What is stock market and how does it work? A 7-minute guide for beginners

Money does not grow on trees. But it can with the stock market. Billionaires like Warren Buffet and Rakesh Jhunjhunwala have proved it time and again. Their success stories have grabbed eyeballs and made the stock market appear like a one-stop destination to make quick money. However, as many as success stories, there are incidences of failures too. The stock market is known to turn people from rags to riches and also vice-versa. This has made some people either too, apprehensive to invest in stocks or excessively excited for the same.

Whichever category a person falls into, it’s important to have a fundamental understanding of the stock market. In order to conclude whether the stock market is the right area to invest in or not, let’s walk through the nitty-gritty of the stock market.

WHAT IS STOCK MARKET?
The stock market, equity market, or share market is a place where investors buy and sell shares of publicly-listed companies. When a person needs groceries, he or she goes to the supermarket. Similarly, when a person needs to buy stock, he or she approaches the stock market.

The stock market is not a physical marketplace but works electronically through the internet. It serves two main purposes. The first is to provide capital to companies which allow the company to raise money to expand its business. The second is to give an opportunity to the investors to share in the profits of companies listed on the stock exchange.

WHAT ARE SHARES?
Stocks provide a share of the company's future profits in return for the capital invested. A share is a unit that represents partial ownership of a company. When a person buys a share of a company, he or she becomes part-owner of that company. Technically, shares are units of stocks, but the two terms are often used interchangeably.

Buying and selling of stocks (or shares) are called stock trading. On purchasing shares of a company, the investor is issued with a stock certificate. A stock certificate or share certificate is a legal document that verifies the shareholder to be owning a specific number of shares of a company. The term shareholder (or stockholder) refers to a person or a company that owns at least one share of a company's stock.

TYPES OF SHARES
There are two main types of stocks- common shares and preferred shares. The term "equities" is synonymous with common shares as their combined market value and trading volume are remarkably larger than that of preferred shares.

The factor that distinguishes them is voting rights. Common shareholders have the right to vote and have a say in corporate meetings such as the annual general meeting while preferred shareholders don't enjoy these rights. However, preferred shares have preference over common shares to receive dividends and also assets in case of liquidation. Liquidation is the process of bringing a business to end.

WHAT IS STOCK EXCHANGE?
Stock exchanges are secondary markets where existing shareholders can transact with potential buyers. The companies listed on the stock market do not buy or sell their own shares on a regular basis. The transactions take place between the existing shareholders and potential investors.

The National Stock Exchange of India Limited, headquartered in Mumbai is India's leading financial exchange. Bombay Stock Exchange is the oldest stock exchange in India as well as Asia. A stock exchange is similar to the e-commerce giant, Flipkart. They allow companies to be listed and connect the buyers & sellers. As millions of people trade in the stock market and it is practically impossible for these exchanges to deal with all the individuals, there are brokers who act as intermediates between the exchanges and the individuals known as stockbrokers. These brokers help in setting up trading and Demat accounts. They also give tips and tools to decide which shares to buy and sell. For all of these, they charge a fee known as brokerage.

CLASSIFICATION OF STOCKS
Stocks can be mainly classified by market capitalization, commonly known as market cap and sector.

Market capitalization refers to the total market value of a company’s outstanding shares of stock. It can be calculated by multiplying the number of outstanding shares by the current market value of one share. For example, a company with 1000 shares of ₹100 each would have a market cap of ₹1,00,000. This figure is used by investors to determine the size of a company. On the basis of their market cap, companies can be divided into large-cap, mid-cap, and small-cap.

Large-cap stocks are the first-class citizens in market capitalization. These are stocks of well-established companies that have been around for years. Mid-cap companies lie in between large-cap and small-cap companies in the market capitalization spectrum. These companies are smaller than large-cap companies in terms of profitability, revenue, client base, etc. but bigger than small-cap companies. Small-cap companies include start-ups and companies that are in their early stage of development.

The classification system to classify stocks by sector consists of 11 sectors. They are:

• Financial
• Real Estate
• Healthcare
• Industrial
• Material
• Energy
• Information Technologies
• Communication
• Utilities
• Consumer Staples
• Consumer Discretionary

WHY INVEST IN STOCK MARKET?
Gone are the days when people worked 9 to 5 or overtime and easily met their financial needs. The world has shifted from working for money to making money work for them. And the stock market is one of the best ways to grow money. Stocks are one of the many investment options apart from bank fixed deposit (FD), mutual funds, gold, etc. But why choose stocks instead of other options?

There are three prime reasons why the stock market continues to be a popular choice despite the uncertainty.

1) Higher Returns
The reason why people invest in stocks is that they provide higher potential returns. No other type of investment tends to perform better in the long-term. While investing in FD give returns of approximately 5-7%, buying stocks of a promising company can give returns of around 14-20%.

In addition to this, many investors prefer to invest for the long-term in stocks to earn long term capital gain on shares. This is because they offer tax benefits over earnings from other short term capital assets. A long-term capital gain (LTCG) is the profit generated from the sale of an investment, here stocks, that has been held by an investor for at least a year at the time of sale. It is determined by the difference in the value of the selling price and purchase price of the stocks owned for more than 12 months. This gain is the net profit that investors enjoy while selling this asset.

2) Minimal Investment
Unlike other investment options that require a certain amount of money to be invested, stocks can be bought for as little as ₹100 depending upon the company. This makes investing in stocks a favorable choice for beginners.

3) Flexibility
Another great advantage of investing in the stock market is the flexibility it offers in terms of holding period. Holding period is the duration for which a stock is held by a shareholder. It can be as short as a few days or as long as several years. With investors having no control over waggling share prices, this gives them the necessary control to manage risks and rewards.

HOW DOES THE STOCK MARKET WORK?
The stock market operates similar to an auction house. It enables buyers and sellers to negotiate prices and trade. Companies wanting to grow their business need to raise capital. For this, companies list shares of their stock on a stock exchange through a process called an initial public offering (IPO). Investors can then buy and sell these stocks and the stock exchange tracks the supply and demand of each listed stock.

Securities and Exchange Board of India or SEBI is a regulatory body founded in 1922 by the Government of India. It promotes transparency and keeps a check on unfair and malpractices to protect the interests of investors.

Stocks are a high-risk asset. Being highly volatile, it involves frequent transactions. Let's understand this with an example. A company, ABC Ltd. is currently facing an internal leadership issue causing most of its senior leaders to quit. This news has led to a drop in the stock prices of this company from ₹2000 to ₹1500 per share. Let's assume that there are two traders X and Y. X believes that the stock price of the company will drop further down and wants to sell his share. Y is affirmative and considers it a momentary lapse. Hoping that stock prices would ascend as soon as the company finds a good CEO, Y decides to buy the share. Here, X is the seller, and Y, the buyer at ₹1500. They can approach the stock exchange through their respective stock brokers and finalize the deal. In this way, the stock market remains a busy place with constant sales and purchases of shares.

Such price swings in the stock market are determined by demand and supply. When the demand for stocks is more than supply, the price increases. When the demand for stocks is less than supply, the price falls. The price of stock sways usually because of the following:
a) Public perception fluctuating demand and supply
b) News
c) Events related to the company or the economy as a whole

HOW ARE SHARE PRICES SET?
The share prices are mostly set through an auction process where buyers and sellers place bids and ask to buy or sell. A bid is the price at which an investor wishes to buy and ask is the price at which the existing shareholder wishes to sell. When the bid and ask match, stock trading takes place.

HOW TO INVEST IN STOCK MARKET?
Digitalization has made investing in and managing stocks effortless than ever. 3 simple steps given below are all it takes to start investing:

1) Open a Trading Account and Demat account
A trading account is needed for buying and selling shares. A Demat account is required for holding shares. It is like a digital wallet where shares are stored. Documents of identity proof, address proof, bank account, photograph, etc. are required to open both these accounts. Accounts can be opened through online discount brokers like Zerodha, Upstox, etc., or through regular stockbrokers like Sharekhan, Motilal Oswal, Angel Broking, etc.

2) Select the segment
One can choose from among numerous sectors such as FMCG (fast-moving consumer goods), finance, telecom, textiles, to name a few.

3) Evaluate risks and decide on a prudent investment strategy
The stock market is a highly unstable area of investment. Thus, it is important to plan risks and consider general precautions.

Investment strategy involves the rules for stock selection, buying price, selling price, holding period, etc. Investors adopt many investment strategies like fundamental analysis, technical analysis, value investing, growth investing, etc., or a combination of them. Investors must employ a strategy that best complements their goal.

Studying past performances, current position and future prospects of a company is critical before investing. Diversification is one way to minimize risks. Investing in companies with diverse market capitalizations, sectors, geographical locations, etc. helps in managing the risk. Day trading i.e. frequent buying and selling stocks based on price swings is immensely risky. A long-term investment is relatively safe and provides maximum benefits over time. Keeping a track of the stock market’s performance assists in staying updated with the trends of the market and make timely decisions.

As opposed to popular beliefs that the stock market requires a very strong knowledge of finance, logic and analytical skills prove to work best. A background in financial planning and risk management helps though. Success in the stock market depends primarily upon the investor’s clarity over the following questions:
a) How to choose stocks?
b) When to enter and exit? (buying and selling based on price or time)
c) How many stocks to invest in?
d) How much to invest in every stock?

Overall, the stock market is a great investment option. With adequate knowledge, strategy, and patience it can prove to be one of the best investment plans in the long run. Once an investor gets the grip of the game, it's worth a play.