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Basics of Stock Market

A basic understanding of the stock market and its functioning, trading/investment tools, various trading segments and their features, will help take investors/traders prudent investment/trading decisions.

Stock Market is a financial market place which facilitates transactions in securities comprising of corporate and government securities. These are long term, fund rising instruments from public. The various ways of raising funds include::

Initial Public Offer (IPO)under it, funds are raised from the public for the very first time by sharing the ownership.

Follow-on Public Offer (FPO) wherein already listed company issues more shares in the public to raise more funds.

Rights Issue is the method of raising additional finance from existing shareholders by offering securities to them.

Developments of aforesaid nature takes place in Primary market while Secondary market enables stock holders to adjust their holdings in response to changes in their assessment of risk and return which ultimately gives the rise of stock transactions/trading.

Demat and Trading Accounts

In order to invest in shares or stocks, one is required to have Demat and Trading account opened with a registered share broker. Share brokers play the role of intermediary in between investor and stock exchanges.

Demat Account: Account where shares are stored in electronic form. Nowadays it has become compulsory to have demat account opened before investing in shares or stocks.

Trading Account: An account which is used to place orders for buying and selling of shares. Trading account is a link between Bank account and Demat account.

When a trader intends to buy shares, he/she needs to first transfer funds from his/her bank account and then shares are transferred to his/her trading account which are then stored in the demat account as per instruction.

Similarly, when a trader intends to sell stocks, his/her trading account takes back the shares from his/her Demat account and sells them in the market. The money is transferred to seller’s bank account after settlement as per instruction.

Types of Stocks

Investors can invest in various types of stocks. Stocks are classified based on various aspects.

Common stock and preferred stock:

On the basis of ownership:

Common stock represents the ownership in a company whereas preferred stock holders have just partial ownership.

Common stock offers more potential over the long term. In addition, stockholders can also vote to elect directors and on other important company matters.

Preference share holders have got preferential rights in the matter of dividend distributions as they enjoy greater priority at the time of distribution of surplus by the company. These stocks are less risky and therefore payouts are generally lower than common stocks.

On the basis of Market Capitalization:

Market capitalization of a stock, is calculated by multiplying the share price by the total number of issued shares. Below given are three different categories of stocks based on market capitalization.

Large Cap stocks:

These are stocks whose market capitalization is high, their market capitalization usually varies from Rs. 200 billion to Rs. 3500 billion. These are large and well-established companies with huge cash reserves and a strong presence in the market. Blue-chip companies such as Infosys, TCS and Wipro which have established themselves as leading players are classified as large cap stocks.

Mid Cap stocks:

These are stocks whose market capitalization is in the range of Rs. 250 to 4,000 crore. These stocks lie between large cap stocks and small cap stocks. Mid caps are medium-sized companies and are riskier than large cap stocks. These are more promising stocks which tend to grow faster in long future.

Small Cap stocks:

These are stocks whose market capitalization is in the range of up to Rs.250 crore. They generally include the start-ups or companies in the early stage of development. Small caps are riskier as they are more likely to default during a downturn. However, they have lots of room to grow and can prove to be a wise 'long term' investment.

Key financial instruments trading in the stock market

Shares/ Equity:

Equities or stocks represent ownership of a company. One can buy or sell shares through broker. By investing in shares, investor receives income in the form of dividends and appreciation in the value of shares.

Bonds:

Bonds, also known as fixed-income securities are issued by borrowers to raise money from investors at an agreed interest rate (known as coupon rate) for a specific period of time (maturity date). It is less risky compared to stocks. Corporate, governments and other entities use bonds to fund projects as well as other activities. Investing in bonds, simply mean lending money to a government or a company.

Mutual Funds:

An alternative investment option to stocks and bonds is mutual funds. It is a professionally managed trust, known as Asset Management Company (AMC) that pools money from investors who are also known as unit-holders. The money is invested in various financial instruments and profit generated from the investments is distributed among unit holders in proportion to units held by them.

Mutual funds are low cost investment that provides professional management of funds and enables diversifying your portfolio across various securities to minimize risk as well as diversification of the portfolio.

Derivatives:

A derivative is a contract between two parties which derives its value from the underlying asset. It can be index, equity, commodities, currencies etc.

This instrument provides a good leverage opportunity and is a great tool for hedging, speculations and arbitraging. It can be traded in index futures and index options, stock futures and stock options.

Government securities market

Fixed income securities issued by the Government, Municipal Corporations and also financial entities such as Banks, PSU’s and others are known as government securities.

Negotiated Dealing System (NDS):

NDS is an electronic trading platform, regulated by RBI, which facilitates the exchange of government securities and other money market instruments.

The NDS has two modules, one each for the primary and secondary market respectively.

Auction is used by RBI for auction of securities issued by the central and state government as well as treasury bills. This electronic platform allows the participants to submit the bids and receive allotment papers.

The secondary market module is used for trading in government securities over-the-counter.

Over-The-Counter (OTC):

The participants report the trades on the NDS. On completion of the reporting process and the trades accepted by the system, the data is transferred to Clearing Corporation of India Limited (CCIL) which is a clearing and settlement agencies especially for government securities.

Negotiated Dealing System- Order Matching (NDS-OM):

It is an electronic, screen based, anonymous, order driven trading system to buy/sell Government securities. RBI introduced NDS-OM in August 2005. It is owned by RBI and maintained by CCIL