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How does the stock market work?

The ‘Stock Market’ is probably one of the most commonly thrown around terms when discussing investments. This shouldn’t be surprising, since the stock market tends to give very competitive returns when compared to other investments, a fact proven over the years by statistics. Plus, no one can deny the fact that the stock market is one of the most important factors in a country’s economy. People like Warren Buffett, Peter Lynch and Charlie Munger have shown the world how stock market returns can be highly profitable.

So, how does the stock market work? In this article we will delve into its intricacies. You will learn what the stock markets is, how the stock exchange works for beginners and the steps to invest in the Indian stock market.

Key Points

  • The stock market or the stock exchange is a market where you can buy stocks, commodities and bonds.
  • When the owners of a business want to raise money for their company, they issue their shares in the stock market.
  • When you place a buy order for a share, your stockbroker passes on your order to the stock market. Once seller and buyer are fixed, the exchange takes place.

What is a Stock Market?

The stock market or the stock exchange is a place where you can buy stocks, commodities, and bonds. It does not hold any shares of its own, instead acts as a platform where investors can buy stocks from the stock sellers. Think of it like a telephone exchange equivalent - instead of connecting a caller and a receiver, it connects buyers and sellers.

A stock market is one of the most important parts of a free-market economy. It is the place where a company can offer you a slice of its ownership in exchange for capital you invest in its stocks. You can purchase stocks of those companies that are listed on the stock exchange.

What is the purpose of a Stock Exchange?

When the owners of a business want to raise money for their company, they issue their shares in the stock market. The stock market allows you to buy shares of a company, and the capital you invest is used by the owners of the company for different purposes - such as growth, maintenance, R&D or even debt settlement. Without the stock market, these owners would have to find large individual investors for their company. Let’s face it, there are only a few Tatas, Ambanis and Warren Buffetts in this world. They won’t be enough for all the companies who wish to grow in their business. Who will invest in these companies? And how? That’s why modern times require a central place where you can purchase and sell stocks of companies that you want to invest in.

How does the Stock Exchange work?

The stock market works mainly in two sections: the primary market and the secondary market. The primary market is where the company issues shares by way of IPOs (Initial public offerings) a process by which the company raises capital. Institutional investors buy these shares from investment banks and the price of the share, once it goes public, is determined by the amount of shares being issued. The secondary market is where you buy shares of the company. It is the secondary market in which we do all of our trading in the stock market. In the secondary market, you as well as institutional investors can buy stocks of a company from the stock market.

When you place a buy order for a share, your stockbroker passes on your order to the stock market. Once seller and buyer are fixed, the exchange takes place. In today’s times, all your orders are executed electronically, which takes just a few minutes. When you trade in a stock market, the prices of the shares change as the share prices are dependent on the perceived value. It’s ultimately a classic case of demand and supply and its impacts. So, when you see the stock price of a company rise, it means someone or many investors are placing a buy order for that stock and shares of that particular company are in demand.

How to invest in the Indian stock market?

Here are some easy steps which you can follow to invest in the Indian stock market:

  • Get a PAN card
    A PAN card is essential for any financial transaction in India. PAN is required for opening a bank account, investing in the stock market and mutual funds, filing Income Tax returns etc.
  • Get a broker
    As an individual trader, you are not allowed to go directly to a stock exchange and trade in the stock market. You need to do this via a registered stock broker.
  • Open a demat and a trading account
    You’ll need a demat account to store the securities you buy. You’ll also need a trading account before you can trade in the Indian stock market.
  • Trade
    With your demat & trading accounts in place, you can now start trading in the stock market. Just contact your broker or access their online trading platforms to place buy and sell orders.
Wrapping Up

  • Before investing in the share market, try some books to invest efficiently and understand the stock market correctly such as “The Intelligent Investor” by Benjamin Graham and “A Random Walk Down Wall Street” by Burton Malkiel. You will get a detailed idea about the workings of the stock market.
  • Once you are done understanding the stock market, you can go select your broker, and open your demat and trading accounts.
  • With those accounts set up, start trading!
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