What Is Stock Exchange?

Stock exchanges are the pillars of the stock market and indirectly the market for equity funds. Their efficiency, transparency and integrity ensures the stability of a major chunk of the financial system. Let us see the major features of stock exchanges, especially in India.

Overview:

When a company is raising capital to finance its operations, it has two major options – sell a share of its company to an investor or take on debt from banks or other institutions or individuals. Many choose the former path as they do not have to give away cash right away in the early months or years of the business.

There are two ways in which a company can sell its share(s). First, it can ask for equity-based investment from an investor (an angel investor or a venture capitalist).

This would be an over-the-counter or OTC transaction, i.e. done privately, sometimes through a broker. Second, once the company has amassed a certain level of capital, net worth or valuation, it can get onboarded to a stock exchange, where the general public can buy and sell its shares (or stocks) easily. A company is said to go public when its stocks get listed as tradable stocks on the stock exchange.

Basics of Stock Exchange

A stock market is a platform where shares of companies can be bought and sold by both institutional investors as well as the general public. The stocks of only those companies that are listed on the exchange can have their shares traded on the exchange. Despite its name, it can be a place where not only stocks but also bonds and derivatives on equity, currency or commodity can be traded.

Modern stock exchanges operate via electronic order book i.e. the placing and execution of all orders take place through an electronic medium. Therefore, the orders placed by investors are matched with the available share prices – when they match, the trade is executed.

As such, investors can invest in listed shares via a broker who gives the investor the platform as well as advice on which assets to buy. However, the investors can also trade in those shares directly via a trading member of the stock exchange using the DMA or direct market access feature of the stock exchange.

How does the Stock Exchange work?

In the Indian stock exchange, autonomy prevails, devoid of “market makers” or “specialists.” Trading operates independently, relying on an electronic limit order book, ensuring a seamless and transparent process. Within this framework, trading computers automatically match orders, aligning investors’ market orders with suitable limit orders. This order-driven market fosters transparency by publicly displaying all market orders. Brokers assume a pivotal role in the stock exchange, serving as intermediaries for all placed orders. 

Through Direct Market Access (DMA), the trading system serves both retail clients and institutional investors. Through the use of trading terminals provided by stock exchange brokers, investors are able to make orders effectively and obtain direct access to the trading system. This structure emphasises transparency, accessibility, and efficiency in India’s stock exchange, promoting a dynamic and inclusive trading environment for a diverse range of participants.

Which companies can get listed?

In order to get listed, a company has to maintain a certain level of valuation and profitability as mandated by SEBI. Without meeting those SEBI criteria, their application for IPO would be rejected. In addition to the criteria set by SEBI, there can be other criteria set by the stock exchanges such as NSE – these need to be met as well and only then will the stock get listed.

Benefits of stock exchange

The following are some of the reasons why stock exchanges exist –

1. Protection of investor and corporate interests –

   Stock exchanges being centralised platforms, the regulation of transactions are much easier to implement if those transactions are conducted through the stock exchange. For example, ensuring that margins in stock trading are paid in time would be next to impossible in a decentralised share-trading system. This would have led to a lack of trust among both investors and corporates, leading to higher transaction costs for everyone as well as unnecessary delays and litigations.

2. Efficient trading of shares –

   Stock exchanges offer higher liquidity to investors as they can easily buy and sell shares on the stock exchange platform than in a decentralised system. Moreover, because liquidity is high and the information related to the stock is publicly and equitably distributed, the price at which the stock is traded is also a fair price (not a negotiated one).

3. Efficient dissemination of information –

   Stock exchanges allow and sometimes mandate easier dissemination of information related to prices of shares and the volumes traded. The huge amount of data generated by the centralised platform allows stockbrokers and investors to trade shares with better knowledge and react to big and small events quickly and effectively. The infrastructure provided by the stock exchange also helps the companies to track their share price and take appropriate action in time.

4. Easier access to capital –

   Getting listed on a stock exchange allows companies to raise capital without having to spend time and resources pitching their stock to individual investors.

5. Less dependency on a handful of investors –

   No single investor can exert too much control over the company’s stock price as publicly listed stocks are more dependent on market demand and supply.

6. Enhanced reputation –

   Sometimes, a lesser known company can gain a lot of reputation by getting listed on a stock exchange. This in turn can help it gain greater market cap more easily. Furthermore, it can use its publicly listed stocks as collateral for availing large loans from financial institutions.

Primary vs secondary market

a. Primary Market:

• New securities are issued directly to investors.
• Companies raise capital by selling stocks or bonds for the first time.
• Investors buy shares from the issuing company by subscribing to IPOs.

b. Secondary Market:

• Previously issued securities are traded among investors.
• No new capital goes to the issuing company.
• Investors buy and sell existing securities, setting prices through supply and demand.
• Stock exchanges (e.g., NSE, BSE) are common platforms for secondary market transactions.
• SEBI (Securities and Exchange Board of India) regulates secondary market activities, ensuring transparency and investor protection.

Types of stock exchange

Various methodologies govern the organisation of trading on stock exchanges, showcasing diverse structures:

• Auction Markets: In this market structure, security prices are set by the highest bids from buyers and the lowest requests from sellers. The dealer is responsible for submitting bids, providing information, and, ultimately, executing deals on behalf of their customers. The dynamics involve negotiation, where buyers seek the lowest possible bid, and sellers aim for the most favourable offer available.
• Dealer Markets: Contrasting auction markets, dealer markets witness dealers publicly stating the prices at which they are willing to buy or sell specific stocks. Dealers facilitate transactions by utilising their own funds to buy and sell securities, injecting liquidity into the stock market. In this context, a dealer might acquire a stock without an immediate buyer, offering a swift transaction process.
• Digital exchanges go beyond traditional trading venues by using technology to link buyers and sellers in an online marketplace. The majority of stock exchanges now use automated ECNs, indicating that electronic trading is widely adopted. These systems enable the seamless execution of buy and sell orders for equities, removing the need for market makers and reducing reliance on physical trading floors.
• OTC Exchanges: These exchanges provide an avenue for purchasing or promoting securities out of primary stock exchanges, typically via broker-dealer networks. OTC buying and selling is not unusual for smaller companies or penny shares that won’t meet the over-the-counter list necessities of major exchanges. additionally, bonds can be traded over the counter, expanding the over-the-counter scope of financial units traded past conventional inventory exchanges.

Major Stock Exchanges in India 

The Bombay Stock Exchange (BSE) is the oldest stock exchange not only in India but also in Asia, formed in 1875. However, in terms of the volumes traded, the National Stock Exchange (NSE) is the leading stock exchange of the country right now and is also located in Mumbai. Both are companies which have a component of private ownership.

As of 2022, nearly 45% of NSE and 18% of BSE are actually held by foreign investors. However, LIC is still the single largest owner of both the companies. Individuals hold a stake of 50.9% of BSE while that number for NSE is 10.4%.

Recently in 2017, the Ministry of Finance also started the India International Exchange in IFSC, GIFT City, Gujarat. It is India’s first international stock exchange and it claims to also be the fastest stock exchange in the world.

The entire framework and execution of the stock market in India is regulated by the SEBI (Securities and Exchange Board of India) and the guidelines set by it. SEBI is the regulator of the securities market in India as per the Securities and Exchange Board of India Act, 1992.

There are other smaller stock exchanges in India such as the Metropolitan Stock Exchange of India and the Calcutta Stock Exchange – however, these exchanges are either defunct or have a far lower level of traffic than the BSE and NSE. There were some regional stock exchanges as well which have eventually amalgamated or ended.

Apart from stock exchanges, there are commodity exchanges in India too like MCX, NCDEX,IEX etc. which allow trading in commodities like bullion, metals, energy etc.

Global Stock Exchanges

Globally there are much larger stock exchanges than BSE or NSE – they have stocks of many more multinational companies trading on them. The top global stock exchanges as per their market cap include –

1. Hong Kong Stock Exchange
2. NASDAQ
3. New York Stock Exchange
4. Shanghai Stock Exchange
5. European New Exchange Technology (EURONEXT)
6. Tokyo Stock Exchange
7. Shenzhen Stock Exchange
8. London Stock Exchange
9. Bombay Stock Exchange
10. Toronto Stock Exchange

Conclusion

Now that you understand the system based on which the entire stock market ecosystem works in India and the world, try taking some time and money out to invest in the stock market for yourself. Open demat account with Angel One, India’s trusted trading platform and broker.

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