HOW DOES THE STOCK MARKET WORK?

By Moksha Grover

Are you scared of investing in the stock market too? Have you heard of people losing all their money by investing in the stock market? If it is so, then you are not alone. There are many individuals with limited experience who are scared to invest in stocks after hearing the horror stories of investors losing 50% of their portfolio value[1]. The reality is that investing in the stock market carries some amount of risk. But it is one of the best methods to increase one’s net worth if carried out in a disciplined manner. Today, most rich and affluent people have the majority of their wealth from investment in stocks.  

WHAT IS THE STOCK MARKET?

The stock market is where investors connect to buy and sell investments — most commonly, stocks, which are shares of ownership in a public company. ` When you purchase a public company’s stock you get entitled to the stock ownership of that particular company that is you become a shareholder. Stock ownership implies that the shareholder owns a slice of the company equal to the number of shares held as a proportion of the company’s total outstanding shares. For instance, an individual or entity that owns 100,000 shares of a company with one million outstanding shares would have a 10% ownership stake in it.[2] Most companies have outstanding shares that run into the millions or billions[3]. Anyone with a brokerage account can easily buy stocks online through the stock market. Most of the stock trades take place between investors. If we buy shares of a company, we are not buying these shares from the company itself. We are buying shares of another investor who has decided to sell his shares.

TYPES OF STOCKS

There are mainly two types of stocks that are common stocks and preferred stocks.

COMMON STOCKS

Common stock is a security that represents ownership in a corporation. Holders of the common stock vote on corporate policies and elect the board of directors. Common stock is further classified on the basis of voting rights. The basic proposition of common shares is that they should have equal rights –one vote per share system. But some companies have multiple classes of stocks, wherein each class of stock has different voting rights. In such a dual-class structure, Class A shares, for example, may have 10 votes per share, while the Class B “subordinate voting” shares may only have one vote per share. Dual- or multiple-class share structures are designed to enable the founders of a company to control its fortunes, strategic direction and ability to innovate[4].

PREFERRED STOCKS

Preferred stocks are a class of stocks that are granted rights different from common stocks. They usually have higher claims over dividends and asset distribution. Preferred stocks have limited or no voting rights in corporate governance. Preferred stocks have more priority to investors than common stocks as they possess characteristics of both bonds and common stocks.

HOW THE STOCK MARKET WORKS?

The stock market works in a very simple and easy way.  In a stock market, buyers and sellers negotiate the prices of stocks and make trades. This process is carried out with the help of a network of exchange. When companies list shares of their stock on an exchange then this process is called Initial Public Offering or IPO. Investors buy and sell stocks among themselves. The supply and demand of stocks are determined by exchange networks like the New York Stock Exchange or the Nasdaq. Supply-demand helps to determine the price of the security. Price is determined by the investors and traders willing to buy or sell. Bidding by the buyer for the highest amount is done. The amount that the buyer is willing to pay is often lower than the amount sellers ask for. The difference in the amounts is called the bid-ask spread. The bid-ask concept is not much of a concern for beginner and long-term investors as the amount differs by pennies.

The working of the stock market is a fascinating example of the law of supply and demand, in real-time. If there are more buyers than sellers, then the price of stocks trends up. If there are more sellers than buyers, then the price falls down. The stock market serves two very important purposes both for the companies and the investors. For the companies, the stock market helps to raise funds from the public and helps in their funding operations. It also helps in the development and growth of the company and further expands its projects and business. As the companies grow and expand their business, shares bought by investors become more valuable, thus helping them to gain more capital. In addition to this, investors also receive dividends from the company as their profits. Public companies selling their shares need to disclose all the material information required and also give a say in how their business works to the investors.

All these processes that help in the working of the stock market seem to be complicated, but in reality, these have become relatively easy with the help of computer algorithms that help in price-setting calculations. Bid, ask and bid-ask all are available on the broker’s website with the required information. Today, the stock market is considered to be one of the most reliable ways of making money.

WHAT IS THE STOCK MARKET DOING TODAY?

Anyone can look at the performance of the stock market with the help of market indexes like the S&P 500 or the DJIA. Previously, when the covid-19 cases in India were at a hike, the stock market fell drastically. But now, in the current scenario around 3.2 per cent of the 1,216 listed companies on the National Stock Exchange that have reported their June quarter earnings have managed to defy the odds by expanding their operating margins on a sequential basis for four consecutive quarters[5]. In India, currently, there are 40 stocks that are defying a widespread trend[6].

HOW TO INVEST IN THE STOCK MARKET?

  1. Decide the kind of account which you want to open: –

The first step to investing in the stock market is to decide the kind of account you want to open. Investment accounts can be opened for anything ranging from short-term goals to long, retirement savings to college savings etc.

  • Open a brokerage account: –

After deciding the kind of account you want to open, you have to open an account at a provider called a brokerage. When you choose a company, do look at their fees and available investment opportunities.

  • Depositing Money: –

To further continue with the investing process, you have to make an initial deposit. You can also set up recurring deposits to automate your investments going forward.

  • Choose your investments: –

Once you are done with the above-mentioned steps. You can buy and sell securities. You can take up mutual funds, exchange-traded funds (ETFs), individual stocks and bonds etc. These include hundreds of individual securities. It is recommended to have a diversified fund-based approach as it reduces the risk of losses and bad investments.

  • Purchasing chosen investments: –

After choosing what you want to buy simply enter the ticker symbol in the buy field and indicate how many shares you want to buy.

STOCK MARKET VS STOCK EXCHANGE

The stock market and stock exchange are two very different things but they are often interchanged with each other. The stock market is a wider term than the stock exchange. In fact, the stock exchange is a part of the stock market. The stock market includes many stock exchanges such as the Nasdaq or New York Stock Exchange (NYSE) in the U.S and NSE – National Stock Exchange in India.

We might have heard people talking about the performance of the stock market. When they talk about performance they mean thousands of public companies listed on multiple stock exchanges. In general, too stock market is a very broad term which comprises all the terms like mutual funds, ETFs, bonds and other securities beyond just stocks.


[1] Adam Hayes, ‘How Does the Stock Market Work?’, Investopedia (1st June 2021) < https://www.investopedia.com/articles/investing/082614/how-stock-market-works.asp&gt; accessed 1st September 2022

[2] Ibid.

[3] Ibid.

[4] Ibid.

[5] Chiranjivi Chakraborty, ’40 Stocks that  are Defying a Widespread Trend in India Inc right now, The Economic Times (1st September 2021) <https://economictimes.indiatimes.com/markets/stocks/news/40-stocks-that-are-defying-a-widespread-trend-in-india-inc-right-now/articleshow/85822852.cms > accessed 1st September 2021

[6] Ibid.