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The stock market is where investors can trade in different financial instruments, such as shares, bonds and derivatives. The stock exchange is a mediator that allows buying/selling of shares.
In India, the two primary stock exchanges are the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE). These stock exchanges facilitate two markets - primary, where companies list their shares for the first time and secondary, where investors buy or sell shares of the already listed companies.
Key Takeaways
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The BSE and NSE run the Indian stock market, which is overseen by SEBI to protect investors and maintain transparency.
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The primary market, which includes IPO listings, and the secondary market, which consists of regular buying and selling, are facilitated by these exchanges.
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Demand-supply dynamics, business performance, and general economic factors all influence the prices of the stock listed on these exchanges.
Participants of the Stock Market
The stock market brings together several major entities that facilitate the seamless and transparent trading of financial products. The stock exchange serves as a central platform for all participants, ensuring that each deal is completed in a regulated, efficient, and safe setting. The major entities consist of:
Securities and Exchange Board of India (SEBI)
SEBI is the market regulator whose primary job is to ensure the Indian stock market functions smoothly with transparency, so that general investors can invest without worries. Exchanges, companies, brokerages, and other participants are all needed to abide by the guidelines laid down by SEBI.
Stockbrokers
Stockbrokers are the members of exchanges. They are the intermediaries who execute the buy and sell instructions from investors in exchange for fees. In the Indian setup, investors need to trade through broking houses/brokers, who act as facilitators.
Investors and traders
There are two types of players in the market – investors and traders. Investors buy company shares to hold them for the long-run and generate a source of income from it. Traders are the opposite of investors and get involved in buying and selling of equities.
Investors are motivated by company performance, long-term growth opportunities, dividend payouts, and other such factors. Traders, in contrast, are influenced by price movement and demand and supply factors.
Trading in the stock market is a process of matching the buyer to the seller. Your broker passes on your buying request to the stock exchange, which then compares it with a seller. Once the trade is fixed and the price agreed, the exchange informs your broker about it, and the transaction takes place. The stock exchange also confirms information regarding the buyer and the seller so that parties don’t default. The actual transfer of stocks then takes place to complete trading. Earlier, the process took days, but digitisation helped reduce the time to T+1, that is, within one day of the transaction.
How Primary and Secondary Markets Work in the Stock Market? [H2]
To understand how the stock market functions, it’s essential to know the two key segments where securities are issued and traded: the Primary Market and the Secondary Market. They form the backbone of capital formation and liquidity in the financial system .
Primary Market
The primary market allows companies to raise capital by issuing new shares through an Initial Public Offering (IPO). During an IPO, investors subscribe to shares at a set price within a fixed period.
After allotment, the company becomes publicly listed and can use the funds for expansion or debt repayment. Companies must disclose financial and operational details as per SEBI’s regulations to ensure transparency.
Secondary Market
After shares are listed, they begin trading in the secondary market, where investors buy and sell securities among themselves. This market provides liquidity, enabling shareholders to exit or re-enter positions as per their financial goals.
Prices in the secondary market are driven by demand and supply dynamics, investor sentiment, company performance, and broader economic conditions. The continuous trading of shares in this market ensures efficient price discovery and reflects the overall health of the economy.
Trading in the Stock Market
Shares of a company can be traded in the secondary market after it is listed through registered brokers who act as intermediaries between investors and the stock exchange. When a buy or sell order is placed, the exchange immediately looks for a counterorder that matches, completes the trade, and instantly notifies both parties.
Share ownership is transferred during the settlement cycle, which is currently T+1, which means that trades are completed in one working day. A contract note outlining trade specifics like price, quantity, and time is given to investors.
Charges like brokerage, stamp duty, Securities Transaction Tax (STT), and GST apply. These ensure transparency and smooth execution, maintaining the trust and efficiency of India’s stock market system.
Understanding the Pricing Mechanism in the Stock Market [H2]
The price of stocks in the market is driven by demand and supply factors. A company’s share price depends partially on its market capitalisation value, which is the total of a company's stock price multiplied by the number of outstanding stock.
The last selling price becomes the new asking price in the market. Say you want to buy 100 shares of company XYZ, and the previous closing price was Rs 40. The value of the shares is Rs 4,000 (40*100).
Another way to estimate a stock’s fair value is through the Discounted Cash Flow (DCF) approach. This method evaluates what a company is worth today based on the cash flow it is expected to generate in the future, adjusted for the time value of money.
Stock exchanges also group companies into large-cap, mid-cap, and small-cap categories and track them through major indices such as Nifty and Sensex. These indices reflect the overall market trend.
Finally, the bid-ask spread, which is the difference between the buyer’s bid price and the seller’s ask price, determines the final trading price when both sides agree on a value.
Steps to Invest in the Indian Stock Market
To invest in stock market India, companies first file a draft offer document with SEBI containing key details about their business and financials. On SEBI's approval, the company offers its shares to investors through an IPO on the primary market.
Shares are then issued and allotted to investors who participate in the IPO. Once listed on the exchange, these shares become available for trading in the secondary market.
When investors place buy or sell instructions, registered brokers execute these orders on the stock exchange. Once a buyer and seller are matched, the trade is completed, and ownership of shares is transferred seamlessly through the exchange’s settlement system.
Types of Stockbrokers in India
India has mainly two major types of stockbrokers– Full-service brokers and Discount brokers.
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Full-service brokers are the traditional brokers who provide a wide variety of services ranging from buying and selling of shares, investment advice, financial planning, portfolio updates, share market research and analysis, retirement and tax planning, and more. These brokers will offer you personalised investment services with individualised recommendations to suit your needs and financial goals.
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Discount brokers are online brokers who offer no-frill stockbroking accounts. They are known for providing the necessary trading facility at the least possible cost but no personalised services.
Important Concepts to Know
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Moving averages – Derived from stock history, they show the general trajectory of a stock and where it is likely to be headed.
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Business cycle – This cycle follows an emotional cycle wherein market fear follows market greed, followed by fear again. The best time to buy stocks is when fear is at its peak, which is when the economy is in a recession, and it is possible to buy stocks at low prices. Conversely, when the economy booms, the prices of stocks soar and allow traders to cash in, realising gains should they sell their shares.
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Diversification – Investing in a wide variety of stocks spread over diverse sectors, is ideal as it cushions traders against inevitable market setbacks and reduces volatility.
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Price of a stock – Stocks shouldn’t be viewed and bought based on their price alone. Consider whether it is overpriced or underpriced as well as other issues such as the condition of the economy or the sector.
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Traders must know the sort of buy or sell order they enter into which can be restricted by price or time frames - Limit orders are those orders which are only carried out by stockbrokers provided the price matches what the trader wishes them to be. Stop-loss orders are given to stockbrokers by traders to prevent a big drop in the value of their stocks.
A Few More Things to Know Before Investing:
Budgeting
The first step in your financial planning is budgeting - a process for tracking, planning, and controlling the inflow and outflow of your income. It entails identifying all the sources of income and taking into account all current and future expenses, intending to meet your financial goals.
Inflation Effects on Investment
As the prices of goods and services increase, the value of the rupee goes down. Real return is the difference between nominal return and inflation.
Risk and Return
Usually higher the risk, higher the maximum returns and vice versa. Risk can be defined as the probability or likelihood of occurrence of losses relative to the expected return on any particular investment. Learn how to analyze risk and returns while investing here.
Power of Compounding
Compounding is the ability of an asset to generate earnings, which are then reinvested or remain invested to generate their earnings. In other words, compounding refers to generating earnings from previous earnings.
Myths About Stock Market
Myth 1: Trading in Stock Market = Gambling
The generic sentiment of people about trading is that it’s a gamble, either you win or lose.
Myth Busted
Investing is more like science, where you need to do proper research about the fundamentals and technicals of the securities, current market trends, and growth prospects of the company.
Myth 2: Past Performance Guarantees Future Returns
While making an investment decision, investors consider ratings or past performance of the stock.
Myth Busted
Investing decisions are based on the future of the company and not just the historical trends. Interest rate, GDP, exchange rate, etc. are some of the major macroeconomic variables that affect the performance of the stock. Investors must also consider quarterly earnings, level of competition, cost of production, new product launch, change in top management, etc.
Myth 3: Stock That Comes Down, Will Go Up Eventually or Vice Versa
Most people believe that a falling stock will eventually go up. Similarly, they also resist buying stocks that are on their all-time high, assuming that they will fall down in near future.
Myth Busted
When a stock falls, investors need to research the reasons for the fall. Is the decline only due to market sentiment, which may reverse? Or is the fall due to some significant event that may hurt the financials of the company? Also, just because a stock has seen a sharp rally, does not mean it cannot appreciate further.
Myth 4: You Need to Invest a lot of Money to Make Money
Myth Busted
The truth is that the investors simply need to be disciplined and well-researched. Regular investing of smaller sums over a long period can unleash the power of compounding and make millionaires out of ordinary investors.
Myth 5: You Need to do Frequent Trades to be Profitable
Another thing that holds prospective investors back from investing is that they think they will have to frequently trade to earn good returns.
Myth Busted
The truth is, quality trades are better than quantity trades. You can do a number of trades without proper research and not earn desired returns. On the other hand, if you invest after thorough research and do quality trades, you might earn good returns.
Myth 6: Trading Stock With Low P/E (Price-to-Earning) Ratios is Good and Safe
The price-to-earnings ratio (P/E) helps to determine whether the stock is overvalued or undervalued. Conventional wisdom indicates that the lower the price compared to earnings (P/E ratio), the better the deal.
Myth Busted
There may be a good reason why the stock is trading cheaply. So, you must consider the growth prospects of the company, operational revenue, product launch (if any), debt structure, peer comparison, management, etc.
Stock Market Bubbles
Some indicators can help to check if the market is overvalued:
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Prices are high relative to fundamental valuation | Peak Valuations - During a stock market bubble, the prices are just pushed up by the sentiment of the market and the herd mentality. Simply put, the fundamentals of a company are not increasing at the same pace as its stock price.
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High leverage – Speculators may borrow money from the brokerages firm (on margin) or NBFCs to keep on the bull rally. The debt cycle keeps increasing, and when stocks drop, the investor wealth can be completely wiped out due to the high margin.
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Government measures such as low-interest rates– Lowering the interest rates encourage people to borrow and invest. It also encourages foreign influx in the form of FDI or FPI. It is inversely related to the stock market. Lowering interest rates, the market goes higher.
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Popularisation of a trend | Behavioural Finance– Sometimes narratives of bull markets overpopularise themselves. The hype around some stocks causes the prices to rise up exponentially, which leads to a bubble.
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A lot of IPOs with oversubscription– Looking at the current scenario, the past two years saw many IPOs, out of which 90% were oversubscribed, which shows the market’s bullish sentiment.
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Market CAP to GDP Ratio - This indicator suggests the valuation of the stock market compared to the GDP of a country. In India the market cap to GDP ratio is around 75%. This means that the Indian stock market valuation is 75% of the GDP. However, in recent months the market cap to GDP ratio has touched 100%.
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PE Ratio - To understand whether the stock markets or company is overvalued, a good indicator is the PE ratio.
PE ratio = price per share / earnings per share
Historically, the Nifty PE ratio ranges between 15-25. In the event that the PE ratio falls below 20, you can say that the market is undervalued. PE ratio between 20-25 indicates that the market is fairly valued. If the PE ratio crosses 25, then the conclusion is that the stocks are overvalued. To understand this a bit better, let’s look at an example.
It’s important to remember that the Nifty PE ratio is a general guideline. Besides this, several more indicators such as the Buffet Indicator, SmallCap Index, and the Sensitivity Index help identify a stock market bubble. However, these indicators are not always accurate in predicting the bubble.
Factors That Trigger A Stock Market Correction
Any development that forces investors to start selling stocks in large numbers will trigger a correction like global economic changes, rising inflation, slowdown in economic growth, or even fear or panic selling. When a critical mass of investors has sold off, it creates a spiralling effect, and more investors get into sell-off mode.
Conclusion
The stock market plays a crucial role in promoting economic development and guiding individuals in creating long-term wealth. Investors are better equipped to make wise decisions when they comprehend how it operates, from pricing dynamics and risk management to market players and trading mechanisms.
Even though market fluctuations can appear complicated, maintaining discipline, doing extensive research, and making long-term investments are the keys to success. Your greatest assets will always be knowledge and patience, regardless of your level of experience trading or your desire to invest in the Indian stock market.
You can confidently navigate market ups and downs and work towards reaching your financial goals by combining wise diversification with solid research.