Chapter 1.3: HOW DOES SHARE MARKET WORK?

Ask any layman about the share market investing, and they will tell you that they don’t know about stock trading. Yet, the stock market is one of the largest avenues for investment. As many as Rs. 6 lakh crore-worth stocks have been traded in the two stock exchanges in India on some occasions. Stock market investing is often called a gamble. It would cease to be a gamble if you understood the basics of the share market.

HOW SHARE MARKET WORKS:

In the previous section, you were introduced to the different market participants and other share market basics. Let’s try to stitch these narratives together and understand how the stock market works.

How does Share Market Work By Kotak Securities®
  • A stock exchange in the platform where financial instruments like stocks and derivatives are traded. Market participants have to be registered with the stock exchange and SEBI to conduct trades. This includes companies issuing shares, brokers conducting the trades, as well as traders and investors. All of this is regulated by the Securities and Exchange Board of India (SEBI), which makes the rules of conduct.
  • First, a company gets listed in the primary market through an Initial Public Offering (IPO). In its offer document, it lists details about the company, the stocks being issued, and so on. During the listing, the stocks issued in the primary market are allotted to investors who have bid for the same.
How Share Market Works By Kotak Securities®
  • Once listed, the stocks issued can be traded by the investors in the secondary market. This is where most of the trading happens. In this market, buyers and sellers gather to conduct transactions to make profits or cut losses.
  • Stock brokers and brokerage firms are entities registered with the stock exchange. They act as an intermediary between you, as an investor, and the stock exchange.

  • Your broker passes on your buy order to the exchange, which searches for a sell order for the same share. Once a seller and a buyer are fixed, a price is agreed finalized, upon which the exchange communicates to your broker that your order has been confirmed.

    This message is then passed on to you. Even at the broker and exchange levels, there are multiple parties involved in the communication chain like brokerage order department, exchange floor traders, and so on. However, the trading process has become electronic today. This process of matching buyers and sellers is done through computers.
    As a result, the process can be finished within minutes.

    How your order is processed

    How is your Market Order Processed By Kotak Securities®
  • However, there are tens and thousands of investors. It is impossible for all to converge in one location and conduct their trades. This is where stock brokers and brokerage firms play role.
  • Once you place an order to buy a particular share at a said price, it is processed through your broker at the exchange. There are multiple parties involved in the process behind the scenes.

  • Meanwhile, the exchange also confirms the details of the buyers and the sellers to ensure the parties don’t default. It then facilitates the actual transfer of ownership of shares. This process is called settlement. Earlier, it used to take weeks to settle trades.

    Now, this has been brought down to T+2 days. For example, if you conducted a trade today, you will get your shares deposited in your demat account by the day after tomorrow ( i.e. two working day).

  • The exchange ensures that the trade is honoured during the settlement#. Whether the seller has the required stock to sell or not, the buyer will receive his shares. If a settlement is not upheld, the sanctity of the stock market is lost, because it means trades may not be upheld.
  • As and when trades are conducted, share prices change. This is because prices of shares – like any other goods – are dependent on the perceived value. This is reflected in the rise or fall of demand for the stock. As demand for the stock increases, there are more buy orders. This leads to an increase in the price of the stock. So when you see the price of a stock rise, even if it is marginal, it means that someone or many placed buy order(s) for the stock. Larger the volume of trade, greater the fluctuation in the stock’s price.

HOW TO INVEST IN SHARES:

Now that you have understood exactly how the stock market works, you may be wondering how to invest in the market.

How to Invest in Shares By Kotak Securities®

Step 1

First, understand your investment requirements and limitations. Your requirements should take into account the present as well as the future.

The same applies to your limitations. For example, you just got a job and earn Rs. 20,000 a month. Your limitation could be that you need to set aside at least Rs. 10,000 for instalment payments for your car, and another Rs. 5,000 for your monthly expenses.

This leaves aside only Rs. 5,000 for investment purposes. Now, if you are a risk-averse investor, you may prefer to invest a larger portion of this amount in low-risk options like bonds and fixed deposits. This means, you have only a small portion left for stock market investing – Rs. 1,000. Further, take into consideration your tax liabilities.

Remember, making profits on short-term buying and selling of shares incurs capital gains tax. This is not applicable if you sell your shares after a year.

So, ensure that your cash needs don’t force you to sell your shares on short-term unnecessarily. Better to take a wise well-thought decision, than attract unnecessary costs in the future.

Step 2

Once you understand your investment profile, analyse the stock market and decide your investment strategy. Find out which stocks suit your profile. If we continue the above example, with a budget of Rs 1,000, you can either choose to buy one large-cap stock or multiple small-cap stocks. If you need an additional source of income, opt for high-dividend stocks.

If not, opt for growth stocks which are likely to appreciate the most in the future. Deciding the kind of stocks you wish to collect is part of your investment strategy.

Step 3

Wait for the right time. Have you ever seen a cheetah or tiger hunt? They lie low for a while waiting for their prey, and then they pounce. Exactly the same way, time is of utmost importance in the stock market. Merely getting the stock right is not enough. Your profits will be maximised only if you buy at the lowest level possible. The same applies if you are selling your shares. This needs time. Do not be impulsive.

Step 4

Conduct your trade either online or on the phone through your broker. Ensure that your broker confirms the trade and gets all the details right. Recheck the trade confirmation to avoid errors.

Step 5

Monitor your portfolio regularly. The stock market is dynamic. Companies may seem profitable one moment, and not-so profitable the next due to some unforeseen factor. Ensure you regularly read about the companies you have invested in. In the case of some unfortunate situation, this will help you minimize your losses before it is too late.

However, this does not mean you panic every time the stock falls. A stock’s price will fall at some point in time, because there will be some investor in the market with a shorter investment horizon than you. So, he will sell his stock and pocket whatever profits possible in that shorter time. Patience is a key virtue in the markets.

What next?

As we read earlier, you need to invest according to your requirements. There are multiple types of stocks out there. Before you form your investment strategy, read about the different kinds of stocks available click here.

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