How does the share market work?

. 6 min read
How does the share market work?

In case you are scared of investing your hard-earned money in stocks, be assured that you are not the only one. Even though the stock market features a considerable risk due to its volatility, if you are disciplined enough and approach it logically, it is the most efficient and effective method through which an individual can build their net worth. It is a platform where investors come together to purchase and sell their investments or stocks of a public company. But, in order to get the most out of this financial instrument, individuals need to have a basic knowledge about this industry as well as its workings. So, let us take a quick look at some of the essential aspects of the Indian stock market.

What is Stock Exchange?

Secondary markets can be often called stock exchanges where existing share-owners have the opportunity to transact with the buyers. However, one should understand that companies listed on the share market do not sell or buy their own shares. Therefore, when investors buy stocks, they are purchasing it from an existing shareholder and not the company. Likewise, investors sell their shares to another investor instead of the company. There are six well-known stock exchanges among which Bombay Stock Exchange and National Stock Exchange are the most famous ones.

BSE (Bombay Stock Exchange)

Founded in the year 1875 by Premchand Roychand, BSE is the oldest Asian stock exchange. It only consisted of 22 stockbrokers in its initial days who would physically meet to carry out their trading activities. In 1874, BSE was relocated to Dalal Street from where it gained its popularity. Sensex was introduced in 1986 as the first ever equity index that provided a foundation that recognises a total of thirty top trading companies in the exchange spanning over 10 sectors.

In addition to Sensex, some of the other essential indices of BSE include but not limited to BSE Metal, BSE FMCG, BSE Pharma, BSE Auto, BSE PSU, and BSE SMALLCAP. According to recent reports, BSE features a rough market capitalisation of nearly $4.9 trillion. Apart from that, BSE also offers a wide range of services like Central Depository Services Limited (CDSL) depository, risk management, market data services, and likewise.

NSE (National Stock Exchange)

Established in 1992, NSE was the first electronic and completely automated trading system in India that successfully replaced the traditional paper-based settlement system and offered a comparatively easy and hassle-free trading facility. It is the biggest Indian stock exchange in relation to market capitalisation.

A benchmark index of NSE, NIFTY also known as National Fifty features fifty top companies that are involved in trading. Moreover, NSE is also considered as the largest exchange in the world when it comes to the volumes of contracts traded in relation to the derivatives sector. This makes the NSE an exceptionally liquid market compared to BSE.

How are Stock Prices Set?

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The stock of a company is first listed via an IPO (Initial Public Offering) where an investment bank determines the projected and current health and performance of a company to identify the IPO’s value for the business. The IPO can also be determined by comparing a similar company’s IPO or by evaluating the firm’s present net value. When a private company transforms to public, this is the primary factor that determines the company’s initial share price.

However, when it comes to determination of prices on a regular basis, there are certain factors that can be taken into consideration. Some of them are as follows.

  • Demand and Supply

When the trading hours start, the demand and supply of shares largely determine their prices. A company that offers a potential of long-term earnings will attract more buyers which, in turn, increases its share prices. Contrary to that, the poor outlook of a company might attract buyers who want to purchase stocks at a cheaper rate, thus, decreasing the price. Stock prices increase when the number of buyers is more than sellers and the prices fall when the number of sellers are more than buyers. A continuous price rise is called an uptrend while a continuous price fall is termed as a downtrend. Prolonged downtrends form a bear market whereas a prolonged downtrend creates a bull market.

  • Herd Instinct

It refers to the tendency of people in mimicking the trading activities of the majority group. For instance, when many people purchase a particular stock to push its price higher, individuals will also follow this trend assuming the prior group knows something that these individuals might not. The situation of the herd mentality does not have any technical or fundamental support for increasing the price yet investors can be seen buying stocks as they are scared of losing out a great opportunity.

  • Market News

These include economic changes, material company events, political events, and earning reports that can cause temporary or sudden changes in the stock prices. However, every piece of news does not have the potential to affect all types of stocks. For instance, news concerning the companies belonging to the oil and gas industry will go on to have an effect on the stock prices of the said companies.

Trading Procedures in the Stock Market

With the advent of online trading facilities, anyone can trade these days by following a few simple steps. The trading procedures are stated below:

  • Selecting a broker:

Investors can buy and sell stocks in the share market only through brokers who are registered by SEBI as members of the Indian Stock Exchange. These brokers can be corporate bodies, partnership firms, or individuals. Hence, the first thing that an investor needs is to find a broker to carry out trading on their behalf.

  • Opening a demat account:

Indian citizens are required to open a dematerialised account with a depository participant such as stock brokers or banks for trading in the securities listed in the stock exchange. A depository is an organisation or institution that holds securities such as mutual funds, bonds, debentures, and shares. In India, the Central Depository Services Limited and the National Securities Depository Limited are two depositories. The depository only interacts with investors via the depository participants who inform the investors of the holdings’ status regularly.

  • Placing and execution of order:

The investor can now place the order either via the depository participant or the broker via Email, phone call, and likewise. Investors need to specify the name, number, and price range of the security that they want to buy or sell. For example, "buy or sell X number of shares of the Y company at Z price range".

The broker will now carry out the trading order according to the instructions given by the investor. The broker will also create a contract note after executing the order that would include the brokerage charge, along with the other necessary trading details to maintain a transparent and straightforward record of trades.

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Q. How can you learn trading?

A. There are various institutions which offer courses that potential investors can take to gain knowledge about the stock market. Apart from that, people can also read books and online articles and follow the news directly or indirectly related to the stock market to learn different aspects of trading. Investors can even opt for trading in minimum quantities to gain some practical knowledge before starting with their career in the industry.

Q. What does bear and bull markets mean?

A. The bear market refers to those times when the prices of the shares rise because the GDP of the country rises. It provides the investors with the confidence that their stock prices will increase. This in turn makes the investors but more stocks as they want to make a profit out of the price difference. Such optimistic investors are termed as “Bulls” as they always think that the market will rise.

On the other hand, a bear market refers to a falling market because the GDP of the country is falling and the unemployment rate is high. Here there are more sellers compared to buyers as they think a recession is coming. These pessimistic investors want to sell all of their stocks as they are doubtful of the rise in share price. Such investors are called the “Bears”.

Q. What are the Indian stock market timings?

A. The stock market timings of India can be divided into three categories depending on the market. They are as follows,

  • Equity Market: Monday to Friday from 9:15 AM – 03:30 PM
  • Commodity Market: Monday to Friday from 10:00 AM – 11:30 PM
  • Agri-Community Market: Monday to Friday from 10:00 AM – 05:00 PM