A layman’s guide to the stock market
What is the share market? Why does it exist? How does it work? What are its advantages and disadvantages?
What is the Share market?
The stock market, share market or equity market mean the same thing. This is the place where you can sell or buy a company’s shares.
To buy a share of a particular company means buying some percentage or part of the ownership of that company. You become the holder of a percentage of that company. If that company makes a profit, some percentage of that profit would be also be given to you. Similarly, if that company incurs a loss, a percentage of that loss would be borne by you.
Let me tell you an example of this in a small case so that it becomes easy to comprehend.
Assume you have to establish a start-up, you have 50,000 rupees but that’s not enough so you go to a close friend and insist him to invest another 50,000 rupees and in return, you offer him a 50–50 partnership. So, whatever profit your company earns in future will be divided between you and your friend. 50% of it would be yours and the remaining 50% of it would be your friend’s. In this scenario, you have given 50% of the shares to your friend in this company. This thing happens on a prominent scale in share market. The only difference is that instead of turning to your friend, you turn to the entire world and invite them to buy shares in your company
History and role of shares
The origin of share markets dates around 400 years ago. Around the 1600s, there was a Dutch East India Company, like the British East India company. In those times, people used to indulge in a lot of exploration via ships. The entire world map was instantiated then so the companies used to send their ships and men to discover new grounds and trade with faraway places. The journey used to be of over thousands of kilometres aboard a ship and it required a mammoth amount of money. No single individual possessed such immense total of money in those times. So, they publicly invited people to invest money in their ships and when these ships would travel long distances and come back with treasures from other lands, they will share some part of these treasures but this was a very risky affair because, during those times, more than half of the ships miscarry to return. They would either get lost or get broken down or got looted. So, investors realized the risky nature of this enterprise and it is not wise to invest in a single ship. So they preferred to invest in 4–5 of them so that at least one of them had chances of coming back. So, this created a share market. There were open biddings of the ship on their docks. Gradually, this system became prospering 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.
Today, Every country has its stock exchange and every country has become greatly dependent upon the stock market.
What is the Stock Exchange?
The Securities Contract (Regulation) Act, 1956 [SCRA] defines ‘Stock Exchange’ as any body of individuals, whether incorporated or not, constituted to assist, regulate or controlling the business of buying, selling or dealing in securities. Stock exchange could be a regional stock exchange whose area of operation/jurisdiction is specified at the time of its recognition or national exchanges, which are permitted to have nationwide trading since inception.
In laymen terms, Stock exchange is that place, that building where people buy and sell shares of the companies.
The market is disserved into the following two types:-
-The primary market
-The secondary market.
THE PRIMARY MARKET
Primary markets are where the companies sell their shares. The companies decide their share prices as they see fit. Although there are some regulations too, the companies cannot manoeuvre too much because it depends upon the demand. It depends on how much price are the people willing to pay for the company’s shares.
If the value of a company is 10 lakh rupees, it sells 10 lakh of its shares and offers shares at Rs 1 per share. Now, if its demand is high and a lot of people want to buy its shares, the company would be able to sell its shares for a higher price. Nowadays, companies decide upon a range. There’s a minimum price and a maximum price. They sell shares in this predecided range.
How many shares can a company have?
Every share of the company has equal value. It is generally the owners of the company who decides how many of its shares it wants to make. If the total value of the company is 10 lakhs, then it may make 10 lakh shares of Rs. 1 each OR it may make 2 lakh shares of Rs 5 each.
Moreover, 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 and they all can then 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, Mark Zuckerberg has retained 60% of the shares of Facebook.
THE SECONDARY MARKET
The people who have bought the shares of the company can sell it to other people. This is called the secondary market where the citizenry trades i.e. buys or sell shares between themselves and others.
In the Primary Market, the companies set the prices of their shares. The companies are unable to rein the prices of their shares in the secondary market. The share prices vacillate depending upon the demand and supply of the shares.
India’s Stock Exchange
Almost every big country has a 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 that has around 1700 registered companies. With so many countries registered in the stock exchange, if we want to observe, overall, whether the prices of the shares of the companies are moving up or down then some measurements have been put in place which is known as SENSEX and NIFTY.
SENSEX and NIFTY
Sensex shows the average trend of the top thirty companies of the Bombay Stock Exchange. The average indicates if the share of companies is moving up or down. The full form of SENSEX is SENSITIVITY INDEX, displays the same.
The number of Sensex, that it has reached 40000 marks, doesn’t mean a lot. The value of this number can be understood only upon comparison with the past numbers because this number has been randomly decided. It was decided at the beginning that the parameter of the stocks 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 40,000 in the past 50 years. So this shows how far up have the share prices of these 30 companies have risen in these 50 years.
Nifty = National + Fifty
Nifty shows the price fluctuations of the shares of the top 50 companies listed on the National Stock Exchange.
How to sell your company’s shares?
If a company wants to sell its shares on the stock exchange, then this is termed as “public listing”. If a company is selling its shares for the first time, then it is called IPO- Initial Public Offer i.e. Proposing the shares to the public for the very first time.
During the days of the East India Company, it was easier to get this done. Anyone could sell the shares of their company to the public but in current time, this procedure is very long and complicated and so it should be. Because it is easy to scam people, Anyone could get listed on the stock exchange with a fake company and exaggerate the value and achievements of their 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. E.g. Harshad Mehta scam, Satyam scam, Nirav Modi case, they were all the same- fooling the people by getting themselves listed on the stock exchange and collected the money before absconding. So as these scams happened, the stock exchanges realized that there are some loopholes and they need to make their procedures stronger and scam proof. To tackle this issue, the rules were made robust due to which there are very complex rules today.
SEBI — Security and Exchange Board of India is the regulatory authority in India established under Section 3 of the SEBI Act, 1992. SEBI Act, 1992 provides for the establishment of Securities and Exchange Board of India (SEBI) with statutory powers for (a) protecting the interests of investors in securities (b) promoting the development of the securities market and regulating the securities market. They have very strict norms.
How can you buy shares?
Before the dawn of the internet, an individual had to physically go to the Bombay Stock Exchange building to buy or sell stocks. However, with the internet in place you just need three things-
1) A bank account — because you would need your money
2) A trading account — to allow you to trade and invest money in a company
3) A DEMAT account — to store the stocks that you buy in a digital form
Most of the banks today have started offering a 3 in 1 account with all three accounts encompassed within your bank account.
Non-professional investors like us will be called Retail investors i.e. Ordinary people who want to invest in the share market. A retail investor always needs a broker. A broker is someone who brings the buyer and seller of shares together. 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%. This brokerage rate is a disadvantage for people who indulge in a lot of trading of stocks. Some platforms charge a brokerage rate of around 0.05% or 0.01%. If you want to invest for a long term then a high brokerage rate wouldn’t make a lot of difference because you would pay it only once.
TRADING VS INVESTING
Investing and trading are two disparate things. Investing means placing a few sums of money in the share market and letting it stay there for some time.
Trading means quickly placing in money at different places and withdrawing it from other places. This all happens in quick succession.
Trading of 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 i.e. Taking out money from one share and putting it in another and earning profit in the process.
Is share market gambling?
A common question that arises in layman’s mind is whether they should invest money in share market or not. A lot of people compare it with gambling because a lot of risks are involved in it.
In my opinion, it is correct to say so because this is indeed some sort of gambling if you are not aware of the type of company and its performance, the parameters of the company had its financial record if you don’t observe its history and accounting information then, in a way, this is akin to gambling because you would not have the slightest of an idea of how the company would perform in the future. You merely listen to people saying that the company is doing well and we should invest in it in the share market and you invest it. You should never wallow to this because it is extremely risky. And, when there are people that do this job day in and out, for instance, the traders, who are experts in this field and have more knowledge about the stock market would outperform the others because they have an idea of how this system works.
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 entrust the experts and let the experts decide which companies to invest in. A lot of mutual funds invest in many different companies to minimize the chances of loss.
I will talk about mutual funds in-depth in the upcoming blogs!
