Finesse, the finance club of Loyola Institute of Business Administration, recently hosted an interactive session with TR Arulrajhan, CEO, ECTRA. It was the inaugural lecture on how the stock market works.
Here are some of the points discussed over the course of an hour:
What is a stock market?
Before we get into how a stock market works, let us discuss what it represents. In simple terms, a market is where people come together and exchange goods for a price as determined by the perceived value of the goods being traded. So, a stock market is essentially a place where stock is exchanged between individuals. It is also known as share market because the stocks represent company shares.
Why do companies issue shares?
As per the Companies Act, 2013, one type of company recognised in India is a public limited company. These companies can approach individuals through recognised platforms such as stock exchanges to raise capital for their business in return for a certain percentage of ownership in the organisation. This is what a share stands for — a financial instrument that makes the holder part-owner of the company in question.
When a company is required to raise a certain amount of capital as investment for the growth of the business, shares are issued at a price that can be purchased by individuals through the stock exchange.
In case the company has significant amount of cash and wishes to share a percentage of its profits with the investors, it may choose to take back the shares from the shareholders (known as buy-back) and help them earn good returns. Many companies in India such as Wipro and Dr Reddy’s Laboratories have announced buyback of shares. The government decided to make dividend incomes of more than ₹10 lakh taxable. Share buybacks will help investors earn their returns without the risk of paying additional taxes.
Why would someone be interested in buying company shares?
Apart from the feel-good factor of being the owner of a company (even though it is to the tune of .00001 per cent ownership), the share market is one place where people can get good returns on their investments. Of course, there is always a risk but it is worth taking because where there is no risk, there is no gain.
If you have ₹1,000 today and you want to increase it without doing any work, what do you do? Do you simply put it in a box and pray that the a god will take pity on you and do something to multiply the money? That’s wishful thinking!
Investing is always the wise decision but there are so many investment options, what do you choose?
For some, fixed deposits are a good choice because you are assured of a periodic return, even though the returns are not great. You could invest in land but that is possible only when you have a substantial sum to invest. And red-tape bureaucracy can eat into your net returns. Chit funds may seem like a wonderful option as far as quick and substantial returns are concerned but that is one alley best avoided!
This leaves us with the share market, which, though fraught with risks, is always a good choice. With some judicious decision-making and proper knowledge of the market, you can earn high returns on your investments. Initially it may seem as if your money is doing no more than sitting idle with someone else... you need to be patient. In fact, you should simply put your money in a reliable company and just forget about it. The money will grow with time and reach proportions that you could have only dreamt of. In five years’ time that ₹1,000 could well multiply into ₹1,00,000!
Of course, there is another side to this coin where you can end up losing a million in a day. It may not always be your fault for there are a number of external factors at play. For every Reliance Industries and Wipro that the Indian stock market has produced, there has been a Satyam and Kingfisher Airlines.
While investing is one way of getting returns from the stock market, trading is another option. This is a short-term approach where you sell your shares as soon as they have made marginal profits so that the money can be utilised in buying other shares. Trading requires a great deal of focus and energy, and is a stressful activity meant only for professionals in this field. It is rare to find someone involved in trading when they don’t want immediate returns on investments.
How do I get started with the stock market?
An individual needs to open two accounts for investing in the stock market — a trading account and a demat account. The trading account keeps track of all financial transactions while the demat account keeps track of the share transactions, and each of them has unique account numbers.
For example, let’s say X opens a new trading account and a demat account with respective account numbers TA001 and DA001. TA001 contains an amount of ₹10,000 as initial deposit and DA001 is null. Now X wants to make his/her initial investment in the stock market. After research and consultation, she/he decides to invest in company A whose current share value is ₹50. The person does not want to put all their eggs in one basket so they plan on starting small with 20 shares. He/she calls up their broker or trading agent Y and asks them to buy 20 shares in X’s name. Y asks X for their demat account number and initiates the transaction for 20 shares to be credited to account DA001. TA001 is linked with this account and an amount of ₹1,000 is debited for the transaction. Thus, X now has 20 shares of company A in account DA001 and a balance of ₹9,000 in TA001.
Now X intends to wait for a year before doing anything more with these shares. Meanwhile, she/he will focus on investing the remaining ₹9,000 in other company shares to get good returns. They have a target of 50-60 per cent returns and aim to achieve the same. Also, they find the whole process of calling up Y tedious and does not like the idea of having someone else doing the exchange for them. There is always the possibility of human error so they have installed an app on their smartphone and now has direct access to the share market.
Is it possible to forecast what price the stocks of a certain company will reach in a given time?
Numerous analytical tools and mathematical models have been developed to give accurate predictions on the performance of stocks in the market. Some analysts also refer to yearly performance charts to give a prediction on whether one should buy, sell, or continue to hold the shares of a given company. However, there could be various factors that result in failed predictions.
Where do the SENSEX, NIFTY and BSE, NSE come into the picture?
SENSEX and NIFTY are indices that reflect the mood of the stock market rising and falling based on various factors such as government policies, announcements, weather, polls, and a host of other economic factors.
The Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) are the two major platforms through which share trading actually takes place. In analogical terms, these may be regarded as the wholesale markets — the fixed-price kind, strictly no bargaining allowed — where companies and shareholders come together for a number of hours every day to trade the shares in their possession.
Initially, interested parties willing to purchase company shares would have to go through a convoluted and complex process that involved huge volumes of paperwork. To make life easier for them, the government decided to digitise these shares and created two storehouses for the shares floating around in the market — NSDL and CDSL. Later, national and regional exchanges were set-up to further ease the trading process. Of these, NSE and BSE are the ones that retain their prominence today.
Artificial intelligence in share market.
Artificial intelligence has been spreading its tentacles everywhere and the stock market has not been left alone. Algo-trading is a new technique where programmed logic is used for trading activities. Returns have been reasonable thus far and it remains to be seen how far this concept develops in the years to come.
Foreign investor influence.
While foreign investors do not directly influence the stock market, any announcement on foreign investments entering the country acts as a trigger that sends the market soaring. Foreign investments are usually a sign of progress and economic development, factors that always bode well for the stock market. Similarly, the trading indices plummet when investors exit the economy.
(The author is a student at LIBA.)