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). Further, there is a primary market where companies list their shares for the first time. Thereafter the shares  are further traded in the secondary market.

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). Further, there is a primary market where companies list their shares for the first time. Thereafter the shares  are further traded in the secondary market.

Working of the Stock Market

Participants:The stock exchange provides a platform for trading in financial products. The companies (listing their shares), brokers, traders, and investors must register with SEBI and the exchange (BSE, NSE, or regional exchanges) before trading.

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.

Now, let’s talk about the two types of markets we have mentioned above.

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. Meanwhile, the bourse 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+2, that is, within two days of the transaction and the process of bringing it down to T+1 is underway.

Understanding the pricing mechanism in the stock market

The price of stocks in the market is driven by demand and supply factors. 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 stocks.  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 fair value of the share is Rs (40*100) or Rs 4,000.

There is another way to calculate the fair price using the discounted cash flow method. The theory suggests that the fair price is equivalent to the total of all future dividend payments, discounted at present value. 

Stock market works through a network of exchanges, broking houses, and brokers, and they function as mediators between companies and investors. Companies get listed in the exchange through initial public offerings or IPO before investors can purchase their shares. IPO helps to establish the market -cap of a company, and the stock exchanges have separate lists for large-cap, middle-cap, and small-cap companies from which investors can pick up shares to buy.

Apart from that, stock exchanges also have indices. Indian exchanges NSE and BSE have separate indices called Nifty and Sensex. These indices comprise shares of the top large-cap companies based on their market volume and popularity of shares. General investors follow these indices to understand the market direction.

Another important concept to learn while on the topic of how the stock market works is the bid-ask spread. ‘Bid’ refers to the price that buyers are willing to pay for an underlying, which is often less than the ‘ask’ price of the seller. The difference between the two prices is called the bid-ask spread. The buyer needs to increase the bid price and the seller needs to reduce the ask price for a trade to happen.