company traded on the stock exchange is limited to what the Company has offered during the process of IPO. Any citizen could subscribe to get shares during the IPO process or can purchase them when listed on the stock market. The IPO process itself is a detailed topic and will cover it in-depth in a later chapter. I hope you have got at least a basic understanding of how companies get listed on the stock exchange and why.

BSE and NSE

So The main purpose of the stock market is to help you facilitate your transactions of buying and selling shares of Listed companies. So if you are a buyer of a share, the stock market helps you meet the seller and vice versa. There are two major two stock exchanges in India are Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). Besides these two exchanges, there are a bunch of other regional stock exchanges that don’t play any major role.

Market participants

Like I said, the Market, is not a single entity story. There are multiple regulated participants involved in the market. Anyone who transacts shares in the stock market is termed as a market participant. Who are investors? They are the people who buy the shares of publicly listed companies. There are different types of investors like common people or retail investors whose investment value is less than Rs. 200,000/-.

High Networth Individual(HNI):

These are individuals who make investments/bids for More than Rs.200,000/- in the IPO Process.

Foreign institutional investors(FIIs)

They are the non-indian corporate entities that could be foreign asset management companies or Hedge Funds.

The Regulator

The need for a regulator is crucial in any environment to prevent any mishaps or fraudulent activities and to ensure the protection of its participants. Like Courts acting as the protector of rules and regulations of a nation, Reserve Bank of India acting as a regulator of the entire banking system of our country, the Secondary Market also has a strong and Powerful regulator. The Securities and Exchange Board of India often referred to as SEBI is the stock market regulator of India. The main objective of the regulator is the development of stock exchanges and makes rules to ensure the protection of interest of the investors and regulate the activities of all Secondary market participants and financial intermediaries.

In general, SEBI ensures… 

1. The stock exchanges (BSE and NSE) conduct its business fairly.
2. Stock brokers and sub brokers conduct their business as per regulations. 
3. Participants don’t get involved in unfair practices.
4. Corporate’s don’t use the markets to unduly benefit themselves (Example – Satyam Computers)
5. Small retail investors’ interests are protected.
6. Prevent manipulation of the markets by Large funds inward / outward flow.
7. Protection of all Market Participants. 
8. Overall development of markets.

Considering the above objectives it becomes rational for SEBI to prescribe some set of rules for the main entities who are directly or indirectly involved in the stock market. The list of all the entities is listed with their significance and examples below.

Credit Rating Agency (CRA)

If a corporate or Govt entity wants to avail loan, or raise funds by issuing any securities, the CRA checks if the entity is worthy of giving a loan or the worthiness of the security being issued. So What does CRA do? They rate the creditworthiness of corporations and the government’s financial products or securities. CRA performs a depth study about the performance and financial background of the Institution and their financial Products like Bonds, Debentures, T-Bills, Commercial Paper, etc, and gives a Rating for the same. While providing the rating they take into account multiple factors like liquidity, safety, Return on Investment, Lock-in period, etc. so as to enable the investor to make intelligent decisions about investment in such products. Some of the Major Credit Rating Agencies are CRISIL, ICRA, CARE.

Stock Brokers and Sub Brokers

Whenever you want to buy or sell shares from the stock exchange you have to do so through registered stock brokers. A sub-broker is like an agent to a stockbroker. What do they do? Act as an intermediary between an investor and the stock exchange. While buying or selling stocks, multiple paper works needs to be done in the background to facilitate the same. 

You can imagine something like, by purchasing a company stock you are becoming a shareholder of the company, so there should be an agreement between you and the company, also with the seller of the stock regarding the mutually agreed price, the quantity of share, etc of trade executed, there is a requirement of an intermediary to intimate transfer of shares from the seller to your account based on the agreement as so on. So Multiple back-end works need to be done while performing trade in the stock market and we don’t have time to write all these agreements and sign them, right? That’s where stock Brokers come into the picture, they perform all these activities for you by taking a mere charge for the service and enabling you to make a trade in a fraction of a second with a Click. How cool is that !!!  Thanks to all advanced technologies and research by Stock Brokers to serve you their best, Some of the leading Stock Brokers in India are: Zerodha, ICICI Direct, Upstox, Sharekhan, Edelweiss….

Debenture Trustees

When companies want to raise a loan they can issue debenture against which they promise to pay interest. These debentures can be subscribed by the public. A Debenture Trustee ensures that the debenture obligation is honored. What do they do? Act as a trustee to corporate debenture. egs are Almost all banks in India.

Depositories

Acts like a vault for the shares that you buy. The depositories hold your shares and facilitate the exchange of your securities. When you buy shares, these shares sit in your Depositary account usually referred to as the DEMAT account. In earlier days Physical share certificates were issued as document proof of the shares you bought, due to difficulty in handling the physical shares and to facilitate fast trading of the same, the shares and securities are issued in electronic dematerialized format. A DEMAT account is a place to store these dematerialized securities, just like a locker. You could imagine such a large number of Demat Accounts within a vault and is maintained electronically by only two companies in India, NSDL and CDSL.. What do they do?  Safekeeping, reporting, and settlement of client’s securities.

Depository Participant (DP)

You cannot directly interact or Open an account with NSDL or CDSL. You need an Intermediator to open and maintain your DEMAT account in NSDL or CDSL. These Intermediators are called Depository Participants. What do they do? They Act as an agent to the two depositories. When we buy a company share, we need to get it on our Demat Account, The DP does the paperwork and intimates the Depositories to transfer shares from the seller Demat account to the Buyer Demat account as per trade agreement.  Stockbrokers and banks which provide Demat accounts act as Depository Participants.

Foreign Institutional Investors (FIIs)

These are foreign entities with an interest to invest in India. They usually transact in large amounts of money, and hence their activity in the markets have an impact in terms of market sentiment. What do they do? Make investments in the Indian stock market to make better returns. The Investments of FII in the stock market is through a highly regulated and controlled environment by Govt. and SEBI, as huge cash inflow/outflow could impact the market performance.  Egs are Foreign corporate, Hedge funds authorized by Rules and regulations of the country.

Merchant Bankers

If a company plans to raise money by floating an IPO, then merchant bankers are the ones who help companies with the IPO process. What do they do? Help companies raise money in the primary markets. They perform detailed studies on the company’s performance, financial position, future growth potential, etc, and help to decide the share price of the Company for the IPO and the banking services required during the IPO process. In addition to this Merchant Bankers also play key roles during Mergers and Acquisitions of companies. Egs are Karvy, Axis Bank, Edelweiss Capital.

Asset Management Companies(AMC)

An AMC collects money from the public, puts that money in a single account, and then invests that money in various investment horizons like equity market Instruments, Debt instruments, Gold, Realestate, etc with the objective of making the investments grow and thereby generate wealth to its investors. AMC appoints well-qualified, experienced, and Talented Fund managers who perform detailed research on various investment opportunities to deploy the Funds they manage so as to provide better returns safely. AMC offers various Mutual Fund Schemes which suit the investor. Egs are HDFC AMC, Reliance Capital, SBI Capital, Axis Mutual Fund.

Portfolio Management System (PMS)

They work similarly to a mutual fund except in a PMS you have to invest a minimum of Rs. 25,00,000 however there is no such cap in a mutual fund. What do they do? Offer PMS schemes. Egs is Religare Wealth Management, Parag Parikh PMS.

Registrar and Transfer Agents (RTA)

The function of an RTA is to maintain a register of securities issued or transferred to investors. During an IPO process, it is the responsibility of RTA to record bid details of all investors for the IPO, issue shares and certificates to successful bidders, and Initiate refunds for unsuccessful IPO subscribers. In a mutual fund environment RTA maintains records of all its investor details, MF units bought, sold, or held by investors and issues the corresponding trade documents to investors / AMC and similar documentation services. Eg. LinkIntime India Pvt Ltd, GE Capital Services India.

By this time you know how and why companies get listed on Stock Market, the IPO Process, Demat Account to Store shares, Stock Broker who provide and Maintain Demat account in Depositories. But the real question is how could I buy / Sell shares ?? How to Open a Demat Account ?? What to do for Purchasing shares of a company ?? Will money get debited from my savings account while Purchasing Shares or as any Charges ?? So let’s try to answer all these questions….

The first thing a Retail investor should do to participate in the Stock Market is to Open a Demat Account, Trading Account, and Savings Bank Account. We all have Savings bank accounts, if you don’t have one, open a Savings Bank account with a Nationalised Bank near you. The choice of Bank is up to you, you can open an account in any bank near you, the only thing to note is that the bank must provide good internet/ digital banking services. Those who already have a savings account could use it or could open a new savings bank account if you wish to have a separate bank account for Investment and trading purposes.

PAN Card is mandatory for participating in the Stock market. After having a savings bank account, you need to open a Trading and Demat Account with a reputed Depository Participant, we advise you to open the same with a leading / trusted stockbroker to ensure more safety for your accounts. Most stockbrokers like Zerodha, Upstocks offer Combined Trading and Demat Account. All you need to do is visit their website and click on the Link to Open Trading + Demat account with the Broker. You will be requested to Fill out certain details, Once the details are verified and accepted you will be requested to print the application and send the documents via post to their registered office. Most documents will be verified only quickly and the Stock Broker will Issue a Username and Password to access your Trading and Demat Account via their Trading Terminal.  The Registration and Account opening procedures are simple and hassle-free and won’t take more than 10 Minutes, so choose the right broker and Open your Trading and Demat account.

What is a trading account ?? Why is it needed ??

When you buy a stock/company share you have to pay money for that, right. You can buy Stocks or securities traded in the Stock exchange only with the money you have on your Trading Account. The money in a Trading account can’t be used for any other purpose, it’s for trading on Stocking Exchange. To buy a Stock of Rs. 100/- we have to transfer Rs.100/- from our Savings account to a Trading account (You can do it from your Broker terminal just by two clicks). The money will be instantly credited to your Trading account and now you can purchase the share through your Brokers Trading Platform. Similarly, when you sell a share the money will come to your trading account, you can transfer this money easily to your registered Savings Bank account. We are also happy to have a Trading account since our Savings account is not directly exposed to Stock market transactions, which is a plus point.

Now You have a Trading Account, Demat Account, and Savings Bank Account. The stockbroker has provided you the username and password to access their trading terminal. Why we have been stressing to open an account with a leading / Trusted stockbroker is that they provide the best user-friendly and technically advanced trading platform, and ensure the safety of the money in the Trading accounts and Shares in the Demat Account. Now you have to log in to the Trading Platform, Pick Stocks you like, Transfer the required amount to Purchase them into your Trading Account, and Buy the Stocks. These Stocks will be received in your Demat account. You can sell the shares when you wish with profits, receive the money in Trading Account and Transfer the same to a Savings account if needed. That’s it .. Buying / Selling of Stocks is as simple as that…..!!! Enjoy your Trading Journey.. But Hold on !!! Don’t just jump into Buying or Selling Stocks, you need to know a few Stock Market terminologies which you will come across in your Trading Platform and also required to become an informed & Intelligent market participant…..

Congrats… Now you have all the prerequisites to effectively Participate in the Stock Market. You have learned about various intermediaries involved in the Stock Market and their major functions. As you have understood the major participants in the Equity market let us get moving further and learn essential terminologies which will benefit you in your Stock Market Journey.

During earlier days a Share or Bond certificate was provided in the physical form when we purchase a Company Share or Govt bond as a proof of transaction. But as time advanced new methodologies got evolved.

The first and foremost thing you require now to trade in the market is a Trading and Demat account. For buying assets, From our savings bank account, we need to transfer money into our trading account. A trading account that is interest-free, linked with the broker will hold a transferred amount which can be used to purchase shares that’ll reflect in the linked Demat account.  A Demat account (short for “dematerialized account”) is an account to hold financial securities (equity or debt) in electronic form. In India, Demat accounts are maintained by two depository organizations, National Securities Depository Limited (NSDL)  and Central Depository Services Limited (CDSL). At this stage, you must have realized that the three financial intermediaries operate via three different accounts – trading account, DEMAT account, and Bank account. All three accounts operate electronically and are interlinked, giving you a seamless experience.

Some of the most fundamental Jargons of the stock market which everyone should be aware of are listed below.

Outstanding shares

The total number of shares issued by the company regardless of whoever holds it.

Public float

out of the total number of shares issued the number of shares traded by the investors are termed as public float.

Face value

Face value (FV) of a stock is the price issued for a share when the company is formed initially or the original cost of a company share decided by the management during initial shares issue is termed as face value of a share. Normally the face value of a share never changes, but the management can change the Face Value if necessary.

Market value

The value at which a stock is traded in the Stock Market, or its the price which we need to pay to buy one quantity of the Company share. The market value of a share changes every second during the market hours based on the supply and demand. If there are more buyers and very low sellers then the Stock price will go up, due to limited supply, and stock price will go down when there are more sellers than Buyers.

Last Traded Price (LTP)

It is the Price at which a Stock was traded at the very last moment in the Market. Throughout trading hours the LTP of the stock varies, as the traded price of a stock changes every second. After trading hours LTP of the stock will show the last price at which it was traded prior to closing of Market Hours.

Large Cap, Mid Cap, Small Cap Companies

Based on the Market Capitalization of a Company it can be Categorized as Large Cap, Mid Cap or Small Cap. 

Large Cap Companies: Market Capitalization > 20,000/- Crore Rupees.

Mid Cap Companies: Market Capitalization between 5,000/- to -20,000/- crore Rupees.

Small-Cap Companies: Market Capitalization < 5,000/- crore Rupees.

Large-cap companies are also termed Blue Chip Companies.

Stock Symbol

The symbol of a company that appears on the trading terminal and is unique for all companies listed on the Stock Market. Eg SBIN for the state bank of India, INFY for Infosys.

Market Sectors

Companies are divided into different domains based on their business categories and are called sectors. Examples are the IT sector, Auto Sector, Banking Sector, Pharma Sector etc and there are dedicated Indices to Track the performance of Sector-Specific Companies Like Nifty IT, Nifty Auto, Nifty Bank, Nifty Pharma etc. These sectoral indices will be showing the performance of that specific sector-based leading companies only.

Market Segments

A market segment is a division within which a certain type of financial instrument is traded. Till now we are discussing the market segment  Called Capital market / Equity Market where we trade shares of a company. There are other segments like the Equity derivative market where we trade futures and options,  Debt Market where bonds, debentures, and securities are issued for trading., Commodities market where Gold, Crude Oil, Silver, etc are shared.

IPO

Initial Public Offer (IPO), is the first sale of shares by a Public Ltd company to the general public. The companies going public raises funds through IPO for business development, working capital requirement, debt repayment, acquisitions, and a host of other uses.

Primary Market

The primary market is where securities are directly issued to the investor by the company. Direct investments in companies happen through the Primary Market. IPO is also executed in the Primary market as during the process of IPO the company directly issues shares to the successful bidder without involving intermediaries.

Secondary market

The secondary market is the place where securities issued from the Primary market are traded among the Public. Financial instruments such as stock, bonds, options, and futures etc are bought and sold in the secondary market. If we bid and get an allotment of shares during the IPO, we can’t sell back those shares to the Company, we could only sell those shares to a potential buyer who is available in the Secondary Market. The same applies to Bonds, we can’t return the bond before maturity to the Govt/issuer, but it can be sold to someone willing to buy it on the Secondary Market. Stock Market is an Example of Secondary Market.

Portfolio

The collection of different kinds of stocks owned by individuals based on their analysis, logic, taste, trend etc is called a portfolio of that Individual. Like Individual Portfolio Every Mutual Fund Scheme has Its own Portfolio of Investment as per the MF Scheme Information Document.

Trend

A market trend is a perceived tendency of financial markets to move in a particular direction based on the market conditions. Mainly there are three types of trends that are upward, downward and sideways trends.

Bull Market

When the trend is upwards for mainly all stocks and all indices are moving up then its called a bull market or if the stock market index is going up during a particular time period, it is referred to as a bull run.

Bear market

When the trend is downwards for mainly all stocks and all indices are moving down then its called a bear market or if the stock market index is going down during a particular time period, it is referred to as a bear run.

Position

If you have to Buy or Sell any stocks during the market hours then you have taken a position in the Market. A long position is when you buy a stock thinking the stock is bullish and sell it later at a higher price. Short Position is when you sell a stock / its derivative at the current price thinking that the stock is bearish and will move down to buy it later at a lower price. You can’t enter into a Short position on Delivery based equity trades but can do it on the derivatives market.

Square off

The process of selling a stock when you have taken a long position or buying a stock when you have taken a short position within the prescribed time period is termed as Sqareoff. It’s the Process of Exiting either your Long or Short positions within the prescribed time limit. Derivatives markets have their own square off period, Intraday Trading Positions must be squared off within the market hours of that day itself.

Positions and Squareoff are terms that are related or applicable mostly to Traders, Investors don’t have to worry about the position or square-off as it’s of no significance to their trading style.

Volatility

A stock price based on its historic performance and time period defined will have a mean or average price around which it is expected to be traded. If the Stock shows a higher degree of divergence from the mean value in either direction, then it can be termed as a highly volatile stock. If the Stock trades without much divergence, i.e. closely trading near to average value, then such stocks have low volatility.

Liquidity

If a stock has high liquidity then at any point in time there will be hundreds of thousands or even lakhs of investors willing to buy and sell that stock and vice versa for low volatile stocks. 

On a daily basis, large quantities of the shares are traded in the secondary market for highly liquid stocks, since at any point of time there are sufficient sellers and buyers in the market to execute a trade, and significant quantity trades happen every second.

52 week high/low

52 week high is the highest price at which a stock has traded during the last 52 weeks (which also marks a year) and likewise, 52 weeks low marks the lowest point at which the stock has traded during the last 52 weeks. The 52 weeks high and low gives a sense of the range within which the stock has traded during the year. Many people believe that if a stock reaches a 52 week high, then it indicates a bullish trend for the foreseeable future. Similarly, if a stock hits a 52 week low, some traders believe it indicates a bearish trend for the foreseeable future.

All-time high/low

This is similar to the 52 weeks high and low, with the only difference being the all-time high price is the highest price the stock has ever traded from the time it has been listed. Similarly, the all-time low price is the lowest price at which the stock has ever traded from the time it has been listed.

Volume

Trading volume is a measure of the total transaction of a given financial asset traded (buy-sell combined) in a period of time. For stocks, volume is measured in the number of shares traded in a specific period of time. Based on the time period it can be Daily volume, Weekly volume, Monthly volume based on the Number of trades executed in a Day, Week, Month respectively.

OHLC

An open-high-low-close chart (also OHLC) is a type of chart typically used to illustrate movements in the price of a financial instrument over time. Here O stands for the open price, H stands for the highest price the share has gown at that point of time frame, L stands for the lowest price the share has gown at that point of time and C stands for the closed Price. For example, the OHLC of ACC on 17th June 2014 was 1486, 1511, 1467 and 1499.

Averaging

Taking a long position in a stock thinking its highly bullish and when its comes down a bit buying some more of the same to average the total amount is termed as averaging a stock. – Not required in this section

Corporate Actions

1. Board Meeting
2. Rights Issue
3. Stock Split
4. Bonus Issue
5. Announcement

Further Public Offering (FPO)

FPO is a process by which a Publicly listed company issues new shares to the investors or the existing shareholders, usually the promoters. FPO is used by companies to diversify their equity base.

Circuit Filter

1. Upper Circuit – The maximum price at which a stock is allowed to move upwards.
2. Lower Circuit – The maximum price at which a stock is allowed to move downwards.