How Does Share Market Work?

It is important to access the right platforms for the generation of wealth. Investing in the stock market emerges as a lucrative choice and brings substantial returns over time. But, in order to capture those returns, one must understand how the stock market works. The stock market is an active marketplace where buyers and sellers exchange ownership in companies. It is an eco-system that impacts global economies, company’s landscapes and gives individuals to the ability to engage in wealth creation.

Key Highlights

• Websites where investors buy and sell shares/stocks; there are two major stock exchanges in India - BSE and NSE.

• They are also known as stockbrokers, and they facilitate trade between the market participants who place buy or sell orders.

• Shareholders benefit from dividends and an increasing value in the shares.

Participants In Stock Market

The stock market is a place where investors can buy and sell shares, bonds, and derivatives of similar securities, such as stock options, through exchanges. It acts as a marketplace for buyers and sellers. In order to understand how the stock market works it is important to know the players of the game. There are four participants in the Indian stock market who make an impact for everything that happens

1. Securities Exchange Board of India (SEBI)

SEBI is the regulatory body overseeing India's stock exchanges, which it monitors for fair and efficient functioning. The overall purpose of this organization is to ensure fair play for all involved parties. SEBI, which is an important regulatory authority for exchanges, companies, brokerages and other players in the markets ultimately runs on the guiding principle of protecting the interests of investors with its rules and orders.

2. Stock Exchange

The stock market is where investors can buy and sell shares, bonds and derivatives; markets are venues for such transactions. There are two primary stock exchanges in India.

Bombay Stock Exchange (BSE) - Sensex is its index National Stock Exchange (NSE) - Nifty is its index

3. Stockbrokers and Brokerages

A broker (either a firm or an individual) finds buyers and sellers, while getting a commission/fee for performing that function. These intermediaries are important to the markets as they help ensure smooth trade execution and offer valuable services for investors.

4. Investors and Traders

Shares represent fractions of a company's market capitalisation. Individuals, known as investors, acquire these shares with the intention of becoming partial owners of the company. Investors, through acquisitions of shares, become part of a company in the long term and this has reasons such as performance, dividends and growth rate. Trading involves buying or selling this ownership stake. Unlike investors, traders may be more focused on market trends, price movements, and short-term opportunities to capitalise on fluctuations in stock prices.

Types of Market

To gain insight into the functioning of the Indian stock market, it is important to understand primary and secondary markets.

1. Primary Markets

The primary stock market offers companies the chance to generate capital for their investment needs and fulfil financial obligations. To enter the primary market, a company undergoes an Initial Public Offering (IPO), during which it introduces its shares to the public for the first time. The IPO spans a specific duration, allowing investors to bid for shares at the company's predetermined issue price. Following the subscription period, shares are allocated to successful bidders, marking the company as public since it has distributed its shares to the general public.

2. Secondary Market

The secondary stock market is where a company's shares are traded after their initial offering to the public in the primary market. The secondary market provides a platform for buyers and sellers to execute transactions, contributing to the ongoing liquidity and efficiency of the stock market. The continuous trading activity in this market allows investors to adjust their portfolios, reacting to changes in their investment strategies or market conditions.

Working of Share Market

From primary listings to secondary market transactions, understanding the working of the share market is essential for investors looking to make informed decisions in their wealth-building endeavours. But, how does the stock market work? Let’s find out:

1. Listing in the Primary Market: Initial Steps

• The company embarks on the listing procedure through an Initial Public Offering (IPO).
• A comprehensive document is presented, divulging crucial company and stock details.

2. Stock Allocation Process in the Primary Market

• Stocks issued during the IPO are allocated to investors who placed bids.

3. Transition to the Secondary Market

• Stocks become available for trading in the secondary market.
• The majority of buying and selling transactions unfold in this dynamic market.

4. Individual Participation and Trading Goals

• Individuals actively participate in buying and selling of shares with the aim of making profits or mitigating losses.

5. Intermediaries in Action

• Entities registered with the stock exchange, such as stock brokers and brokerage firms, act as intermediaries.
• Your broker conveys your buy order to the exchange, initiating a search for a corresponding sell order for the same share.

6. Buyer-Seller Matching Process

• The exchange searches for corresponding buy/sell orders for the same stock.
• Identification of a seller and a buyer results in a mutually agreed-upon price

7. Confirmation and Communication Chain

• The exchange informs your broker that your order has been confirmed.
• The broker relays confirmation to you, completing the transaction.

8. Electronic Evolution in Trading

• The trading process, though involving various parties in the communication chain, is predominantly electronic today.
• Computers play a crucial role in swiftly matching buyers and sellers, concluding transactions within minutes.

Steps To Invest in the Indian Stock Market

Here is a step-by-step guide on how to invest in the stock market:

Step 1: The first step is to choose a reputable broker and evaluate their brokerage fees, trading platform, and the services they offer.

Step 2: Open a Demat and trading account. While the Demat account will store your shares electronically, the trading account will allow you to buy and sell shares on the stock exchange.

Step 3: After the completion of the KYC process, your accounts are opened. Now you can fund your trading account.

Step 4: Log in to your trading account from the broker’s app or website to start investing. Select the stock that you want to invest in and the amount you wish to invest based on your financial goals and risk tolerance.

Step 5: Place a market order (buying at the current price) or limit order (buying at a specified price).

Step 6: Execute the purchase order. Once the transaction is processed, the stocks will be credited to your Demat account.

After investing, you must track the performance of the stocks regularly, as this will help you sell underperforming stocks at the right time or invest in high-performing ones.

How To Evaluate a Stock Before Investing?

Before investing your hard-earned money in a stock, there are two key ways to evaluate the stock:

1. Fundamental Analysis

• Understand everything about the company that you wish to invest in, such as the business model, company’s management, current valuation, financials, future growth prospects, etc.
• Compare the company’s performance with peers in the same sector. This will tell you if the company is underperforming or overperforming.
• Analyse the company’s past performance to understand how the management has tackled market fluctuations.
• Check the financial metrics of the company to get an overview of its health and future such as debt-to-equity ratio, return on equity (ROE), net profit margin, market capitalisation, etc.

2. Technical Analysis

• Study stocks and price movements, trends, and volume patterns.
• You can use Relative Strength Index (RSI) and moving averages to study the technical analysis.

Which Are the Fundamental Entities Available in Indian Stock Markets?

With the stock market explained, you must also know the fundamental entities in Indian stock markets. These are:

1. Stock Exchanges: These are the platforms where trading takes place. In India, there are two primary stock exchanges – Bombay Stock Exchange (BSE) and National Stock Exchange (NSE).

2. Market Regulator: SEBI is the market regulator that ensures the stock markets in India work efficiently and transparently.

3. Primary and Secondary Markets: In the primary market, companies issue IPO to the public for the first time. The secondary market is where existing securities are traded.

4. Investors and Traders: These entities buy and sell securities.

5. Stockbrokers and Brokerages: These are registered intermediaries who execute purchase and sale orders on behalf of investors. They charge a brokerage fee or a commission.

Myths About Stock Market

Myth 1: Stock market is the same as gambling.

Fact: Not at all. Investing in stock market requires research about the company you are planning to invest in, its performance, financials, growth prospects, and market trends. Gambling is pure luck and doesn’t require any research or analysis.

Myth 2: You need a lot of money to invest in stock market.

Fact: The fact is that you can start with as little as ₹500 and don’t need a fat wallet to begin investing. What’s more important is financial discipline. If you regularly invest smaller amounts over a long period of time, you will be surprised to see the returns due to the power of compounding.

Myth 3: You have to trade frequently to earn good returns.

Fact: By doing a thorough research and investing in the right stock, you can earn good profits. So, it is not necessary to buy a number of stocks, rather focus on buying a few high-performing stocks.

Myth 4: If a stock is falling, it will eventually rise or vice-versa.

Fact: There can be multiple reasons for the stock prices to fall or rise. You have to analyse the reasons and not go by hearsay. Resist buying stocks whose prices are falling assuming it will eventually rise.

Myth 5: Stock market always gives quick profits.

Fact: When you invest in the stock market, you must have the patience to wait for profits because the market gives good returns over time, not overnight.

Myth 6: Stock market is only for experts.

Fact: Anybody with proper knowledge can invest and earn decent returns. So, it’s not limited to only those who have expertise in trading and the stock market.

Myth 7: Dividends from stocks are guaranteed.

Fact: Not all companies pay dividends. Some reinvest the profits for growth and expansion instead of distributing to investors.

Myth 8: Trading in stocks with low P/E (Price-to-Earning) ratios is safe.

Fact: P/E ratio indicates whether a stock is undervalued or overvalued. There may be a good reason why the stock is trading cheap. So, you must consider the growth prospects of the company, operational revenue, product launch (if any), debt structure, peer comparison, management, etc. 

Myth 9: Stock market is risky.

Fact: This depends on your investment style, where and how you invest. While short-term trading is considered risky, long-term diversified investing is one of the safest ways to grow wealth.

Myth 10: Investing is too complicated for the common man.

Fact: Though investing may seem daunting initially, it's not rocket science. With the wealth of information and resources available today, anyone can learn the basics of investment and start building wealth for the future. Online courses, books, and reputable financial websites can help to expand your knowledge and gain the confidence to make informed investment decisions.

Example of How Does Share Market work?

When you purchase a stock today, the credit is processed by the end of the day. The stock exchange ensures the trade of stocks is honoured during the settlement process. If the settlement cycle extends beyond T+2 days, it jeopardises the integrity of the stock market as it implies that trades may not be upheld.

Stockbrokers uniquely identify their clients through an assigned investor code. Following an investor's transaction, the stockbroker issues a contract note containing details of the trade, including the time and date.

In addition to the stock's purchase price, investors are obligated to pay brokerage fees, stamp duty and securities transaction tax. For sale transactions, these costs are deducted from the sale proceeds, and the remaining amount is disbursed to the investor.

Both at the broker and stock exchange levels, multiple entities/parties, such as the brokerage order department and exchange floor traders, are involved in the communication chain.

Conclusion

The share market is a vibrant ecosystem, and understanding its working mechanism empowers investors to make informed decisions. From primary listings to secondary market transactions, participants in the share market play integral roles in shaping the financial landscape and contributing to the overall efficiency of this vital economic engine.