What is Stock Market in Simple Words? and How It Works?

What is the stock market?

This article is the first lesson of this course, where we need to understand what a stock market is and how it actually works.

If we try to understand the definition of the stock market on different websites, it is very easy.
According to other websites, the stock market is a place where stocks of companies, also known as shares, are traded, i.e., financial instruments are bought and sold.

A Stock Market is also known as equity market or share market.

But when we think of the Market, the first thing that comes to mind is a place or a shop where we can buy the things we need. E.g., Food, Clothes, Groceries, Medicine, etc.

Similarly, the stock market is also a place where we can buy stocks, bonds, ETFs, and other financial instruments. In simple words, the stock market is the “stock exchange.” The word “exchange” means to trade or barter. It means it is a financial institution where company stocks and government bonds are traded.

Why is stock market is necessary?

Let’s understand that, in simple words, as we discussed above, a Stock Market (Stock Exchange) or Share Market is a place where stocks (Shares), bonds, and other financial instruments are bought and sold.

Similary, in India, There are two main stock exchanges, BSE (Bombay Stock Exchange) and NSE (National Stock Exchange), available for buying and Selling of those financial instrument or trading.

Now, sometimes, the question arises in our mind: Why is the stock exchange necessary? Let’s understand it, Why is the stock exchange is established? idea behind the Stock Market / Stock Exchange.

Maybe only a few of us know that the first stock exchange in the world was the Amsterdam Stock Exchange, which some people established. The idea behind establishing the Stock exchange was to provide funding for those who wanted to start new businesses. And for raising funds, they came up with the idea of issuing shares that investors could buy.

But this is not the only thing behind the establishment of the Stock Exchange.

Let’s assume that you want to invest in some ABC company. What first thought comes to mind? What about security and safety? Before investing, we always think about the safety of our hard-earned money.

Similarly, when stocks / shares are exchanged between people or institutions, it becomes necessary to have documentation and records to avoid fraud and to have control over the transactions. People need to be confident that the transaction and the exchange they are making are safe and secure.

And this is how the exchange house or exchange board, was created. Today, we all know it as the stock market or stock exchange.

Stock Market: How it Works?

Let’s understand How stock market works with one simple example.

Suppose you want to buy some vegetables or fruits. So you don’t go directly to the farmer to buy them. Right?

Here, some people might say that they do go directly to the farmer. But what if you need to buy different vegetables or fruits at the same time?

Would you go to different places to buy different things? Exactly not! For example, if you want to buy an apple, would you go to Kashmir, or to Nagpur to buy oranges, or to Kerala to buy coconuts?

So, it is not practically possible to go to different places to buy different things.

That’s why we have vegetable and fruit vendors at our places. They buy them from farmers and sell them to us. Similarly, as we don’t go directly to the farmer to buy vegetables or fruits. The farmer sells vegetables to brokers in a big vegetable market. The broker then auctions the vegetables and fruits to the small vendors. and that Small vendors bid on them and buy them. Afterwards, the shopkeepers add their profit and sell it to us.

Now you will understand easily how the stock market works.

There may be some differences, but the basic concept remains the same. A company that wants to raise funds to fulfil its financial needs, such as expansion of business, payment of debts, or other production-related work, will issue an IPO (Shares) in the market.

Let’s assume that a company named “ABC” wants to raise a $100 million fund. The company decides to sell 100,000 shares in the stock market. On the other side, some investors want to invest in new companies. Now suppose you are also an investor and want to buy 1000 shares of “ABC.”. Now The company wants to sell their shares, and as an investor, you want to buy them. But who will guarantee this transaction? Who will ensure the safety of this transaction?

That’s where the stock market comes in.

The stock exchange not only allows transactions between the company and the investor,. Also, it ensures the safety of that transaction. Here, the Stock Exchange works as a mediator. In reality, The exchange itself does not carry out the transaction. Instead, broker firms carry out the transaction on behalf of the exchange. However, the exchange is responsible for its security.

What are the Financial Instruments in the Stock Market?

Here, we have earlier discussed financial instruments, so if you are a novice in the stock market, you might think about what financial instruments mean. As you have now understood, the stock market involves the buying and selling of company stocks. However, it is not only the thing that is exchanged. Various other financial instruments are also traded in the stock market, such as bonds, ETFs, Mutual Funds, Derivatives, futures contracts, etc. This is why the common term “financial instruments” is used.

Type of Financial Instruments

1. Stocks: It is also called “Shares” or “Equities.” The company listed on a stock exchange has stocks in the open market. Before entering the stock market, a company must have to go through a process of listing. This concept has been discussed in this article: What is Stocks? you can check after reading this article.

2. Bonds: In simple words, a bond is a financial instrument issued by the government to raise funds for government projects, policies, and other activities. By issuing bonds, the government takes a loan from investors and promises to return the principal amount along with interest.

3. Derivatives: Now, before going to this topic, first you must understand that Derivatives are a complex topic that cannot be described in a few words. For just now, you should know that derivatives are known as futures and options. Investors use futures and options to protect their investments in adverse market conditions.

Stock Exchanges in Indian

The Indian stock market is a vibrant and growing market, offering a wide range of investment opportunities for both domestic and foreign investors. There are two main stock exchanges in India: the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE).

Bombay Stock Exchange (BSE)

Established in 1875, the BSE is the oldest stock exchange in Asia.
It has over 7,000 listed companies, making it the largest stock exchange in India.
The BSE offers trading in equities, currencies, debt instruments, derivatives, and mutual funds.
It has a popular equity index, the S&P BSE Sensex, which is the most widely tracked stock market benchmark index in India.

National Stock Exchange (NSE)

Established in 1994, the NSE is a newer stock exchange but has grown rapidly to become the largest stock exchange in India by trading volume.
It has over 2,000 listed companies.
The NSE offers trading in equities, derivatives, and debt instruments.
It has a popular equity index, the Nifty 50, which is the second most widely tracked stock market benchmark index in India.

Key Highlights

The Indian stock market is the 10th largest stock market in the world by market capitalization.
The market has been growing steadily in recent years, with the BSE Sensex index rising by over 100% in the past five years.
The Indian government is encouraging foreign investment in the stock market, and there are a number of investment vehicles available to foreign investors.
The Indian stock market is a good investment option for investors who are looking for long-term growth.

FAQs

What is the stock market, in simple words?

A stock market is a place where financial instruments such as shares, bonds, and mutual funds are bought and sold.

How does the stock market work?

The stock market connects companies raising capital by selling shares to investors seeking to profit from those shares’ value.

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