How Does The Stock Market Work For Beginners?

Basics of share market. How Does The Stock Market Work For Beginners

What is Share Market & how it works?

Share Market as the name suggests, means sharing, sharing of profits. When you buy shares of a company, you are entitled to recieve a "share" from the profits earned by the company. Lets see this with an example.

Businesses come to gather investment

 Businesses come to gather investment A group of people are running a business. They decide that they wish to expand their business, and so they reach to a bank and take a loan. They handed over a couple of their company's shares to the bank. As a result of this, this business will now share its profit with the bank. This type of "fund raising" is called debt. A few years later, they again decided to raise some more money. But this time, instead of going to a bank, they went to "Stock Markets". "Share" market, and "stock" market are same terms. Here in stock markets, they submitted their documents, and a price band was set for the prices of this business's shares. A total number of "maximum" shares to be sold are also decided. Price band is the basic amount between which people can offer to buy shares of this company. For example, the lower band, or lower range was set at 300 rupees per share. Likewise, upper band, also called upper range was set at 350 rupees per share. For our example, lets say that the company is selling a total of 100 shares. In practical terms, companies sell lakhs and crores of shares, but to keep our example simple and easy to understand, we are using 100 shares as the total figure. For the next few days, interested people, people like you and me, other investment companies etc, can place their offers to buy shares of this company. This is called Initial Public Offer, IPO of the company.

Initial Public Offer, IPO

 Initial Public Offer, IPO If the business is very good, and many people are interested in buying the shares, then people might place their offers at the upper band of 350 rupees per share. Not only this, but number of shares "demanded" might also cross the total available shares of 100. May be 500 shares are being demanded now. In this case, all the people will not get the shares. Some might not even get a single share. If its just an average business, then offers might be close to the lower band of 300 rupees only. Total demanded shares are also less than 100.

Investors entitled to get profits earned by company

 Investors entitled to get profits earned by company When the IPO gets closed, meaning new offers are not entertained anymore, and after distributing the shares to the people who got it, then the company gets listed in stock markets. Company got the investment it asked for, and people like you and me got the shares of the company. We are now entitled to get a share from the profits of the company. Company has sold its "Equity" to raise the funds it needed. We are holding equity shares of the company now.

Traders buying and selling stocks

 Traders buying and selling stocks On the day when the company got listed, people who did not got the shares, they will try to buy the shares from the "Share market" now. Suppose you got the shares during the IPO at 350 rupees per share, and I did not, and I want to own some of the shares. So my only option is to buy some shares from you. The company is not selling its shares anymore. They already sold what they wanted to sell. So now, I will try to buy shares from you. How can I do this? By giving you more price per share, isn't it?

Buyers place bids to buy stocks

 Buyers place bids to buy stocks I place a "bid" of rupees 360 per share. Suppose you agreed, and sold me some shares at this price of 360, then the "new" price of the share in the market is rupees 360. Suppose you did not agreed, and did not sold the shares, then I can further increase the "bid", but price of the share remains unchanged until a trade happens. The "Last Traded Price", also called LTP, is the price which you see in share markets. This is how price increases in stock markets.

Sellers asking price to sell stocks

 Sellers asking price to sell stocks Suppose, you got the share in IPO, and you want to sell it now. You placed a "offer", also known as "ask price", in the market at rupees 360 per share. Nobody came to buy. So you reduced your "ask price", and now you are asking 340 rupees. Someone bought a few shares, and now price of 340 is the LTP, which becomes the current price of the share in the market. This is how prices fall.

Upper and Lower circuits

 Upper and Lower circuits Stock Exchanges have fixed a minimum and a maximum limit for every stock listed in stock markets. These are called Lower and upper limits. Neither "bids", nor "ask prices" are accepted beyond this range, for that day. If a falling stock reaches its lower limit, then its said that it has hit a lower circuit. Sellers cannot ask lower "ask prices" for this stock now, but only for that day. Next day when the stock market opens, then again lower prices can be asked. Similarly, when a rising stock reaches its upper limit, then buyers cannot "bid" higher for that stock now, again, only for that day. The stock is said to have hit its upper limit now. Next day when stock markets open, then buyers can bid higher and buy the stock. Lets see an example. In our example above, you got the share at 350 rupees. Then you sold some of it at 360 rupees. I still want more shares, so I placed another bid of 370. You sold some shares to me again. Suppose the upper limit of the stock for that day is 400 rupees. I placed a bid of 400, and you sold me some more shares, but I want more shares. You are ready to sell me more shares at 410 rupees, but I cannot place a bid greater than 400, so no trade is happening. The stock has hit its upper limit now. Only way any trade can happen now is if you agree to sell me some shares at 400, otherwise I will have to wait till next day to buy more shares. Generally upper and lower limits are set at 5%, and in some cases exchanges can increase these to 10% to 20% on the same day. Notice, at this point, the actual company whose shares you have bought in IPO, is not benefitting in any way from this trading. This trade is happening between you and me, not between me and the company. The company got its investment money during the IPO, and now its just people like you and me who are buying and selling the shares.

Companies announce dividends, a share from their profit

 Companies announce dividends, a share from their profit At the end of 3 months, if the company made any profits, they might announce a "dividend". Dividend is the actual "share from profits" which share holders get. Suppose the company announced a rupee 3 dividend per share, and you have 100 shares of the company, then you get 300 rupees as your "share from the profit". To be entitled to earn this dividend, you need not hold the share for all 3 months. You can simply have the share in your account on the "dividend effective date", which is also announced by the company, and earn the dividend. Because of this reason, you will see prices of a share rising near the "effective date", specially if the dividend announced is high. The percentage of dividend announced, also called dividend yield, is calculated by dividing dividend per share by current price and then multiplying by 100. For example, price of share is 300 rupees. Dividend announced is 3 rupees, So dividend yield is 1% = ( 3/300 ) * 100 The higher the dividend yield, the better. You can find a list of upcoming dividends here:

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