How share market works?
Updated: Jan 29
Everyone knows about share market these days. People are aware that share market is place where we can buy and sell shares of a company. However, there are some nuances that I think people are not aware of, and hence this is my attempt to explain the overall process from scratch. I will be explaining the topic in brief and there is further depth to the topic. My goal is to explain in such a way that an average person is able to understand and comprehend the overall process without any difficulty. I will try not to use any term that is not well understood by an average person. So, lets start!
What is a company?
Company is a legal organisation meant to conduct business and earn profits. These companies might produce some products or services and provide it to its customers and earn profit in the process.
What is a share?
Companies can have single or multiple owners. Companies have many reasons to have multiple owners. Suppose there is a company that needs Rs. 100 for to be established and the money can be arranged from 5 individuals, then each of them owns portion of the companies. If the whole company is valued at Rs. 100 and there are 5 owners with equal ownership then each of them owns 20% of the company. If Rs. 5 is the profit of the company then each one of them is entitled to Rs. 1 as their share in profit (20% of Rs. 5). Overtime owners might want to increase/decrease their portion of their ownership. To aid the same, shareholding is defined in terms of "share". A share is the smallest ownership possible in a company. In the above example, if the company decides to keep the share prices as Rs.1 then each of them will have 20 shares. Nobody can own half a share. They have to buy/sell at least one share. The seller of the share will receive Rs. 1 for each share sold and buyer will get 1% in exchange of Rs. 1 in this case. Thus shares aid the process of ownership transfer and keeping the ownership in a liquid form.
What are types of companies?
There are different types of companies. There are many categorisations possible but we will stick to the categorisation where the differentiation is based on the number of owners of the company.
One man company: This is a company where all the ownership is with only one person. All the profits and losses will be his/hers.
Private Company: A company where the share holders are between 2 and 200. These companies can not offer shares to public.
Public Company: A company where a shares can be offered to public. These companies must have minimum 7 share holders. There is no limitation of maximum shareholders in a Public Company.
Out of the above, only public company is the one we are interested in as the other two are not for general public at large. Please remember, there are many other requirements and categories of businesses. We are keeping the view plain and simple to understand the concept.
What are stock exchanges? What is NSE and BSE?
Stock exchanges and stock market are used interchangeably for organisations that aid transfer of shares from one owner to another. NSE (National stock exchanges) and BSE (Bombay stock exchanges) are important stock exchanges in India.
Types of Public Company
Based on how the company shares are traded between owners, public companies can be classified as -
Listed Public company: These public companies's share are freely traded in stock exchanges like BSE and NSE.
Unlisted Public company: These public companies's shares are not traded on stock exchanges and are traded in over-the-counter (OTC) marketplaces. OTC marketplaces are decentralised markets where the exchange of shares happen directly between the parties without any broker or exchange.
What is a stock broker?
In earlier days, the trades on stock exchanges used to happen through brokers that used to place orders manually in the exchanges. These brokers were called stock brokers. However, nowadays most of the trades happen electronically through broker terminals. There are many stock brokers in India like Zerodha, Upstox, Groww etc. These brokers usually charge a fees for facilitating the trade.
What is demat account?
Demat account gets its name from dematerialised account. These demat accounts are digital lockers where shares and other securities are stored. These accounts are created in depositories like CDSL(Central Depository Services Limited ) and NDSL (National Depository Services Limited). Your broker will only aid the transfer of shares from/to your demat account that resides with your depository.
How share market works?
Any transfer of shares between two parties will happen only if there is a difference in opinion on the price of share. Buyers think that the price is going to increase further and sellers will think that the prices are going to decrease. This difference in opinion creates a need to exchange of shares for money. To aid this transaction, buyers and sellers place their orders in stock exchanges and wait for their orders to get filled. The present systems are electronically operated and order placement and allocation happens very quickly in real time. There are many checks and balances to this system. Once your orders are filled the shares will be visible in your demat account. If you are a seller then the corresponding amount (after deduction of fees and taxes) will be reflected in your broker terminal. You can read about the details of allocation process in the article on Auction theory in my blog.
What happens when you hold the shares of a company?
When you buy shares of a company you are part owner of the company. You get to participate in the decision making of the company. If company makes profits and decide to distribute it to its shareholders, then you will get the dividends basis the same. You will be invited for Annual General Meetings( AGM) and will participate in choosing board members that will manage the business.
How share holders exercise their control over the company?
Every publicly traded company has a board that takes decision on important matters. These board members are elected by the shareholders through voting/nominating. The voting rights will be proportional to the percentage of shares an individual/organisation holds. Large investors have huge capital deployed in the company and will be effected more from the performance of the company, and hence higher voting power. Shareholders will chose board members that are aligned to their point of view and will act according to the same.
I hope this short article was able to help you comprehend the overall process. The whole article is designed for a very mechanical understanding of the markets and there are many details I have left out intentionally. Please consider this as a starting point in the journey and dig deeper into the topics if you want.
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