How the whole Stock Market Works

How the whole Stock Market Works

Basics of the Stock Market for Beginners

The world of stock investment is quite complex. And if you have decided to invest, or if you are thinking about it, it may seem very confusing to you.  So, to make it easy, MoneyPip decided to make this Article, where you’ll get all the information related to the world of stock Market investment topic-wise. 

It won’t help you to make money quickly, but you’ll be able to properly understand the world of investing and learn the stock trading basics. And you’ll also learn about the roles of important people of the world of stock investment, which will help you to make investment decisions. 

Like, cricket has an ecosystem having ICC as a unit. The cricket teams and cricket boards of all the countries are a unit.  After that, leagues like IPL and Big Bash are a unit. Stadiums are a unit. Different formats of cricket, like one-day, T-20, test matches, are a unit. Umpires are a unit. And all these units are interconnected. 

Similarly, Stock Market investment has an ecosystem which has several different units, like market participants, assets, instruments, SEBI, exchanges, brokerages & depositories, dealers/ brokers,  MoneyPip, Share Market, mutual funds, and many more. All these units are also interconnected  and constitute stock investment ecosystem.

Market participants

So, in this Article, we’ll tell you about all of them  topic-wise.  Today, we will discuss the first topic – market participants. Market participants means all the people and the companies  who invest in the stock market. 

>>>Market participants are of two types

• Retail Investors
• Institutional Investors

First are Retail Investors, who are people like you who trade or invest in stocks. The retail investors who invest a huge amount in the market are called HNI (High Net Worth Individual Investors).

The second type of market participants are Institutional Investors. They collect funds and then invest them. Mutual funds, hedge funds, corporations, banks, trusts, charities, all these fall under this category.

They may be based in or outside India. They have a very large amount to invest. That’s why, in the stock market, they have a higher share, and they can cause significant market movements. If we take a look at stock market participation in India, the retail investors have increased at a rate of 11% CAGR  in the past 10 years. 

If we compare, in the financial year 2009, 1.7 million new investors joined the market. And in the financial year 2019,  2.8 million new investors have joined the market. That was about the stock market participants.

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Assets and Asset Classes

In this article we will talk about assets and asset. So, what is an asset? 

What is an Assets classes?

In the language of Finance, an asset is that which has some economic value.  And people, thinking that it’s value will grow in future, buy them,    like fixed deposit, land, EPF, PPF, gold,  stock, etc. 

Now, let’s understand  what is asset classes. Imagine that you are in a mall. They have different sections like clothes, movies, gaming and foods.    And all those items are kept  in different sections or floors. Every section has  the same characteristics. Food section has all food-related shops.

It may be the case that food section  has many different varieties like pizza, dosa, North Indian, etc. But, their overall characteristics  remains the same, which is food items. An asset class is exactly like this. It is made up of those investments or securities whose characteristics are the same.

For example, in real estate asset class, investing options like residential flats, commercial spaces, lands are available. And it requires more time to buy and sell them as compared to Stocks. Market participants can put their money  in different asset classes or assets keeping  in mind their goals, objectives, and risk capabilities.

Asset Classes

Now, let’s see what are  the major asset classes and what are the characteristics  of each of them. The first asset class is fixed income. It gives you a pre-decided rate of return. You must have heard about fixed deposit.    Mostly FD gives the return of  around 7 to 8%. And it is the most common  and trusted form of investment in India. 

Apart from FD, PPF, EPF, Debt funds,  Government and corporate bonds, etc. Come under this asset class. Generally, this asset class  has very low risk. And it gives returns hovering around  inflation rate. 

The second asset class is Real Estate. Physical assets like land, residential  or commercial properties come under this asset class. This asset class is also used  to protect against inflation. This asset class does have a bit more  risk because property rates can change depending on the area of your property. 

It’s returns also remain  around the inflation rate. It is very complex to understand  this asset class. And it’s liquidity is very low, means it may take longer time  to buy or sell it. 

Third asset class is Commodities. This asset class consists of  those physical assets  which an investor can store and trade. It’s most common example is gold.  Apart from gold, silver, sugar, and  food crops come under this asset class. This asset class also have some risk. As in, the prices of all these items  fluctuate frequently. Talking about returns, they also give returns nearly  equal to the inflation rate. They are very complex to understand and they have high liquidity.   

And the fourth Asset Class is Equities.  This is the asset class  where by investing in it, you get the ownership, means shares of a company. You can trade these shares  on stock exchanges like NSE or BSE. Investors make profit  when share prices rise or when companies announce dividends.   

This asset class, on the basis of  market capitalization, can be categorized into small-cap, mid-cap, and large-cap stocks. This asset class is comparatively more risky. And it’s returns are also very high and it can easily beat the inflation. This asset class also requires  more time to understand and it provides high liquidity. 

So, which one is the best asset class  among these?  If we see on the basis of  long term returns only, then equity asset class in the last 20 years, has beaten all the rest of asset classes. So, should you put your money  into equities?  This decision depends on how much risk you can take and what is the objective  of your investment. 

Generally, it will be too much to say that by Investing Money into different asset classes the risk of your portfolio will be reduced because generally it has been observed that when an asset class is giving  negative returns at the same time, other asset classes  can give you positive returns also. 

And can balance your overall portfolio. So, this is all about asset classes.    Now, how to invest in  different asset classes? Through which different methods, we can invest in these asset classes?  

Infrastructure Providers

Stock Market

Now, we’ll talk about infrastructure providers of the stock market ecosystem. Infrastructure providers are the companies which enable the transactions  and functioning of different instruments. It means all the digital and physical infrastructures required for the investor to invest is provided by the infrastructure provider.

The most common example of  infrastructure provider is a stock exchange. Just like vegetable market is a place where you can buy different vegetables, similarly, a stock exchange is a place or platform where you can buy or sell different stocks. 

A stock exchange is a place where, with the help of a broker and the stock exchange, two investors can buy or sell stocks  without knowing each other. You must have heard about Bombay Stock Exchange (BSE) and National Stock Exchange (NSE). They are the two major stock exchanges of India where people buy or sell stocks. 

BSE was Asia’s first stock exchange  and over 5000 companies are listed on it. On the other hand, around 1600 companies are listed on NSE. And just like you can buy a phone or any other item both at Flipkart and Amazon,      similarly, you can buy stocks  both at BSE and NSE, provided that stock is listed and available to buy on that exchange. 

Second infrastructure providers  are depositories. Depositories are the companies who store the stocks bought by you in electronic form. Like, investors used to get a stock certificate earlier which you would store physically.  Similarly, in this digital age, the stocks bought by you are stored with the depositories. 

You can store stocks with the depositories  through your Demat account.      Depositories help you to transfer stocks and perform various other functions, like checking your statements, checking what stocks you do have, and providing information related to your transactions. An investor doesn’t interact much with the depositories, because, generally, your broker keeps in touch with the depositories and provides you all information related to your portfolio. 

Central Depository Services Limited (CDSL) and National Securities   Depository Limited (NSDL)  are the two major depositories of India. The third major infrastructure providers are RTAs, i.e, Registrar and Transfer of Agents. Just like there are depositories in case of stocks, there are RTAs in case of Mutual Funds. 

All trades of a mutual fund investor, like subscription, redemption, transfer, etc. are recorded by RTAs. RTAs also help mutual fund investors in providing their portfolio and statements to them. Whenever you invest or transact in a mutual fund, whether directly through AMCs, i.e, Asset Management Companies or through platforms like Zerodha Coin, Grow or Scrip-box, your transactions are processed by RTAs. 

And RTA coordinates with AMC to add or delete units from your portfolio. Cams and Karvy are   the two biggest RTAs of India. The fourth infrastructure providers  are AMFI, i.e, Association of Mutual Funds of India. It is an association of 44 active AMCs of India which helps in the development and promotion of mutual funds. 

You must have seen the ads “Mutual Funds SahiHai.” These ads and the promotion campaign  are also sponsored and launched by AMFI. So this was all about the major infrastructure providers.

Intermediaries and SEBI

Intermediaries

Now, we’ll talk about Intermediaries and SEBI. Intermediaries are the people or companies that perform essential tasks and functions  in the stock market ecosystem. The most common example of intermediaries is brokerage houses. Brokerage houses help investors in buying or selling the stocks. And brokers charge you with brokerage fees for that.

Brokers can be further divided   into Two Types. 

• Discount Brokers
• Full-Service Brokers

The first type is the Discount brokers, like Zerodha, Upstox. They just provide you a platform to execute trades. The second type is the full-service brokers  like HDFC Securities, KotakSecurities, that also provide advisory  and research services  apart from placing orders. Generally, discount brokers charge lower fees than full-service brokers. 

Your broker keeps in contact with   the stock exchange. And as soon as you place an order, your broker contacts with your exchange and buys or sells your stock. If you want to know in detail about infrastructure providers,   like stock exchanges, then do watch the fourth video of this series.  

Second intermediaries are AMCs,  i.e, Asset Management Companies.      They are commonly known as  Mutual Funds House. AMCs create and launch different mutual funds schemes. They use different filters like investors’risk profiles and objectives  to create different mutual funds.     

Two AMCs can also create mutual funds  for the same objectives, like large-cap investments. But they can be different in their fees, management style, etc. Currently, there are 44 AMCs in India that provide different mutual fund schemes. Apart from mutual funds, AMCs also create ETFs.

Third intermediaries are distributors or agents. These are the people who sell mutual fund schemes to you. They get a commission on selling the mutual fund. The fees you pay daily as an expense ratio are used to pay commission to the agents. Distributors or agents have an ARN, i.e, AMFI Registration Number, but they are not authorized by SEBI to give financial advice. 

The next intermediaries are dealers. They are people who can deal on behalf of investors. You must have seen people buying or selling stocks on their phones. Dealers are the ones who place investors’ orders on the stock exchange. Choosing stocks in the stock market always involves risk      because you never know if that stock will give you positive returns or negative returns. 

It’s even harder for new investors  and also requires a lot of research, or you may lose your money. There are three intermediaries to make it easier. They are research analysts, investment advisors, and portfolio managers. All these three types of professionals are registered with SEBI,      i.e. Securities and Exchange Board of India. Research analysts are the companies or people who research on stocks and make reports on them.     

But they can’t offer you  investment advice. After understanding your   investment objectives and risk, investment advisors research on stocks      and advise you on where to invest. Portfolio managers are the people or companies  who can manage your whole portfolio. They can also buy or sell stocks on your behalf. The point to note is   that a portfolio manager can perform all the functions of an investment advisor.

And an investment advisor can perform all the functions of a research analyst. So, that was all about different types of intermediaries. Now let’s talk about SEBI. SEBI governs all the units that we have discussed till now  in the video series on the stock market ecosystem. SEBI was established by the government of India in 1992 to protect the investors. 

Before that, investors were prone to many frauds. And SEBI was formed   to deal with this problem. The main objective of SEBI is to ensure that all the units   in the Indian stock market run in a defined and systematic manner, and investors get transparency  and all the essential information before they invest   so that they can be safe from fraud.

SEBI keeps introducing new laws and rules which help investors  and the whole ecosystem. So, that was all about the intermediaries and SEBI. This video series on the stock investing ecosystem ends here. It takes quite a knowledge and research to invest in the stock market. And this was our small initiative to make stock investment easier for you. 

We hope that you have got more details about the major units in the stock investment ecosystem and you have understood  how the whole stock market works. If you have any questions  on any topic of this entire Article, please do tell us in the comment section below.