What is Stock Market?

After understanding the IPO process and the reality behind the company’s primary and secondary market, let’s move on to the next phase of the stock market.

Being a public company, now the company has to disclose all the information which is related to the company to the people. The shares of a public limited company are bought and sold every day on the stock exchange.

We will understand in detail in this chapter the reasons why the participants in the stock market buy and sell shares.

What is the stock market after all?

As we read in Chapter 2, the stock market is an electronic market, where sellers and buyers interact together.

For example, take the current situation of Infosys. At the time of writing this chapter, who will be the next successor to Infosys has been a big issue and many senior employees have also resigned from the company in the recent past. Due to this the prestige/reputation/value of the company is getting affected. And because of this, the company’s stock fell from Rs 3,500 to Rs 3,000. Whenever there is news of a change in management, the company’s share price i.e. share price/stock price gets affected.

Suppose there are two traders – T1 and T2

T1’s view on Infosys – The company’s stock will go down further as the company may face a lot of difficulties or challenges in choosing a new CEO.

If T1 deals with this view then it should sell Infosys shares.

But T2 is looking at this situation differently and has a different point of view. According to him, the stock of Infosys has already shown a lot of response on the successor issue, now soon the company will get a new leader and after that, the stock of the company will go up after his arrival.

If T2 goes into the deal with this view, it should be a buyer of Infosys stock.

So at Rs, 3,000 T1 will be the seller or seller and T2 will be the buyer of Infosys.

Now both, T1 and T2, will give buy/sell instructions through their respective stockbrokers and the broker will execute these deals through the stock exchange.

The stock exchange will ensure that both the orders are received and the transaction is completed. This is the main or primary function of the stock market, to provide or create a platform where buyers and sellers can trade shares.

A stock market is a place where market participants trade in listed companies according to their respective perspectives. And the deal will happen only if the partners have different perspectives. Buying and selling can happen in the market only when there is a different point of view.

6.3- How do share prices move up and down? Or how and why does the share price change?

Let us try to understand the movement of the stock with the example of Infosys. Let’s say you trade in the market i.e. you are a participant of the stock market and keep a close eye on the Infosys company.

It is June 11, 2014, it is 10 in the morning and the price of Infosys is Rs 3000. The company’s management gives this news in the media that the company has got a new CEO, who will take the company to new heights. The company has full faith in the ability of that new CEO.

Two questions come here-

How will this news affect the Infosys stock price?
If you want to deal in Infosys, would you buy or sell shares?

The answer to the first question is very simple. This news will increase the share price of the company.

There was a problem with the leadership of the company in Infosys, and now that problem has been resolved. When such a positive announcement is made, the market participants try to buy the stock at any price and that is why there is a sharp rise in the stock which is called a rally in the market language.

Let’s understand this in a little more detail…

No.	Time	LTP	Selling Price	Buyer Perspective	New LTP
1	10:00	3000	3002	Buying	3002
2	10:01	3002	3006	Buying	3006
3	10:03	3006	3011	Buying	3011
4	10:05	3011	3016	Buying	3016

Note that the buyer is ready to pay whatever the seller is asking for. This reaction, between the seller and the buyer, causes the price of the stock to go up.

As you can see the share price increased by Rs 16 in 5 minutes. Although this example is a hypothetical situation, it actually happens. The stock price rises on the expectation of some good news coming or going.

In the above example, there are two reasons for the stock price to go up. One, the issue of leadership of the company was resolved. Second, the new CEO who has come will take the company to new heights.

Now the answer to the second question is very simple, you will buy Infosys stock because good news has come about the company.

Now let’s move on to the same day. At 12:30 PM, ‘The National Association of Software and Services Companies’ ie NASSCOM issued a statement/notification. NASSCOM is the trade association of Information Technology companies of India i.e. IT companies and its words mean a lot for the IT industry.

So Nasscom said in the notification that there are indications that there has been a decline of 15% in the IT budget of the customers, and its impact can be seen further on the IT industry.

At 12:30 PM, assume that Infosys is trading at 3030. A few questions for you…

How will this new information affect the stock of Infosys?
If you had to make a new deal after this news, what would it be?
What will be the impact on other IT stocks in the stock market?

The answer to all these questions is very simple. But before answering let us understand the notification of NASSCOM in detail.

Nasscom said that there is a possibility of a 15% decline in the IT budget of the customers. This means that there will be a decrease in the income and profits of IT companies. So this is not good news for the IT industry.

Now let us try to answer the above 3 questions…

Since Infosys is the largest company in the IT sector, there will definitely be a reaction there. But this reaction may not be visible in any one direction because on the same day, some time back, good news has also come from the company’s side. But a decline of up to 15% in earnings is not a trivial matter, and hence the stock price of Infosys may see a fall.

If someone wants to make a new deal at 3030, then there will be a deal to sell Infosys.

What has been said in the notification of NASSCOM will be applicable to all IT companies, not just Infosys. So in such a situation, selling pressure can be seen in all IT companies.

So as you have seen that the participants of the stock market react to the news and events and due to that reaction the price of the shares keeps on fluctuating.

Maybe a very reasonable question comes to your mind at this time. You might be thinking that what will happen if today there is no news about any one company? Will there be no change in the share price of that company?

The answer to this question can be yes or no and it completely depends on the company that is being talked about.

For example, let’s say that there is not a single news about two different companies…

Reliance Industries Limited
Shree Laxmi Sugar Mills

As we all know that Reliance is one of the biggest companies in the country and whether news comes about this company or not, market participants keep buying and selling its shares, hence its share price keeps on changing continuously.

Many people do not know the other company, so if there is no news on that company, then the share price may not change, and even if there will be a change, then it’ll bevery little.

In short, it can be said that the price changes due to the anticipation of news and events. These news and events can either be directly related to the company or industry or related to the entire economy. For example, Narendra Modi becoming the Prime Minister was seen as positive or good news and as a result, the entire stock market saw a boom.

In some cases, there may be no news yet there may be a change in the prices. This may be due to demand-supply.

How is the trading of shares done?

You decided to buy 200 shares of Infosys at Rs 3030 and keep this stock with you for 1 year. But how does this happen? How does the whole process of buying shares go? What happens once you buy a share?

Fortunately, there is a very good process for this which makes the whole job easy.

To buy Infosys, you need to log in to your trading account (provided by your broker). After placing an order to buy shares, you will receive an order ticket containing the following information:

The price at which you wish to buy Infosys shares.
How many shares do you want to buy?

Before your broker passes this information on to the exchange, he will want to know that you have enough money to buy these shares. When he is satisfied that you have the money then your order ticket will be sent to the stock market. After the order reaches the stock exchange, the exchange will try to find a seller (through its order matching software) who is willing to sell you 200 Infosys shares at 3030.

Maybe the seller is only one person who is ready to sell the whole 200 shares at 3030 price or there are 10 people each of whom wants to sell 20 shares or there may be only two people, one with 1 share and the other Ready to sell 199 shares. How many people are there whose sold shares are coming to you, it is not very important, it is important for you that you get 200 shares at 3030 price. You have ordered this. The stock exchange tries to do that if there are sellers present in the market then you get the shares. Once the deal is done, all these shares will be electronically credited to your Demat account and will be electronically deducted from the seller’s Demat account.

Shares are yours, now?

After you buy the shares, the shares remain in your Demat account. Now a part of the company is yours i.e. you are also a partner in the company. To understand, let us tell you that if you have bought 200 shares of Infosys, then you are a shareholder of 0.000035% in Infosys. Being a shareholder of the company, now you will continue to get all the facilities like dividend, stock split, bonus, rights issue, voting rights, etc. We will understand all these in detail later.

What is the holding period?

The holding period is the period for which you wish to hold the shares. You will be surprised to know that the holding period can be anywhere from a few minutes to a long time. For example, when asked by well-known investor Warren Buffett, he said that for me the holding period means holding the stock forever.

In this chapter, we have seen earlier in an example how Infosys share rose from 3000 to 3016 in 5 minutes.

This is a very good return for a holding period of 5 minutes and if you are satisfied with it you can close the deal and exit and find a new opportunity for yourself. This is entirely possible in the market. Many times such deals happen when the market is bullish.

HOW TO VIEW THE RETURN?

Everything in the market revolves around a specific issue and that is whether you are getting a good return on your investment or not. If you are earning good money or getting good returns in your deals then all your past mistakes can be forgiven because getting returns is the most important thing. Returns are generally viewed as annual earnings. There are several methods of measuring returns that you need to know. Below we are telling you some methods of returns and how to calculate them.

Absolute Return – This return tells you how much you have earned on your transaction or investment. This part gives you the answer to the question that if I bought at Infosys 3030 and sold it at 3550, then what percentage of the total money I made in this deal.

The formula to measure this return is:

{Sell price÷Price at the time of purchase-1}×100

in our example

{3550÷3030-1}×100

= 0.1716×100

= 17.16%

This would be considered a fairly good return.

Compound Annual Growth Rate (CAGR) – If you want to compare your two investments, then the absolute return is not a very good measure. For this, you have to take the help of CAGR. If I bought Infosys share at 3030 price and held the share for 2 years and then sold it at 3550 then CAGR will be useful to know how fast my investment grew in these 2 years. Time plays an important role in CAGR whereas it does not play any role in total return.

The formula to calculate CAGR is:

Here Ending Value = Selling Price

Beginning Value = Buying price

Now if you put this formula in your question then

{[3550/3030]^(1/2)-1}= 8.2%

This means investment grew at 8.2% for two years. We all know that at present, fixed deposits (FDs) are getting returns of up to 8.5% in many places in the country and the capital is also safe there. In such a situation, a return of 8.2% will not look attractive.

That is why whenever you want to know the returns of many years, then CAGR should be used. Use Absolute Returns only when you want to know returns of one year or less.

What if you bought Infosys at 3030 and sold it for 3550 within 6 months? In that case, you will earn a return of 17.6% which is a return of 34.32% (17.6%*2) for one year.

So it is always best to measure the returns annually.

What are you in the market for? / Where are you in the market?

Each market participant comes with his own unique style. His style gets better as he spends time in the market. How much risk a person can take in the market also affects his style. Each participant either falls under the category of trader or investor.

A trader is a person who recognizes the opportunity and makes a deal with the expectation that he will exit the trade as soon as he gets the profit. A trader’s perspective is very short-term. A trader is always alert and at the time of the market, which we call the market hour, is always looking for opportunities and keeps on assessing his risk and reward. The trader does not give priority to anyone in bullish and bearish, he just keeps looking for opportunities. There are 3 types of traders.

There is no problem with taking it. For example, he will buy 100 shares of TCS at Rs 2212 on June 12 and sell it on June 19 at Rs 2214.

Some of the world’s famous traders are – George Soros, Ed Seikota, Paul Tudor, Vaughan K Thar, Stanley Drucken Miller.

An investor is one who buys a stock with the expectation that it will make a substantial profit. He is ready to give his investment a long time so that his investment can increase. The holding period for an investor or investors can be of a few years. Generally, there are two types of investors…

Growth Investor – This type of investor tries to find such companies which have opportunities to grow. Because of the emerging industry or because of the current economic situation. Buying companies like Hindustan Unilever, Infosys, Gillette India in India in 1990 would have been an example. These companies have shown great growth since then as their entire industry has undergone major changes. These companies have created a lot of wealth for their shareholders because of this growth.

Value Investor – A value investor tries to identify good companies and invest in them. It would have been important for the company to be in its early stages or a well-established company in the market. A value investor is always on the lookout for a company that is getting below its original value due to a bad market mood. An example of this is the shares of L&T. Due to the bad environment for some time, the stock of L&T fell badly in August-September 2013, this stock fell from ₹ 1200 to ₹ 690. At ₹690 (considering the fundamentals of the company), its valuation was quite affordable. So this was a good opportunity to buy it. The investors who bought it at that time also got its reward when in May 2014 this share reached 1440.

Some of the well-known fall value investors are Charlie Manger, Peter Lynch, Benjamin Graham, Thomas Roe, Warren Buffett, John Bogle, John Templeton, etc.

So what kind of investor would you like to be in the stock market?

Highlights of this chapter –

1. The stock market or share market is the place where a trader or investor can buy or sell shares.
2. A stock market is a place where sellers or buyers meet electronically.
3. There are people in the market with different views and perspectives.
4. The stock exchange provides the facility that buyers and sellers can meet electronically.
5. Events and news drive stock prices up and down every day.
6. Stock prices fluctuate due to demand and supply.
7. When you own a share, you can get facilities like bonuses, dividends, rights from the company.
8. Holding period means how many days you hold that share.
9. When the holding period is one year or less then you should see the total return and if the holding period is of several years then you should see the CAGR return.
10. There are two main differences between a trader and an investor – the risk appetite and the holding period.