What is stock market and how does it work?

A stock market is a place where issuing, buying, and selling of shares or stocks of a company happens. In this post, you can know what is stock market and how stock market works.

First of all, let’s try to understand how stock markets came into existence.  Usually, when a small or medium business wants to grow, it requires money. It has two major sources to raise money.

When a company sells part stake to other investors and raises money, it’s referred to as a company going public, it basically comes to the stock market and issues shares or stocks initially to many people in a process called Initial Public Offering(IPO).

Afterward, the people who got shares keep on trading then among themselves on a platform called stock exchange. For better investing you should be very clear about the basics of the stock market and What is a stock exchange.

Once a company issues shares through an IPO, it becomes a public company, and it gets listed on Stock Exchanges. Exchanges are places where buyers and sellers of stocks meet.

Stock is a word used to express an investor’s ownership in an organization. Those who hold stock are commonly called stockholders or shareholders. As a shareholder, an investor theoretically holds a portion of everything from the organization.

The organization’s profitability tells whether its stock is traded at a higher or lower rate. The latest concept of a stock market began in the late 16th century.

If you want to make wealth over the long term, the stock market is the right option. But before that, let’s try to understand in detail what is stock market and how the stock market works. Most of the wealthiest persons in the world became richer because of the stock market only.

They invested in good companies when they were small, and over time these companies became big. When they became big companies, they gave good profits to their shareholders by sharing profits.

When compared to the last 3 decades, the stocks have given more money when compared to bonds, bank FD, etc. and other asset classes.

To get better profits in the stock market investment we should know two basic things –  How to select good stocks, and How to invest in the stock market. Let’s take a look at these things one by one.

What is Stock?

A stock represents an ownership share in a company. Stocks are nothing but part ownership of the company. Stocks are also called Shares. If a company has a total of 100 shares while formation and you own 5 shares, It means you owned 5% of the company.

Because of buying the stocks or shares, the company will provide you with a piece of company future profits in return for the capital you invested.

But why would the company give away its ownership? When a company needs to raise its capital, it can issue the shares of stock for sale through a process called IPO.  

If investors sell their shares at a higher price than the initial purchase price, they make profits, and if they sell the shares at a lower price than the initial purchase price, they make a loss. Before buying any stocks, Investors should know what is stock market and How the stock market works.

How does Stock Market work?

When an organization gets established in the market, it may require an increase in its services, so in order to do that, it requires huge capital to work. An organization can raise its capital for business needs by the issue of shares for sale in Initial Public Offering(IPO) to the public.

When the organization is issuing its shares to the public for the first time, then it is listed in the IPO. These stocks can be bought in the primary market and then are traded in the secondary market.

What is IPO?

When an organization is issuing its shares to the public for the very first time, then it is known as Initial public offering (IPO). It is the process through which a private company becomes a public company. 

When a company brings an  IPO, They offer to issue shares of their company at a fixed price range and offer investors to invest in IPO. IPO is a direct contract with the organization and the buyer.

The IPO process is carried out in Primary markets, where companies directly issue shares to people who want to invest. If there are 100 shares and 200 people want shares, then the lottery is done and shares are allocated. 

In an IPO, the buyers can purchase the shares from the organization, but to sell the shares, they must wait till the organization is registered on the stock market which is a secondary market.

If once the shares of the organization are sold in an IPO, within a week, the organization gets registered on the stock market. Now when the organization is registered on the stock market, the buyers who have bought the shares in IPO can sell their shares.

The buying and selling of shares can be done with the help of stockbrokers, and it is known as the secondary market. Most share trading can take place in the secondary market.

What is stock Exchange?

In India stock exchange works as a market where stock, bonds, and commodities are the financial instruments. It is a place where buyers and sellers trade with financial tools during the market time of any business day.

The commodity price is determined according to the demand and supply rules. Moreover, people can only trade when the company is listed in the stock exchange.  In India, there are two major stock exchanges.

What is Nifty and SENSEX?

Nifty is the stock market index for National Stock Exchange (NSE) while Sensex is the stock market index for BSE Limited, Nifty consists of 50 stocks whereas SENSEX consists of 30 stocks.

Nifty and Sensex are basically Index which measures the performance of the top 50 companies and the top 30 companies respectively.

If the economy is doing good, most of the top 50 companies from different sectors will be doing good and hence Nifty and Sensex will rise. Nifty and Sensex are also representatives of the economic situation of India

Nifty is determined from the word “National Stock Exchange Fifty”- it consists of top 50 companies of different sectors  that are traded on NSE. NSE was introduced in 1996.

It is maintained by IISL(India Index Services and Products Ltd). If the demand of shares increases, the Nifty goes up, and if the demand decreases, it goes down.

The Sensex is an indicator of the top 30 companies listed on BSE(Bombay Stock Exchange) which is in Bombay.

In BSE there are thousands of companies but to calculate the SENSEX they consider the top 30 companies on the basis of market capitalization, trading history, etc.

If the demand increases, the SENSEX goes up, and if the demand decreases, it goes down.

Different types of stocks

There are 4 different types of stocks in which the common shares and Preference shares are major.

Common Shares

When you buy the stock of a company, you also get voting rights in the decision of the company. Common stock is the stocks with normal voting rights.

It represents ownership in a company to claim the dividend. Investors get one vote per share to elect the board of directors, who manage the major decisions made by management. In IPO, common shares are allocated.

In the long term, a common stock generates higher returns than any other investment. The higher return comes at a cost as common stocks involve the most risk.

The common shareholders will not get money if a company goes bankrupt or liquidates, until the creditors, bondholders, and preferred shareholders are paid.

Preference shares

Preferred stock signifies some sort of ownership in a company but usually doesn’t come with the voting rights, which may vary depending on the company.

Investors are usually guaranteed a fixed dividend forever. It has variable dividends that are never guaranteed. In the case of liquidation, preferred shareholders are paid off before the common shareholder.

The company has the right to purchase the shares from shareholders for any reason at any time. Some people consider the preferred stock as a debt rather than equity.

Common stock can receive variable dividends and have voting rights as most stocks are issued as common.

Preferred stock costs more to buy, but the dividend is fixed forever with higher lender rights than the common shareowner.

What determines the share price?

The stock prices go up or down because of supply and demand. When a stock is considered as desirable due to the recent success of the company, a strong industry sector, or just investor sentiments, then its price goes up.

The most important factor in determining the price of any stock is the future earnings and profits that the company is going to generate.

If a company is expected to do well and earn more profits, investors will ultimately benefit from higher profits in the form of higher dividends.

If investors are hesitating to buy a stock due to the company faltering, a weak industry sector or the price is simply too high, that lack of demand will cause the price to drop.

The price will move low and then reach a point when investors are willing to buy again , and the cycle will start all over again.

Most of the successful investors buy the avoided stocks that still have strong earnings and a good future for a low price and wait for the price to rise.

Benefits of Stock Market Investment

The stock market is one of the most potential places to invest your money. As investing in the stock market is risky; you can either draw huge gains and losses.

An investor can secure your financial position and earn money with the benefits of the stock market investment. Here are some benefits of stock market trading. 

a) Investment gains

You can grow your money by  stock market investment. The stock market tends to increase in value, though the prices of individual stocks rise and fall daily.

Investments in solid companies that are capable of growing can help investors to make profits. If you invest in different stocks, you build your wealth by leveraging growth in different sectors of the economy.

It results in a profit even if some of your individual stocks value losses.

b) Dividend income

Some of the stocks provide income in the form of a dividend and deliver annual returns to investors. These returns are provided even if the stock has lost value and represents income on top of any profits that come from selling the stock.

It can help to fund a retirement or pay for even more investing as you grow your investment portfolio over time. Before learning about the dividend income you should be aware of what is Dividend or dividend meaning.

c) High returns potential

There are hundreds of stocks in stock markets that have generated even 10 to 100 times returns for investors over the long term.

Companies like Infosys, TCS, Granules, etc are examples wherein the long term, investors have been rewarded heavily.

This could not have been possible with any other regular asset class like gold, property, etc 

d) Ownership

Stock Market Investment also produces benefits to become a part of one of the business owners. Share holders vote on corporate board members and certain business decisions.

They also get annual reports which help to learn more about the company. If you own stock in the company you work, it can be a way to show loyalty and balance your personal finances to the success of the business.

How to get started in Stock market

Once you have decided to step into stock markets, the first step is to open a Demat and trading account. Finding best trading account and Demat account is mandatory to buy and sell shares of any companies. You can open a Demat account with India’s largest stockbroker Zerodha.

The next step would be to start learning about how to select good companies for investing in stock markets. You can also go for buying mutual funds instead of directly buying shares if you want to start safely. Read our article on Mutual funds for beginners here 

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