What Is the Stock Market?
A stock market, also known as a stock exchange, is a venue for trading securities, such as shares and financial instruments. Sellers of securities are matched with their buyers in a stock market, and they trade with each other using rules imposed by the market’s governing authority, such as the Securities and Exchange Board of India (SEBI). For example, the National Stock Exchange (NSE) matches the best bid offer (BBO) with the lowest sale price. If there are not enough buyers for the security, then an assigned market maker steps in to make up for the difference and accomplish the sale.
Stock markets serve an important function in the economy by enabling entrepreneurs to raise capital, and companies to expand their operations using funding from the markets. On the other hand, stock markets generate profits for buyers of securities by making informed bets on growth prospects for these companies. These tasks are accomplished with the help of extensive regulations that govern trades and enforce mandatory disclosure of details from both sides.
Depending on trading volume and economic conditions, stock markets can be bellwethers of the broader economy. For example, major indices at major stock markets plunged during the financial crisis of 2008 and rose to new heights after the Great Recession of 2008, reflecting the Indian economy’s period of sustained growth.
However, there have been times when the market is disconnected from the mainstream economy’s problems. For example, despite an almost-complete economic shutdown and reports of record losses and unemployment numbers, markets in the Indian market reached new records during the coronavirus epidemic.
How Do Stock Markets Work?
To understand the working of a stock market, it is important to understand the stakeholders involved in its operations. Broadly, there are three parties involved in the process: buyers or those interested in purchasing shares either individually or in large blocks, sellers or those interested in making a sale of their shares at a profit or loss (as the case may be), and market makers or the intermediaries responsible for matching buyers with sellers and vice versa. Interactions between these three participants are governed by a complex set of rules and regulations that are necessary to maintain order and fairness in the market.
Other market participants influence trading activity or help clear trades by verifying and validating transactions. For example, brokers charge buyers and sellers for providing capital and conducting trades. Investment advisers and analysts influence buy and sell decisions by issuing periodic reports about a stock’s prospects after research.
How Are Stocks Traded?
The basic math of a stock trade consists of the difference between the bid and ask prices. After a stock is listed at an exchange, market forces take over. It is traded multiple times in a day. Some investors purchase the stock, or bid for it, at a low price. Other traders sell it, or ask for it, at a high price. The difference between the purchase and sale price is known as a bid-ask spread.
This spread is important for several reasons. First, it is an important source of revenue for market makers who make money off the price difference between these prices. Second, it is an indicator of the liquidity and interest in the stock. The narrower the spread, the more the stock’s liquidity because it means that traders are interested in owning or selling it. In general, liquid stocks are less susceptible to wild price swings because of the higher number of traders that make up their market. Illiquid shares, on the other hand, are more liable to display steep increases or decreases in their price because a single large transaction has the potential to draw investors into the company or drive them out of it.
Understanding Broad Market Movements
There are thousands of companies listed on the stock market and each company undergoes multiple price gyrations in a day. Therefore, it is impossible to gauge the market’s broad movements by tracking individual stocks. Instead, indices are used as tokens of the market’s mood.
In the world of finance, index refers to a subset of the stock market which facilitates determining the overall performance of the stock market. Index comprises a basket of stocks that track the performance of these securities and further helps in gauging the overall sentiment of the stock market. The index is also referred to as an indicator that serves as a benchmark to analyze the performance of a portfolio’s returns.
Furthermore, in the index, stocks do not only belong to a specific industry such as pharma, or banks, instead, but they are also picked up from all the major sectors. Thus, indexes help us in showing the overall picture and not just a specific sector of the stock market. One can also invest in stock indexes through various mutual fund schemes and exchange-traded funds (ETFs).
In the Indian context, there are two main stock exchanges: The Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). Sensex is an index that belongs to the BSE and NIFTY 50 belongs to the NSE.
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- SENSEX-
- The Sensex is one of the oldest stock exchanges in India. It comprises the total value of 30 stocks of companies that are listed on the BSE. Indeed, these stocks belong to the largest corporations in India and, thus, represent the Indian economy’s performance at large.
- To simplify, if the Sensex is moving upwards, then the investors or traders in the market will prefer buying stocks and on the other hand, if the Sensex is moving downward, the investors or traders will prefer to hold back their positions. The Sensex movements are tracked regularly which helps in analyzing the overall growth, and industry-related development.
- Below are the criteria which are used in selecting the 30 stocks of the Sensex:
- Stock must be listed on the BSE.
- Large-cap stocks with high market capitalization.
- High liquidity.
- Average daily turnover.
- Wide industry representation
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NIFTY 50-
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The NIFTY 50 is the flagship index of the National Stock Exchange and one of the most recognized stock market indexes in India. It tracks a total of 50 stocks of huge companies related to various sectors and industries. The NIFTY 50-based stocks are all large-cap-oriented companies that form almost three-fourth of the total capitalization in India. NIFTY 50 helps in benchmarking fund portfolios and launching of index funds, ETFs, and other structured products.
Below are the criteria which are used in selecting the 50 stocks of NIFTY 50:
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Stock must be listed on the NSE and should be included in NSE’s futures and options trading list.
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The company’s registered office should be in India.
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Large-cap stocks with market capitalization up to INR
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High liquidity
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High volume
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History of Stock Market-
The idea of trading goods dates back to the earliest civilizations. Early businesses would combine their funds to take ships across the sea to other countries. These transactions were either implemented by trading groups or individuals for thousands of years.
Throughout the Middle Ages, merchants assembled in the middle of a town to exchange and trade goods from countries worldwide. Since these merchants were from different countries, it was necessary to establish a money exchange, so that trading transactions were fair.
Antwerp or Belgium today, became the center for international trade by the end of the 1400s. It’s thought that some merchants would buy goods at a specific price anticipating the price would rise so they could make a profit.
For people who needed to borrow funds, wealthy merchants would lend money at high rates. These merchants would then sell the bonds backed by these loans and pay interest to the other people who purchased them.
The first modern stock trading was created in Amsterdam when the Dutch East India Company was the first publicly traded company. To raise capital, the company decided to sell stock and pay dividends of the shares to investors. Then in 1611, the Amsterdam stock exchange was created. For many years, the only trading activity on the exchange was trading shares of the Dutch East India Company.
At this point, other countries began creating similar companies, and buying shares of stock was all the rage for investors. The excitement blinded most investors and they bought into any company that began available without investigating the organization. This resulted in financial instability, and eventually, in 1720, investors became fearful and tried to sell all their shares in a hurry. No one was buying, however, so the market crashed.
Another financial scandal followed in England shortly after— the South Sea Bubble. But even though the idea of a market crash concerned investors, they became accustomed to the idea of trading stocks.
Although the first stock market began in Amsterdam in 1611, America didn’t get into the stock market game until the late 1700s. It was then that a small group of merchants made the Buttonwood Tree Agreement. This group of men met daily to buy and sell stocks and bonds, which became the origin of what we know today as the New York Stock Exchange (NYSE).
Although the Buttonwood traders are considered the inventors of the largest stock exchange in America, the Philadelphia Stock Exchange was America’s first stock exchange. Founded in 1790, the Philadelphia Stock Exchange had a profound impact on the city’s place in the global economy, including helping spur the development of the U.S.’s financial sectors and its expansion west.
In 1971, trading began on another stock exchange in America, the National Association of Securities Dealers Automated Quotations or otherwise known as the NASDAQ. In 1992, it joined forces with the International Stock Exchange based in London. This linkage became the first intercontinental securities market.
Unlike the NYSE, a physical stock exchange, the Nasdaq allowed investors to buy and sell stocks on a network of computers, as opposed to in-person trading. In addition to the NYSE and the NASDAQ, investors were able to buy and sell stocks on the American Stock Exchange or other regional exchanges such as the ones in Boston, Philadelphia, and San Francisco.
History of Stock Exchange in India-
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The Indian stock market traces its history back to the late 18th century when the trading floor was under the shade of a sprawling banyan tree opposite the Town Hall in Mumbai. A few people would meet under this tree to informally trade in cotton. This was because Mumbai was a busy trading port, and essential commodities were traded here often. The Companies Act was introduced in 1850, following which investors started showing an interest in corporate securities. The concept of limited liability also put an appearance around this time.
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By 1875, an organization known as ‘The Native Share and Stock Brokers Association’ came into being. This was the predecessor of the BSE.
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In 1894, the Ahmedabad Stock Exchange came primarily to enable dealing in the shares of textile mills in the city.
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The Calcutta Stock Exchange was formed in 1908 to facilitate a market for shares of plantations and jute mills.
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It was in 1920 that the Madras Stock Exchange took shape.
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In 1957, the BSE was the first stock exchange to be recognized by the Government of India under the Securities Contracts Regulation Act.
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The SENSEX was launched in 1986, followed by the BSE National Index in 1989.
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The Securities and Exchange Board of India (SEBI) was constituted in 1988 to monitor and regulate the securities industry and stock exchanges. In 1992 it became an autonomous body with completely independent powers.
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In 1992, the NSE was formed as the first demutualized electronic exchange to ensure market transparency.
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NSE began operations in the Wholesale Debt Market (WDM) segment in 1994, the equities segment in 1994, and the derivatives segment in 2000.
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In 1995, the BSE switched to an electronic trading system from the open-floor system.
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In 2015, SEBI was merged with the Forward Markets Commission (FMC) to strengthen commodities market regulation, facilitate domestic and foreign institutional participation, and launch new products.
- Today, the BSE is measured as the world’s 11th-largest stock exchange, and the market capitalization is likely to be around $1.7 trillion. The market capitalization of the NSE is estimated to be over $1.65 trillion.
