Basics of Indian Stock Market

What is Investment?

An investment is an asset or item that is purchased with the hope that it will generate income or will appreciate in the future. In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the future to create wealth. In finance, an investment is a monetary asset purchased with the idea that the asset will provide income in the future or will be sold at a higher price for a profit.

The term “investment” can be used to refer to any mechanism used for the purpose of generating future income. In the financial sense, this includes the purchase of bonds, stocks or real estate property.

 

What is Stock Market?

A share market is where shares are either issued or traded in.

A stock market is similar to a share market with additional features that helps you trade financial instruments like bonds, mutual funds, derivatives as well as shares of companies. A share market only allows trading of shares.

The key factor is the stock exchange – the basic platform that provides the facilities used to trade company stocks and other securities. A stock may be bought or sold only if it is listed on an exchange. India’s premier stock exchanges are the Bombay Stock Exchange and the National Stock Exchange.

 

Types of Share Market-

  1. Primary Market-

This is where, a company gets registered to issue a certain amount of shares and raise money. This is also called getting listed in a stock exchange.

A company enters primary markets to raise capital. If the company is selling shares for the first time, it is called an Initial Public Offering (IPO). The company thus becomes public.

 

  1. Secondary Market-

Once new securities have been sold in the primary market, these shares are traded in the secondary market. This is to offer a chance for investors to exit an investment and sell the shares. Secondary market transactions are referred to trades where one investor buys shares from another investor at the prevailing market price or at whatever price the two parties agree upon.

 

 

Financial Instruments Related to Stock Market-

  1. Bonds-

Companies need money to undertake projects. One way of raising funds is through bonds. When a company borrows from multiple investors in exchange and returns timely payments of interest to the investors, it is called a bond.

A bond is nothing but the funds borrowed by a company for some project developments from individuals instead of bank or financial institution. Thus, a bond is a means of investing money by lending to others. This is why it is called a debt instrument.

From investor’s point of view, bond is almost similar to the fixed deposits in banks with withdrawal of interest at fixed intervals. All interest rate, maturity date are applicable to bonds same as F.D. Bonds, however, does not share the profit of company with the investors.

  1. Shares-

The share market is another place for raising money. In exchange for the money, companies issue shares. Owning a share is same as holding a portion of the company. These shares are then traded in the share market.

When you buy shares of a company, you actually become their partner. Thus, as a stockholder, you share a portion of the profit the company may make as well as a portion of the loss a company may take. As the company keeps doing better, your stocks will increase in value, but if company suffers loss, your share price will also be dropped. You can sell your shares in secondary market at on-going rate which may be less or more than your buying price. Hence it is considered as a riskier instrument.

 

  1. Mutual Funds-

A mutual fund is a professionally-managed investment scheme, usually run by an asset management company that brings together a group of people and invests their money in stocks, bonds and other securities.

As an investor, you can buy mutual fund ‘units’, which basically represent your share of holdings in a particular scheme. These units can be purchased or redeemed as needed at the fund’s current net asset value (NAV). These NAVs keep fluctuating, according to the fund’s holdings. So, each investor participates proportionally in the gain or loss of the fund.

The biggest advantage of investing through a mutual fund is that it gives small investors access to professionally-managed, diversified portfolios of equities, bonds and other securities, which would be quite difficult to create with a small amount of capital. The risk in mutual funds compared to direct investment in share market is low.

 

  1. Derivatives-

The value of financial instruments like shares keeps fluctuating. So, it is difficult to fix a particular price. Derivatives instruments come handy here. These are instruments that help you trade in the future at a price that you fix today. Simply put, you enter into an agreement to either buy or sell a share or other instrument at a certain fixed price.

SEBI & It’s Functions-

SEBI stands for Securities and Exchange Board of India. SEBI is mandated to oversee the secondary and primary markets in India.

SEBI has the responsibility of both development and regulation of the market. It regularly comes out with comprehensive regulatory measures aimed at ensuring that end investors benefit from safe and transparent dealings in securities.

Basic Objectives of SEBI-

  1. Protecting the interests of investors in stocks
  2. Promoting the development of the stock market
  3. Regulating the stock market

 

Stock Market Key Terms –

 

  1. Bull & Bear Markets-

Markets are often described as ‘bull’ or ‘bear’ markets. These names have been derived from the manner in which the animals attack their opponents. A bull thrusts its horns up into the air, and a bear swipes its paws down. These actions are metaphors for the movement of a market: if stock prices trend upwards, it is considered a bull market; if the trend is downwards, it is considered a bear market.

  1. Dividends-

A share is a portion of the company. When the company makes profits, share-holders often receive a part of it. Every year, companies distribute a small amount of profits to investors called as dividends. This is the primary source of income for long-term shareholders – those who don’t sell the stock for years together. Dividends are generally some percentage amount of on-going market price of the share. Sometimes company may offer you some extra shares as dividend.

 

  1. Market Capitalization-

Companies, when get listed, issue some amount of shares. Market capitalization refers the total rupee market value of a company’s outstanding shares.

Commonly referred to as “market cap,” it is calculated by multiplying a company’s shares outstanding by the current market price of one share. The investment community uses this figure to determine a company’s size, as opposed to using sales or total asset figures.

For example, if a stock is priced at ₹50 per share, and there are 1,00,000 shares in the hands of public investors, then its market capitalization stands at ₹50,00,000.

Market capitalization matters when stacking stocks into different indices. It also decides the weightage of a stock in the index. This means, bigger the company’s market value, the more its price fluctuations affect the value of the index.

  1. Top-Down, Bottom-Up Approaches-

The top-down approach first takes into consideration the macro-economy. You understand the trends and outlook for the overall economy. Using this, you choose a one or more industries that are expected to do well in the near future. This is because every industry reacts to overall economic conditions like inflation, interest rates, consumer demand and so on, in a different way. Select one amongst the industries after in-depth analysis. Next, you understand the workings of the industry, the players and competitors and other factors that affect the sector. Based on this, you select one of the companies in the industry.

The bottom-up approach is just the opposite. You do not look at the economy or select an industry first, but concentrate on company fundamentals. You first understand what your priorities are – high growth or steady income through high dividends. Using appropriate ratios like the Price-to-Earnings ratio or the Dividend-yield, you select a bunch of stocks. Next, analyse each of these companies; find answers for questions like what factors drive profits? Is the company management efficient? Is the company heavily indebted? What is the future outlook? And so on. Based on the results, select the company that best fits your requirements.

The bottom-up approach is most suited for weak market conditions. This is because; the underlying belief is that these companies will perform well even if the economy is poor.

 

  1. Rolling Settlements-

Settlement is the process whereby payment is made by the buyers, and shares are delivered by the sellers. A rolling settlement implies that all trades have to be settled by the end of the day. Hence, the entire transaction – where the buyer pays for securities purchased and seller delivers the shares sold – have to be completed in a day.

In India, we have adopted the T+2 settlements cycle. This means that a transaction conducted on Day 1 has to be settled on the Day 1 + 2 working days. This is when funds are paid and securities are transferred. Thus, ‘T+2’ here, refers to Today + 2 working days. Saturdays and Sundays are not considered as working days. So, if you enter into a transaction on Friday, the trade will be settled not on Sunday, but on Tuesday. Even bank and exchange holidays are excluded.

  1. Short-Selling-

Suppose you expect shares of a company to fall tomorrow for whatever reason, you enter an order to sell shares of the company at the current market price (considering you already have some shares of the company). Once the share price falls adequately tomorrow, you buy at the lower rate. The difference in the sale and buying prices is your profit. However, if the share prices increase after you sold at a reduced price, then you end up with a loss.

This entire scenario is called as short-selling. Simply put, you first sell at a high and then buy at a low. Short-selling helps traders profit from declining stock and index prices. Since this is usually conducted in anticipation of a stock movement, short-selling is considered a risky proposition.

 

  1. Margin Trading-

In simple terms, it can be referred as ‘credit trading’. You can take credit and buy shares through that even if you actually don’t have any money. Many brokers offer this facility to the investors. But you need to return the money with interest within the offered amount of time by the broker. Brokers offer the credit for a fixed amount of time like 3days, 5 days etc. after which it is automatically squared-off at current market price. It is very useful for short-term trading but can be very risky if your market prediction goes wrong.

For example, Suppose, you buy 5000 shares of ₹1000, costing total of ₹50,00,000 using credit (by borrowing money from broker). You sell the shares with ₹50 high, you get a profit of 50×5000=₹2,50,000 (some amount to be paid as interest to broker) without investing actual of your money. But if the share price drops by ₹50, you need to pay up the loss of ₹2,50,000 + interest to broker.

 

  1. Cost Averaging-

Rupee-cost averaging is a concept when you buy a stock in small bunches, instead of buying in lump-sum. This helps reduce the average cost of your investment.

Suppose there is a down-trend going on for a company, and you want to buy some shares in the down-trend to get profit once the up-trend starts. If the price is dropped to ₹100, and you buy 1000 shares, this will cost you ₹1,00,000 total. But if there is further downfall is possible, you can buy 500 shares and ₹100 and wait till the price falls to ₹95, buying next 500 shares at ₹95. This will cost you ₹97,500, saving your ₹2,500.

This concept comes handy when a stock falls after you have bought it. The fall in share price gives you an opportunity to buy more and reduce your average cost of investment. This way, when you finally sell the shares at some time in the future, you end up making more profits.

 

  1. Circuit Filters and Trading Bands-

Some stocks are more volatile than others. Too much volatility is not good for investors. To deal with this volatility, SEBI has come up with the concept of circuit filters. The market regulator has specified the maximum limit the price of a stock can move on a given day. This is called a price trading band. If a stock breaches this limit, trading is halted in that stock for a while. There are three levels of limits. Each limit leads to trading halt for a progressively longer duration. If all three circuit filters are breached, then trading is halted for the rest of the day. NSE define circuit filters in 5 categories including 2%, 5%, 10%, 20% and no circuit filter.

Also, prices may not be same on the two exchanges – NSE and BSE. So, circuit filters can be different for shares on the two exchanges. It provides a buffer time for a falling stock to recover and to provide some stoppage to the volatility of the stock.

         10. Price-Targets and Stop-Loss Targets-

A price target indicates that the price of share is unlikely to climb above the level. So, once the share price touches the target, you may look to sell it and pocket your profits. A stop loss, meanwhile, acts as a target on the lower end. It lets you know when to sell before the stock falls further and worsens your loss.

Some brokers provide the facility to set your own price and stop-loss targets. If you set these targets, the shares are automatically sold once the target is reached. You can set certain price target for buying the shares also.

Working of Share Market-

A demat account is very essential for stock market trading. The demat account is necessary to trade in any kind of stock market.

Demat account is much similar to a bank account. Much like a bank account which holds the records of transactions of cash, a demat account holds records and certificates of financial instruments like shares, bonds etc.

 

Types of Stocks –

Stocks are classified on various parameters like size of the company, dividend payment, industry, risk, volatility, as well as fundamentals.

The types of different stocks can be cleared from the diagram:

 

Stock Types Diagram
Stock Types

Types Based on Market Capitalization-

 

Stock Types Diagram
Stock Types Based on Market Capitalization

 

 

Important Things to be considered-

  1. Analysis of Stocks-

You must analyse the market and decide your investment strategy. According to your investment amount, you must decide the small-cap or large-cap stocks.

Suppose, you have ₹10,000 to invest. You can either buy 10 shares of ₹1,000 or 100 shares of ₹100. You must analyse the market while deciding this. If the ₹1000 share is likely to gain ₹10 and the ₹100 share is likely to gain ₹2, because of number of shares, you will make profit of ₹100 from ₹1000 share and ₹200 from ₹100 share.

  1. Deciding Demat Account and Broker Firms-

You need to pay certain price for demat account yearly. Also the broker firms charge certain amount as commission on each of your buy-sell transaction irrespective to your loss or profit. Also, on profit, you need to pay certain amount of tax to government. You must consider all these amounts while trading and deciding your sell value.

 

 

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