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How does the stock market work?



Capital markets can be broadly categorized as,

  • a) Primary market
  • b) Secondary market

In a primary market, a firm offers its shares for the first time for subscription, commonly known as Initial Public Offerings (IPO). When an investor of the primary market wants to sell his holding, or buy additional shares, it can be done through Secondary markets.

The different kinds of participants in the capital or stock markets are individual investors, mutual fund houses, insurance companies, financial institutions, foreign institutional investors and corporate.

Working of a stock market

Any person desirous of trading in the stock market has to place an order with an exchange house/ broker, specifying the number and at what price he wants to buy, which in turn routes the order to the exchange. The exchange tracks the flow of orders of each stock at various prices. Once the matching of buying and selling price is done, the order is executed. The buyer pays the money and gets shares and seller pays shares and gets money through the broker. Now majority of the trading is done electronically.

Clearing and settlement

While, trading in the stock market one has to be aware of the settlement. Settlement refers to the process whereby payment is made by the buyer against shares delivered by the seller. The exchange ensures that the buyers receive the shares and sellers receive the payment in time. The entire process of settlement of shares and payment is managed by stock exchanges through clearing house, formed specially to ensure that the process of settlement takes place smoothly.

Clearing houses are entities setup by stock exchanges to ensure hassle free settlement. Brokers collect shares/money from their clients and deliver it to the clearing house on the day of settlement. Clearing house then ensures that money/shares are received by the broker, who in turn transfers to their clients. Clearing house guarantees the settlement of all trades and in case of default b a particular broker, it makes good the difference from its own funds.

Exchanges now follow rolling settlement cycle on T+2 basis, where T is trading day. In rolling settlement, settlement id done in two working days after transaction is done.

For example: if a person buys shares on Friday, he/she pays on Friday and the shares are delivered in his/her Demat account by Tuesday as Saturday and Sunday the market being closed.

Similarly, if a person sells shares on Wednesday, he/she gives shares from the Demat account and payment is credited in account by Friday. At NSE clearing and settlement is managed through NSCCL (National Security Clearing Corporation Limited). NSCCL manages a definite settlement cycle and without any deviations. It collects all transactions over a defined period and ensures liabilities of participant members in honoring the payment and delivery of shares.

What is Dematerialization or Demat account?

Dematerialization in short called as ‘demat’ is the process by which an investor can get physical certificates converted in to electronic form maintained in an account with the depositary participant. The investors can dematerialize only those shares which are registered in their name and belong to the list of securities admitted for dematerialization at the depositories.

Depository

The organization responsible to maintain investor’s securities in the electronic form is called the Depository. In other words, a depository can therefore be conceived of as a “Bank” for securities. In India there are two such organizations namely, NSDL and CDSL. The depository concept is similar to the Banking system with the exception that bank banks handle funds whereas a depository handles securities of the investors. An investor wishing to utilize the services offered by a depository has to open an account with the depository through a Depository Participant.

Depository Participant

The market intermediary through whom the depository services can be availed by the investors is called a Depository Participant (DP). As per SEBI regulations, DP could be organizations involved in the business of providing financial services like banks, brokers, custodians and financial institutions. This system of using the existing distribution channel (mainly consulting DPs) helps the depository to reach a wide cross section of investor s spread across a large geographical area at a minimum cost. The admission of the DPs involved a detailed evaluation by the depository of their capability to meet with the strict service standards and a further evaluation and approval from SEBI. Realizing the potential, all the custodians in India and a number of banks, financial institutions and major brokers have already joined as DPs to provide services in a number of banks, financial institutions and major brokers have already joined as DPs to provide services in a number of cities.

Benefits of Depository Services

Trading in demat segment completely eliminates the risk of bad deliveries. In case of transfer of electronic shares, you save 0.5% in stamp duty. It avoids the cost of couriers/notarization. No loss of certificates in transit and saves substantial expenses involved in obtaining duplicate certificates, when the original share certificate become mutilated or misplaced. Depository services offer many more services which you will only experience once you start trading in securities; therefore now I am not dragging more on that.

How to Open a Demat Account?

Opening a depository account is as simple as opening a bank account. You can open a depository account with any DP convenient to you by following these steps : Fill up the account opening form, which is available with your DP.

Sign the DP client agreement, which defines the rights and duties of the DP and the person wishing to open the account. Receive your client account number (Client ID).

This client id along with your DP id gives you a unique identification in the depository system.

There is no restriction on the number of DP accounts you can open. However, if your existing physical shares are in joint names, be sure to open the account in the same order of names before you submit your share certificates for demat.

How to dematerialize your share certificates?

Dematerialization of your existing share certificates, which are in the physical form is very easy open a demat account. You need to fill up a dematerialization request form, which is available with your DP. Submit your share certificates along with the form; (write “surrendered for demat” on the face of the certificates before submitting it for demat). Receive credit for the dematerialized shares in to your account within 15 days.

Stock Index:

Stock index helps in measuring the market movements. Return on the index is supposed to represent return on the market i.e. the return you could get if you had the entire market in your portfolio.

An index is a market representative, which serves as an effective proxy/sample to the market against which a portfolio can be benchmarked. Indices are efficiently used in developing derivatives products like index futures and index options. For example if an investor is bullish on the banking sector, he/she can buy futures on bank index, instead of buying too many different banking shares.

Index construction

An index consists of representative stocks, selected based on liquidity and market capitalization, industry representation etc. Index value is arrived at by calculating the weighted average of the prices of these stocks. Index is adjusted continuously for stock specific event like stock split, rights, bonus etc. Index is updated by replacing stocks as and when necessary to remain as market representative. Weights in calculating indices could be Market capitalization, price or equal weight. Market capitalization weighted method is the most widely used. Sensex and Nifty are market capitalization weighted indices. DJIA (Dow Jones Industrial Average) is price weighted index.

Bombay Stock Exchange

Bombay Stock Exchange limited or BSE is the oldest stock exchange in Asia, established in 1875. In a new face BSE is a corporate entity now. The BSE-Sensex is being tracked worldwide for investment in India. It follows "Market Capitalization Weighted” methodology.

BSE launched BSE-100 Index, the ‘BSE-200’ and the ‘DOLLEX-200’ indices to provide a better representation of the increased number of companies listed, increased market capitalization and the new industry groups. Followed by the launch of BSE-500 Index and 5 sectoral indices in 1999, BSE launched "Sector Series (90/FF)".

Bombay Stock Exchange

  • BSE Auto Index
  • BSE BANKEX
  • BSE Capital Goods Index
  • BSE Consumer Durables Index
  • BSE FMCG Index
  • BSE Healthcare Index
  • BSE IT Index
  • BSE Metal Index
  • BSE Oil and Gas Index
  • BSE Mid Cap Index
  • BSE Small Cap Index

The Exchange also disseminates various investment inputs like P/E Ratio, P/BV Ratio and the Dividend Yield Percentage on daily basis of all its major indices. You can also track more on these indices inhttps://www.bseindia.com/.

National Stock Exchange

NSE was promoted by leading Financial Institutions at the best interest of the Government of India and was incorporated in November 1992.

NSE first started operations in the Wholesale Debt Market (WDM) segment in June 1994, The Capital Market (Equities) in November 1994 and Derivatives segment in June 1990.

NSE has several Indices. S&P CNX Nifty being the prominent one, it consists of 50 stocks represents 25 sectors of the economy. It is owned and managed by India Index Services and Products Ltd. (IISL); joint venture of NSE and CRISIL. The index is used for benchmarking, derivatives and index funds etc. IISL manages various indices covering majority of sectors. For more details on National Stock Exchange and its Indices, you can also visit https://www.nse-india.com/.

Capital Markets