Stock Market Basics: Learn What is Share Market and How It Works

What is the stock market in simple words?

The stock market, share market, or equity market- all three mean the same. These are markets where you can buy or sell a company’s shares. Buying shares of a company means buying some percentage of ownership of that company. That is, you become the holder of a percentage of that company. If that company makes a profit, some percentage of that profit would also be given to you If that company book a loss, a percentage of that loss would also be borne by you.

Telling you an example of this on the smallest scale, presume you have to establish a start-up. You have 10,000 rupees, but that’s not enough. So, you go to your friend and tell him to invest another 10,000 rupees and offer him a 50-50 partnership. So, whatever your company profits in the future, 50% of it would be yours. 50% of it would be your friend’s.

In this case, you’ve given 50% of the shares to your friend in this company. The same thing happens on a larger scale in the stock market. The only difference is, instead of going to your friend, you go the entire world and invite them to buy shares in your company.

History and purpose of Shares?

The origin of share markets dates to around 400 years ago. Around the 1600s, there was a Dutch East India Company, like the British East India Company, There was a similar company in the country of Netherlands today, known as the Dutch East India company. In those times, people used to indulge in a lot of exploration using ships.

The entire world map had not yet been discovered So the companies used to send their ships to discover new lands and trade with faraway places. The journey used to be thousands of kilometers aboard a ship. There was a huge amount of money required for this Not one person possessed such amounts of money individually in those times.

So, they publicly invited people to invest money in their ships. When these ships would travel long distances to go to other lands and come back with treasures from there. They were promised a share of these treasures/money eventually. But this was a very risky affair Because, during those times, more than half of the ships failed to come back.

They got lost, broke down, or got looted. Anything could happen to them So investors realized the risky nature of this enterprise, instead of investing in a single ship, they preferred to invest in 5-6 of them So that at least one of them had the chance of coming back. One ship used to approach multiple investors for money So, so this created somewhat of a share market.

What are Docks?

Docks are the places where the ships come out from. There were open biddings of the ships on their docks. Gradually, this system became successful because the money crunch faced by the companies was supplemented by the common people. And the common people got a chance to earn more money. You must have read in the history books about how rich the English East India Company and the Dutch East India company became during those times.

How The Market Works

Today, each country has its own stock exchange and every country has become greatly dependent upon the stock market. The stock exchange is that place, that building where people buy and sell shares of the companies.

The stock market works through a network of exchanges — you may have heard of the New York Stock Exchange or the Nasdaq. Companies list shares of their stock on an exchange through a process called an initial public offering or IPO. Investors purchase those shares, which allows the company to raise money to grow its business. Investors can then buy and sell these stocks among themselves.

How to sell your company shares

If a company wants to sell its shares on the stock exchange, then this is termed a “public listing”. If a company is selling its shares for the first time, then it is called IPO- Initial Public Offering that is, offering the shares to the public for the first time.

During the days of the East India Company, it was very easier to get this done. Anyone could sell the shares of their company to the public. But today, this procedure is very long and complicated, and so it should be. Because think about it, how easy it is to scam the people.

Anyone could get listed on the stock exchange with a fake company, and exaggerate the value and achievements of its company. They could lie to the people and the people would foolishly invest in his company. He then could abscond with the money. So it has become extremely easy to scam somebody. India in its history has been a witness to a lot of scams like these.

For example, the Harshad Mehta scam, and Satyam scam were all the same- fooling the people and getting themselves listed on the stock exchange. Collecting the money and then absconding So as and when these scams happened, the stock exchanges realized that they need to make their procedures stronger and scam-proof.

For this, the resolutions and rules were made stronger due to which there are very complicated rules today.

What is SEBI?

SEBI- Security And Exchange Board of India is a regulatory body that looks into issues like which companies should be listed on the stock exchange and whether it is being done in the proper manner or not. If you want to do this (i.e. get listed), then you would have to fulfill the norms of SEBI. Their norms are very strict, for example,

  • There need to be a lot of checks and balances on the accounting of your company. At least two auditors must have checked your company’s accounting.
  • This entire process may take around 3 years.
  • More than 50 shareholders should be pre-present in the company if you want a company to be publicly listed.
  • When you go to sell their shares but there’s no demand for it amongst people then SEBI can remove your company from the stock market list.

How many shares does a company have?

A point to be noted here is that every share of the company has equal value. It is upon the company to decide how many of its shares it wants to make. If the total value of the company is 1 lakh, then it may make 1 lakh shares of 1 re each, Or it may make 2 lakh shares of 50 paise each.

When companies sell their shares in the share market, it never sells 100% of them. The owner always retains the majority of the shares to keep possession of his decision-making power. If you sell all the shares, then all the buyers of the shares would become owners of the company.

Since they all become owners, they all can take decisions regarding that company. The individual who has more than 50% of the shares would be able to make decisions regarding the company. Therefore the founders of the company prefer to retain more than 50% of the shares.

For example, 60% of the shares of Facebook are retained by Mark Zuckerberg. The people who have bought shares of the company can sell it to other people. This is called the Secondary Market where people buy and sell shares amongst themselves and trade in shares.

In the Primary Market, the companies set the prices of their shares. The companies cannot control the prices of their shares in the secondary market. The share prices fluctuate depending upon the demand and supply of the shares. So the prices of the shares fluctuate depending on the demand and supply.

India Stock exchange?

Almost every big country has its own stock exchange. There are two popular stock exchanges in India.

  • One is the Bombay Stock Exchange which has around 5400 registered companies.
  • The other is the National Stock Exchange which has 1700 registered companies.

With so many countries registered on the stock exchange, If we want to observe, overall, whether the prices of the shares of the companies are moving up or down, How do we view this?

To measure this, some measurements have been put in place- Sensex and Nifty.

What is Sensex?

Sensex shows the average trend of the top thirty companies of the Bombay Stock Exchange averaging out, whether the shares of the companies are moving up or down.

The full form of Sensex, the sensitivity index, displays the same. The number of Sensex has reached 40,000 marks. The number itself means not a lot. The value of this number can be understood only upon comparison with the past numbers Because this number has been randomly decided.

They decided, at the start that the values of the shares of the thirty companies would be this. So we compile all the numbers and then say that it is 500. So, gradually, the Sensex has been rising and it has reached the 40,000 mark in the past 50 years. So this shows how far up have the share prices of these 30 companies gone in these past 50 years.

There is another similar index- NIFTY- National + Fifty Nifty shows the price fluctuations of the shares of the top 50 companies listed on the National Stock Exchange.

How can you invest money in the stock markets?

During the times of the East India Company, one could go to the docks where the ships departed from and indulge in biddings and buy and sell stocks. Before the dawn of the internet, one had to physically go to the Bombay Stock Exchange building to do this.

However, with the internet in place you merely need three things-

1. Bank account

2. Trading account and

3. DEMAT account

A bank account because you would need your money. A trading account, allows you to trade and invest money in a company. A DEMAT account to store the stocks that you buy in a digital form.

Most banks today have started offering a 3 in 1 account with all three accounts encompassed within your bank account. People like us would be called retail investors, that is, common people who want to invest in the stock market. A retail investor always requires a broker. A broker is someone who brings together the buyer and seller.

For us, our brokers could be our banks, a third-party app, or even a platform. When we invest money through brokers in the stock market, a broker retains some money as his commission. This is called “brokerage rate”.

Banks mostly charge a brokerage rate of around 1% But 1% is a little high. That’s not how much it should be If you look properly, you would discover platforms that charge a brokerage rate of around 0.05% or 0.1%.

This brokerage rate is a disadvantage for those who want to indulge in a lot of trading of stocks. If a lot of stocks are bought and sold in a day, a lot of money would be siphoned off as a brokerage fee. But if you want to invest for the long term, then a high brokerage rate wouldn’t make a lot of difference because you’d pay it only once.

Investing vs Trading

Investing and trading are two different things.

  • Investing means putting in some amount of money in the stock market and letting it stay there for some time.
  • Trading means quickly putting in money at different places and withdrawing from some places. This all happens in quick succession.

In fact, trading shares is a job in itself. There are a lot of people in our country who are traders and do this job all day long taking out money from one share and putting it in another taking out from one place, putting it in another, and earning profit in the process.

An important question that arises is whether you should invest money in the share markets?

A lot of people compare it to gambling because there are a lot of risks involved. In my opinion, it is not correct to say so because it is not really any kind of gambling. If you are aware of the type of company and its performance, company parameters, and its financial records, if you observe its history and accounting information properly, then, in a way, it is like a market that operates on calculation.

You merely listen to people saying that the company is doing well and we should invest in it in the share market, so that’s why you invest in it. You should never do this because it is extremely risky. And obviously, when there are people that do this job day in and day out, for example, the traders, who are experts in this field and have more knowledge about the stock market. They obviously would outperform the others because they have an idea of how this all works.

So, in my opinion, you should never directly invest in the share market and instead, rely on the experts.

A very competent form of it is mutual funds Because in mutual funds you don’t directly decide which companies you would invest in. In mutual funds, you place your trust in experts and let the experts decide which companies to invest in. In fact, a lot of mutual funds invest in many different companies to minimize the chances of loss.

For instance, I’ve given the example of the East India company. Investors quickly realized that they should not invest their money in one single ship. Investing money in 5-6 of them would ensure that at least one of them came back. Mutual funds work the same way, investing money in many different places.