What is Equity Market and How It Works?

Understanding an Equity

Equity consists of funds that shareholders invest in a company plus a certain amount of profit earned by them that is retained by the company for further growth and expansion. Equity is a primary asset class when it comes to investing and diversifying one’s portfolio. Additionally, derivatives allow equity to diversify beyond just shares into securities such as bonds, commodities and currencies. Equities and their derivatives are traded on stock exchanges like BSE, NSE, NYSE etc.

What is ‘Growth’ in the Equity Market? 

Growth in the stock market refers to an appreciation in the value of a company’s stock. Following the growth strategy of investing, investors bid for growth stocks issued by small businesses with the potential for higher growth in percentage terms. These companies typically reinvest their profits into expanding their businesses, leading to potential capital appreciation and higher stock prices over time.

Types of Equities

Several of the most prevalent forms of equity include the following:

Common stock

Corporations, both public and private, can issue ordinary shares, and common shareholders are the owners of a firm who give the first equity money required to launch the business. Common stock ownership in a public firm has several advantages for investors. Several of its primary advantages include the following:

• Appreciation of capital
• Dividends
• Voting rights
• Marketability (i.e. ease with which shares can be purchased or sold)

There are a few disadvantages to owning common stock. While common shareholders control a portion of the corporation, they are in a relatively weak position, as senior creditors, bondholders, and preferred shareholders all have first rights on its revenues and assets. While bondholders are guaranteed interest payments, dividends are paid to shareholders at the discretion of the company’s directors.

Preferential stock

Preferred stock is a category of capital stock that entitles stockholders typically to fixed dividends before common stock and to a stated dollar value per share in the case of liquidation. If a business’s ability to pay interest and dividends deteriorates due to weak earnings, preferred shareholders are better protected than common shareholders but worse off than creditors. Preferred shares are available in various configurations, including convertible, retractable, and variable-rate preferred shares. One disadvantage of preferred shares is that the majority of them are non-voting. However, when a specified number of preferred dividends is withheld, preferred shareholders typically receive voting rights.

Additional paid-in capital

Additional paid-in capital (APIC) is an accounting term that refers to money an investor pays more than a stock’s par value. APIC, which is frequently referred to as “contributed capital over par,” occurs when an investor purchases newly issued shares directly from a corporation during the company’s initial public offering (IPO). APIC, which is categorised on a balance sheet under shareholder equity (SE), is considered a profit potential for businesses because it results in excess cash from stockholders.

Treasury stock

Treasury stock, also known as treasury shares or reacquired stock, is previously issued stock that the issuing corporation buys back from stockholders. As a result, the overall number of available market shares decreases. These shares have been issued but are no longer outstanding and are not considered in dividend distribution or earnings per share calculations (EPS).

Other comprehensive income/loss accumulated

Subtracting net income received from overall gains and losses on the income statement basically gives us those incomes or expenses that are yet to be realised/recognised but have been accounted for in the income statement. This value is called Other Comprehensive Income (OCI). Since they are a part of the overall financial health of the company, investors should take them into consideration for assessing their potential investments.

Retained Earnings

Earnings retained are a critical subject in accounting. The word refers to the previous profits of a company, less any dividends paid in the past. The term “retained” refers to the corporation retained earnings rather than distributed to shareholders as dividends. As a result, retained earnings decline when a business incurs a loss or pays dividends but grow when new profits are generated.

How Do Equity Markets Work? 

The stock market comprises the stock exchanges, brokers, companies, investors, and regulatory bodies. The stock market provides companies with easy access to capital. The stock market acts as a marketplace that provides a platform for buyers and sellers to trade bonds, shares, and derivatives. 

For any beginner wishing to enter the stock market, it is important to understand how the market works. Here are some of the primary activities that happen in the stock market. 

Listing: It is important for companies to list on the stock market to raise capital from the public. A company decides to go public by issuing shares of stock. These shares represent ownership in the company and entitle shareholders to a portion of its profits and a say in corporate matters. To get listed on a public stock exchange, the company conducts an Initial Public Offering or IPO, offering its shares to the public for the first time. Investors may purchase these shares through underwriters, investment banks, or brokerages.

Secondary Market: After the IPO, the company’s shares trade on secondary markets such as the NSE and BSE. These markets facilitate the buying and selling of existing shares among investors. In the secondary market, stock prices are influenced by factors like company performance, economic conditions, and news.

Investor Participation: Various types of investors participate, including individuals, institutional investors (mutual funds, pension funds), and high-frequency traders, with the primary objective of making a profit. 

Regulation: Equity markets are regulated by government authorities to ensure fairness and transparency. Regulations include disclosure requirements, trading rules, and mechanisms to prevent fraud.

Market Indices: Indices like the NIFTY50 and SENSEX track the performance of groups of stocks, providing benchmarks for market performance.

Dividends and Capital Gains: Investors may receive dividends (profits distributed by companies) and realise capital gains when they sell shares at a higher price than they purchased them.

Information Flow: Market participants rely on information from financial reports, news, and analysis to make informed investment decisions.

Top Stock Exchanges in the Indian Equity Market 

India has two major stock exchanges: the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). The Bombay Stock Exchange is the oldest stock exchange in India and Asia, having started in 1875. Meanwhile, NSE is one of the largest stock exchanges in the world.

What are the Timings of the Equity Market? 

Following is the timing for trading on stock exchanges in India. The stock market in India remains open from 9:15 a.m. to 3:30 p.m. (Indian Standard Time) from Monday to Friday. The pre-opening session starts at 8:45 a.m. The closing happens from 3:30 p.m. to 4:00 p.m.

During the pre-opening session from 9:00 a.m. to 9:15 a.m., traders can place advance orders to buy and sell securities. 

What is the Difference Between Stock and Equity? 

Stock and equity are often used interchangeably, but they have distinct meanings in the world of finance. A stock represents a tradeable unit of ownership in a specific company and is also referred to as a “share” or “equity share.” When you purchase stock, you become a shareholder in that company, which means you have a claim on its assets and earnings. Stocks can be traded on stock exchanges, and their prices can fluctuate based on supply and demand, as well as the company’s performance and market sentiment. “Equity” in a broader sense refers to an ownership interest in a company, regardless of whether the company is listed or not. Equity can include stocks, preferred stocks, and other forms of ownership.

How Can You Trade in Equity? 

In India, you must invest in the stock market through an intermediary, such as a stockbroker, along with a depository. The process to trade in the stock market involves the following steps:

1. Open an Account: Sign up for a brokerage account. You’ll need to provide personal information and financial details.
2. Fund Your Account: Deposit funds into your brokerage account. The amount you deposit determines your buying power.
3. Research: Before trading, research the companies and stocks you’re interested in. Analyse financial statements, news, and market trends to make informed decisions.
4. Place Orders:  You can adopt a trading style that suits you. You can buy or sell stocks using different types of orders, including market orders (buy/sell at current market price) and limit orders (set a specific price to buy/sell). 
5. Monitor Your Investments: Keep track of your portfolio’s performance, market news, and any corporate developments related to your holdings.’
6. Risk Management: Establish a risk management strategy, such as setting stop-loss orders to limit potential losses.
7. Diversify: Avoid putting all your capital into a single stock. Diversify your investments across various companies and sectors to spread risk.
8. Stay Informed: Continuously educate yourself about the stock market and economic conditions. Stay updated on your investments and be prepared to adapt your strategy as needed.

How Can You Do Equity Trading Online? 

Nowadays, you can execute trades directly through an online trading platform. An online trading platform is a trading environment provided by your broker. When you open a Demat account, you will be given access credentials to your online trading account, through which you can place buy or sell orders, monitor your portfolio, track the performance of your investment, and access the market 24*7. 

These are the steps to follow to trade equities online: 

1. Select a Brokerage: Start by choosing an online brokerage that suits your needs. Look for low fees, a user-friendly platform, and research tools.
2. Open an Account: Sign up for an account with your chosen brokerage. You’ll need to provide personal information and may need to verify your identity.
3. Research: Conduct thorough research on the stocks you want to trade. Analyse financial reports, follow market news, and use research tools provided by your brokerage.
4. Understand the Trading Platform: Familiarise yourself with the brokerage’s trading platform or mobile app. Learn how to place various types of orders, such as market orders and limit orders.
5. Execute Trades: Use the trading platform to buy or sell stocks. Specify the stock symbol, quantity, and type of order. Execute trades when you’re ready.
6. Stay Informed: Stay updated on market trends, economic news, and any changes in your investments. Continuously educate yourself about the stock market.

Factors to Consider Before Trading in Equity 

Following are the factors to consider before you start trading in equities.

1. Risk Tolerance: Assess your risk tolerance level. Understand that the stock market can be volatile, and prices can fluctuate significantly. Determine how much risk you are comfortable with and tailor your investment strategy accordingly.
2. Investment Goals: Define your investment goals and time horizon. Are you looking for short-term gains or long-term wealth accumulation? Your goals will influence the types of stocks you choose, your trading frequency, and your exit strategy.
3. Financial Situation: Take an honest look at your financial situation. Consider factors such as your income, savings, and debt. Ensure you have an emergency fund and allocate only disposable income to equity trading. Avoid investing money you cannot afford to lose.
4. Avoid emotional biases: Never make any trading decision swayed by emotion, like fear or greed. Study the current market trend, research each stock, and avoid contrarian bets if you are not absolutely certain.  
5. Diversification: Diversify your portfolio to spread risk. Don’t put all your capital into a single stock or sector. A diversified portfolio can help mitigate losses when one investment underperforms. Consider investing in different industries, asset classes, or geographic regions.
6. Research and Education: Stay informed about market news and economic indicators. Understand the companies you’re investing in, their financial health, and industry trends. Continuous learning and staying up-to-date can help you make informed decisions and adapt to changing market conditions.

What Are the Pros and Cons of Trading in the Equity Market?

Pros of Trading in the Equity Market

1. Potential for High Returns: Equity markets have historically offered the potential for significant returns over the long term. Investors can benefit from capital appreciation as stock prices rise, and some stocks also provide dividends, offering additional income.
2. Liquidity: Equity markets are highly liquid, allowing investors to buy and sell shares relatively quickly. This liquidity makes it easy to enter and exit positions, providing flexibility in managing your portfolio.
3. Diversification: Investing in stocks allows for diversification, spreading risk across different companies, sectors, and industries. Diversified portfolios are less susceptible to the poor performance of a single investment.

Cons of Trading in the Equity Market:

1. Risk and Volatility: The equity market is inherently volatile, subject to daily price fluctuations influenced by various factors, including economic conditions, geopolitical events, and market sentiment. This volatility can lead to substantial losses, especially for short-term traders.
2. Lack of Guarantees: Unlike some fixed-income investments, there are no guarantees of principal or returns in the equity market. Stocks can lose value, and investors may not recover their initial investment.
3. Time and Research: Successful equity trading requires time-consuming research and ongoing monitoring. Investors must stay informed about market trends, company news, and economic indicators. Without adequate research, making informed investment decisions becomes challenging.

FAQs

How Can I Invest in the Equity Market?

To invest in the equity market, you need to open a brokerage account with a financial institution or online brokerage. After funding your account, you can buy and sell stocks through the brokerage’s trading platform.

Are equity and share the same?

Yes, in financial terms, “equity” and “share” both represent ownership interests in a corporation. However, equity is a much broader term that represents ownership stakes in a company.

What Are the Risks Associated with Equity Market Investing?

Equity market investments are subject to various risks, including market volatility, company-specific risks, economic downturns, and geopolitical events. Stock prices can fluctuate significantly, and investors may lose some or all of their investment.

What is a simple trading strategy for beginners?

Beginners can consider starting with swing trading. However, it is important to understand that all types of trading involve risks. Hence, traders should educate themselves and research the stocks before trading.

What is a safe trading strategy?

You may choose your trading style depending on your investment goals and the amount of time you are ready to invest in the market. However, if you are a beginner, A safe trading strategy is to focus on long-term investing.