How Does the Stock Market Work?

Last Updated: 9 Dec 2024

A stock market is a platform where you can invest in various financial instruments, including shares, bonds, futures and derivatives. Irrespective of your choice of investment, the stock market is more than equipped to offer you the ideal instrument and immense opportunities to make profits. However, before you enter the stock market, it is wise to understand the functioning of the market to be better equipped to make informed decisions.

The Stock Markets in India

There are two major stock exchanges in India:

• Bombay Stock Exchange (BSE).
• National Stock Exchange (NSE).

Types of Share markets:

There are two types of share markets in the country:

• Primary share market: This is where companies or businesses register themselves and list for the first time. Companies enter the primary share market to raise funds by offering their stocks to the general public. When a company lists itself in the primary share market and offers to sell its shares for the first time, it is known as Initial Public Offering (IPO). Here, you must understand that shares are a physical representation of a small value of the company, and owning the shares means that you are a part-owner of the company in the proportion of the shares you hold.
• Secondary share market: After the company lists in the primary market, the actual trading of a company’s shares occurs in the secondary share market. After a company’s shares are listed on a stock exchange, investors can trade, i.e., sell or purchase the shares through a broker. In the present digital age, you can easily open a Demat Account and a Trading Account, following which you can effectively trade in stock markets via broking platforms.

Who Regulates Stock Markets in India?

The Securities and Exchange Board of India (SEBI) regulates the stock market, the stock exchanges and the Depositories Participants in India. It was constituted in 1992 under the SEBI Act. Along with the overall administrative control of stock markets, SEBI is also entrusted with the role of conducting inspections and formulating rules for the transparent functioning of the stock markets.

Who are Stockbrokers?

Stockbrokers are financial intermediaries who enable you to buy and sell shares by providing the service of opening a Demat account and trading account. For the service, they charge a small brokerage fee. Stockbrokers/brokerage firms are registered with SEBI and act as a link between the investor and stock markets.

How can you Trade in the Stock Market?

Before the advent of the internet, you were required to visit brokers and instruct them for transactions physically. However, with numerous new digital technologies, stockbrokers provide digital trading platforms through which you can trade in just a few clicks. These are:

• Web trading applications
• Terminal software
• Mobile-based apps

How does the Actual Trading Occur?

• After opening a Demat Account and Trading Account, you can use the trading platform to choose an individual stock, specify the number of shares you want to buy or sell and execute the order.
• Once you execute the order, the broker checks whether your account has the requisite funds.
• If there are enough funds, your order is finally executed on the stock exchange. For instance, if you have issued a purchase order, it will be matched with a similar sell order.
• The exchange then confirms the transfer of ownership of shares. You then receive an intimation about the settlement, and the shares start to reflect in your demat account after two working days.

How to Evaluate a Stock Before Investing?

You can evaluate stocks through the following two processes:

• Technical analysis: Technical analysis is the study of chart patterns, graphs and diagrams on a screen. The idea is to understand price and volume trends and pick stocks accordingly. Here, you analyse a slew of factors like moving averages, Relative Strength Index (RSI), etc.
• Fundamental analysis: It is the analysis of factors that explain a company’s real valuation. Here, you analyze some key factors, like Returns on Equity, Earnings Yield, GP Margin, Debt to Equity Ratio, Interest Cover Ratio, Market Capitalization, etc., to have greater clarity regarding stock prices with the assistance of a stock market app.

How are Stock Market Returns Calculated?

Typically, you can use two methodologies to calculate market returns:

• Absolute Return Methodology: Here, variables, including buying price, selling price, returns and return percentage are used to calculate returns.
• Compounded Annual Growth Methodology: Here the returns are calculated based on the overall period. Market experts prefer this methodology over the absolute return methodology.

Key Players in the Stock Market

To learn how share market works, it’s necessary to know its key participants. Four major players in the Indian stock market comprise:

• 1. Securities Exchange Board of India (SEBI): SEBI is the regulatory body that oversees how the share market works. The organisation was set up to protect investors’ interests and ensure that the securities markets operate fairly and transparently. SEBI sets regulatory frameworks that exchanges, companies, brokerages, and other market participants must adhere to, thereby preventing malpractices and ensuring fair trading.
• 2. Stock Exchanges : Stock exchanges are those markets where investors can trade in shares, bonds, and derivatives. The two leading exchanges in India are the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). These exchanges enable trading by providing a well-structured framework where buyers and sellers can meet each other, thereby ensuring liquidity and price discovery.
• 3. Stockbrokers and Brokerages: Intermediaries between customers and the stock exchanges, brokers negotiate buy and sell orders as a service and receive a fee or commission for undertaking the order on behalf of the clients. Brokerages maybe full-service firms offering many services or even discount brokers where they specifically focus on order execution.
• 4. Investors and Traders: Investors buy stocks to seek ownership in companies and usually have long-term visions. Traders, on the other hand, trade equities and sell them to make quick profits based on short-term price movements. Both are required to sustain market liquidity and activity and contribute to a healthy financial ecosystem.

Types of Stockbrokers in India

In India, stockbrokers are mainly categorised into two types: Full-Service Brokers and Discount Brokers.

• Full-service brokers are traditional brokerage firms that offer a wide range of services. These include executing buy and sell orders, offering investment advice, financial planning, portfolio management, and conducting detailed market research. They deliver tailored investment solutions based on individual financial objectives, making them suitable for investors who seek comprehensive guidance on how share market works. However, their extensive service offerings usually come with higher fees.
• On the other hand, Discount Brokers focus on offering fundamental trading services at a lower cost. They usually operate online and do not offer advisory services or extensive support. Discount brokers cater to self-directed investors who know how share market works and who prefer to manage their own trades without significant brokerage fees. Discount brokers offer efficient trading platforms that enable users to execute transactions conveniently.

Ultimately, the choice between a full-service broker and a discount broker will depend upon one’s specific needs, trading preferences, or willingness to pay for additional services.

Why Do People Lose Money in the Stock Market?

There are several important factors that lead to people losing money in the stock market. The first one is not having a strategy and idea how share market works; in the absence of a well-defined plan for purchasing and selling shares, investors may make impulsive choices that result in losses. Meanwhile, risk management can make losses significantly worse, with traders unable to place stop-loss orders suffering huge drops as markets go against them. Getting an idea of these factors along with how share market works will help the investors to make decisions that offer them profits.

What Are the Reasons for a Company Not Listing on a Stock Exchange?

There could be many reasons that a company, that has perfect knowledge of how share market works, is not on stock exchange.

• Listing Involves Higher Regulatory Compliance: Listing subjects the business to strict regulatory compliance such as regular financials and audit requirements which is costly and time consuming. Most organisations like to steer clear of these burdens, so that they can stay highly adaptable in their business model.
• The desire for Privacy: A public company becomes an object of public scrutiny along with scrutiny of shareholders. That is why some businesses lay low and keep their company private for full control of their business and decisions without compromising with others.
• Financial Concerns: Companies facing financial challenges or with limited growth potential may choose to stay private or explore other funding options, such as private equity, instead of going public.
• Market Conditions: If overall market conditions are weak, it becomes less likely that companies want to list due to concerns of being undervalued, not performing well in the stock market.
• Cost Factors: The cost of going public, which includes underwriting fees as well as ongoing costs for remaining compliant often outweigh the benefits forcing firms to dispense with listing altogether.

Conclusion

Thus, the stock market is a place where stocks and securities are electronically traded. The first step before investing in stock markets should be to open a Demat and Trading Account with a reliable financial partner like IIFL. A trusted brokerage platform can provide you with cutting-edge market reports, alongside facilities like brokerage cashback and zero AMC charges for up to one year on your Demat Account.

Frequently Asked Questions

1. How does the share market work step by step?

The answer to the query on how share market works is that it operates through a structured process. First, companies issue shares via an Initial Public Offering (IPO) to raise capital. Once listed, investors can buy and sell these shares on stock exchanges through brokers. Orders are matched based on supply and demand, facilitating transactions in real time.

2. How does the share market give profit?

To understand how you can get profit you need to know how share market works. The share market generates profits primarily through two mechanisms: capital appreciation and dividends. Investors earn capital gains when the price of their shares increases over time. Additionally, some companies distribute a portion of their profits as dividends, providing shareholders with regular income alongside potential price growth.

3. How do stocks make you money?

Stocks make money for investors through capital appreciation and dividends. When stock prices rise, investors can sell their shares for a profit. Many companies pay dividends, which are cash payments made to shareholders from profits, providing a steady income stream in addition to potential gains from selling shares. This offers a basic idea of how share market works.

4. Who controls the stock market?

The stock market is regulated by government bodies, with the Securities and Exchange Board of India (SEBI) being the primary regulator in India. To get an idea of what is stock market and how it works you must know about SEBI. SEBI establishes rules and guidelines to ensure fair trading practices, protect investor interests, and maintain market integrity while overseeing stock exchanges and market participants.

5. Who will decide the share price?

Once you know how share market works you will understand that the share prices are determined by the forces of supply and demand in the market. When more investors want to buy a stock than sell it, prices rise. Conversely, if more people want to sell than buy, prices fall. This dynamic interaction reflects investors’ perceptions of a company’s value and overall market conditions.