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How does the stock market work?

Introduction

Ownership through buying stocks goes back to several centuries. The early Romans are said to use an instrument that represents a stock. This instrumentshowed their participation in public works.The contractors in charge of aparticular project would sell this instrument to raise money. The concept of buying stock has evolved over the centuries.

Now, if you own stock in a particular company, you are that company’s shareholder. As the stock is a unit of ownership in a company, you now have ownership of that company. If the company does well, you can receive your share of profits and dividends from the total gain. You might also get a right to vote in some of those company’s decisions.

Take, for instance, there is a business selling cakes. This business wants to raise more money to buy heavy machinery that will help it produce more. To purchase those machines, the company needs more funds. One of the ways how this company can raise funds is tolist its shares to the public. Suppose you buy 100 shares of this company. You are now a shareholder of this business. If each share is 1 unit of that company, you have 100 units of that company. You are now eligible to receive profits and dividends based on these 100 units. 

If the company suddenly decides to switch from making cakes to making soaps, as a shareholder, you get a right to make a vote either supporting or going against this decision. The company might have to change its plan depending on the vote you and the other company shareholdersmake regarding this decision.

What is a stock market?

A place where buyers and sellers of stock come together to trade is called a stock market. These buyers and sellers buy and sell stocks of companies eligible to trade in the stock market. A buyer quotes the highest price they are willing to pay for a particular company’s stock. That is called the bid price. A seller quotes the lowest price that they are ready to accept for the same stock. That is called the asking price.

Suppose the buyer wants to buy 100 shares of company XYZ at ₹105. And the seller of these sharesintends to sell 100 shares of the same company for ₹110. The price might for the trade to take place would be somewhere between the bid and ask price. 

Types of the stock market:

There are two types of the stock market, the primary market and the secondary market.

Primary market:

The primary market is where new securities like a stock of a particular company are created. A company can sell its stock for the very first time to the public in a primary market. This is called an Initial public offer.The company directly purchases the stock as opposed to being bought from another buyer.

Secondary market:

The secondary market is where securities such as stocks and bonds are sold to investors. Once a company lists itself in the primary market and finishes its initial public offer, its shares can be bought and sold in the secondary market.A stock exchange is a type of secondary market. It determines the price of a particular stock based on the demand and supply of the stock. It allows for active trading. If a buyer wants to buy shares of ABC company, the buyer has to purchase these shares only from a seller selling shares of ABC company.

How does the stock market work?

In earlier days, the registered shares who wanted to trade in the stock market followed the open-outcry method to trade in shares. The traders were required to be physically present on the trading floor of the stock exchange and used to yell, use hand signals or gestures to buy and sell shares. That led to severe chaos and confusion. To avoid this, the government came up with the concept of electronic trading.

In electronic trading, registered online stock brokers can act as agents to help you buy and sell shares. 

With the introduction of the dematerialization account (demat account) some twenty-five years ago, the disadvantages of the open-outcry method were removed. Paper certificates were converted into electronic format. All the details of shares and other securities trades are now stored online. This is called a demat account. You now cannottrade in the Bombay Stock Exchange (BSE) or the National Stock Exchange (NSE) without a trading account and a demat account.

You can now buy and sell shares and trade in the stock market through a stockbroker. To trade in shares, the stockbroker would want you to have a trading account, a bank account and a demat account. A trading account helps a trader buy and sell shares.When you start trading electronically, your account acts as the link between your demat account and your bank account. You place the order for shares through the trading account. Once the orders are placed, the number of shares traded is stored electronically in your demat account and the money is debited from your bank account.

Conclusion:

Once you have a demat account and a trading account, you can invest in the stock market. You should also understand that with each investment comes its share of risks. The stock market carries a lot of risk. The volatility of the market is extremely fragile, as an investor, you might need to consider a diverse portfolio of investments to reduce the risks that you might have to face.

Disclaimer:

ICICI Securities Ltd. ( I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. – ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai – 400 025, India, Tel No : 022 – 2288 2460, 022 – 2288 2470.The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. The contents herein above are solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments or any other product. Investments in securities market are subject to market risks, read all the related documents carefully before investing. The contents herein mentioned are solely for informational and educational purpose.



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