How Share Market Works: A Detailed Guide
You must have encountered these terms like, Share Market, Stock Market, Sensex, NIFTY, NASDAQ, NSE, BSE, IPO, Stock Exchange, etc, and may have wondered what are the basic concepts behind these interconnected words. While watching the news you may have come across headlines like
- “Sensex has gone up by 200 points“
- “NIFTY closed at an all-time high”
- “A Particular company has listed its IPO” and
- “Stock Market Crashed and its time for recession”
You will understand the complete life-cycle of the stock market and it’s working from a startup point of view.
As a student of a different background than finance, these terms may take little time to assimilate, and if you are looking forward to expanding your learnings because you want to start investing and trading, in the beginning, you may find these terms overwhelming. So here I will explain “How Share Market Works”, and various terms related to it in the simplest language possible and in complete detail with graphs and data and suitable examples.
I will explain each mentioned term like Share Market, Stock, Sensex, NASDAQ, IPO, etc with its correct description.
STORY TIME: Let’s take an example where you are an owner of a tea-selling business
Stage 1: You as a tea seller
Suppose you sell “Tea” at a corner in Delhi or wherever you live. You make such good tea that there are always people waiting to have a cup of tea and in return, you earn good money. While selling tea you came across one problem, the people have to wait for a long time to get their tea, and all your quantity gets sold within a few hours. One day you thought that if the people liked my tea so much why should I not open a few more shops nearby with good seating arrangements? My earning will grow exponentially.
Stage 2: You need capital (Money to open multiple shops)
You can start on your own if you have enough capital to invest in this optimistic business, and if you don’t have it then you have to take a loan from your friends or your family members. So you took a loan from your friends and family and started the shop and everything went well and after your business did good you returned the money to your family and friends. Here I will tell you about the business term “Bootstrap“.
Bootstrap: You can call your business or startup Bootstrapped when you start a business with your own money and with a little help from your friends and family and successfully convert your business into a profitable one.
Bootstrapping a business is an excellent funding approach that keeps ownership in-house and limits the debt you acquire while starting your business. You have more control and power over your business and don’t have to deal unnecessarily with unexpected demands from your investors.
At this stage, your business is registered as a privately limited company and is run by an individual please keep this in mind because in the future you will be making your company a public limited one to list in the share market to get public investments.
Stage 3: More Demand and how investors earn from your company
After the successful running of your bootstrapped business, the demand increased rapidly tempting you for more outlets. Now, you decided to cash upon it by opening a tea store in the entire Delhi for example. But now you need a lot of money to rent shops and hire employees to run the shops throughout Delhi. You cannot bootstrap anymore.
Now you need a larger capital so you may go to the bank for a loan, but the bank charges 12-13% on a loan and their EMI starts from the next month only and it takes time to build up a business. The EMI of the bank will be on your head while you are thinking of executing the business plan for your shops and instead of growing your business, you end up losing it.
You have another option in case the bank loan is not suitable for your requirements, and that’s to approach an angel investor. Angel Investors don’t lend you money but they invest it in your business which you don’t even have to give back to them instead they will invest in your company for a fixed amount of shares and a percentage of ownership in your business of tea selling.
For example, you and the angel investor agreed to an INR 1 Crore investment or $1 Million for an exchange of 10% of ownership in the company. This means that you will give back 10% of your profit to the investor. Suppose you earned 100,000 thousand or $100,000 then 10% of this earning (10,000 or $10,000) will be given to the angel investor and this transfer of money is legally binding and you can’t withdraw from it.
Angel investors don’t work with you, they will invest in your business and will take a percentage of profit from you. With all of this process, you have established your business across Delhi and now you have multiple outlets running with their full potential. Upon getting overwhelming success from Delhi, now you decided to expand your tea-selling business to various states across the country and for this, you will again require huge capital, an Angel Investor may not have enough money to support this cause. In this case, you can get your desired capital from a Venture Capitalist.
Venture Capitalist
A Venture Capitalist is a private equity investor that provides capital to companies with high growth potential in exchange for an equity stake(means shares). Simplified further a Venture Capitalist is a well-established company capable of investing a big amount in any business in exchange for a percentage of ownership just similar to an angel investor but as a company with more financial power and expertise.
Where can I find these VCs and Angel investors?
Search for a good financial advisor or an Investment banker after that you will have to create a good portfolio and a presentation for your business with the help of a financial advisor and the Investment banker and then present it to the board after a thorough checkup of your business, it’s execution, profit, revenue expectations, and growth potential in the future and a whole lot of things, if they find everything okay, you are likely to get your required funding.
Your Business’s status so far
You diluted 10% of your business to get an initial investment from an angel investor, further to expand your business you diluted 10% again to get VCs on board.
In the meantime, your business is successfully registered as a company and isn’t operated as an individual-owned company anymore.
Massive Expansion of your business
Luckily your business seems to be not stopping anytime soon and is growing exponentially, and now you want to open your outlets in the entire country. You will again require capital and this time it will be a massive capital requirement that neither an angel investor nor a Venture Capitalist can contribute to. In this case, you will go to normal people and you will ask them to invest in your company in exchange for a few shares, but all of this work does not happen by bargaining on the streets but rather with a well-defined structure that is under government surveillance.
Time for IPO
Your next goal is to expand the presence of your business all over the country for example all over India. But angels and VCs can’t fulfill your capital requirements. Whenever a company goes to the general public to raise money for the first time, it is called an IPO (Initial Public Offering).
Types of Companies in India
As per Indian law, there are 7 types of companies, we will understand all about these 7 types of companies in another post. For now, we will consider only two types of companies a private limited company and a public limited company.
Private vs Public Company
So far your tea-selling business has been registered as a PVT LTD company which means a privately listed company that is managed by one person or a few people. To get funding from the open market and trade in the share market you will need to convert your company to a Public Limited Company that will make your company legally valid to trade in stocks publicly and will allow the public to buy and share your shares. Understanding all these small details will help you understand “How Share Market Works.“
The Process of IPO
There is a process of IPO. First, you need to hire an underwriter or an investment banker and they will review your company profile, how much fund is needed, and how many shares you will list in the share market alongside the eligibility criteria to be listed as a public limited company. After this, your files will be sent to the SEBI if you are an Indian company. For other countries, you will be checked by your respective organization and then after a thorough checkup, you will be allowed to bring your IPO. You can’t list your IPO without the approval from your respective board.
The share market is like a big shop where all the trade-related work happens.
Here you can read about various stock exchanges from around the world
You will list the number of shares and the price of each unit.
It is completely up to you to decide the prices of each unit of shares, for example, when Paytm went live they listed each share price at INR 2150 for Facebook they started with $38 per unit of share. It is also worth understanding that you should not consider an unrealistic price for your share it may remain under-subscribed which will put a dent in your humble beginning and is considered bad for a company to start with while looking for public funds. Most companies bring IPO when the market is at a full record high and people have high purchasing power, that’s why during the COVID most companies delayed their IPO.
How Much Money Did We Get from the IPO?
Let’s assume you issued 1 million means 10 lakh shares of your company each listed for INR 2100 and your IPO became successful and received overwhelming subscription. You will make a total of 1,00,00,000 * 2100 = INR 21,000,000,000 (Twenty-one thousand crore) approx $2.4 billion. This is not your money rather this is the money of the public given to you for growing your company and they will benefit from each share if your company grows.
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The Main Part: How is the Share Price Determined and How Does the Rate Change?
The most important part is to understand how the share price of a company is determined after the listing.
Look at this image! Here you can find that there are companies with share prices highlighted in green and red. Green is for those whose shares were sold for a profit and red determines the loss.
The price of each share of a listed company is determined by the demand and supply. For example, your tea-selling business is doing great and it is expected to grow exponentially in the coming years. The demand for the shares of your company will increase exponentially tempting your stock prices to go high because your share is in demand and thus people will keep increasing the bidding price to buy your share, and it will result in an eventual increase in the share prices.
In the same way, a company’s share falls because it is not showing any sign of possible growth in the future thus the shareholders sell the share at the same or lower price on which they purchased the share to take quick exit. This is how the Share Market Works.
Now Let’s understand the meaning of all those terms that I mentioned at the beginning of the article.
Share market or Stock Market: A place where the trading of shares takes place.
Sensex: Sensitive + Index = Sensex is India’s stock exchange that hosts the 30 well-established and financially sound companies listed on the Bombay Stock Exchange.
NIFTY: National Stock Exchange + Fifty, an index representing the top 50 companies listed on the National Stock Exchange (NSE) of India, chosen based on market capitalization and liquidity
NASDAQ: America’s Stock Exchange
NSE: India’s National Stock Exchange market
BSE: Bombay Stock Exchange
IPO: Initial Public Offering
Frequently asked questions
How does the share price fluctuate while trading?
When a company performs well, it attracts traders, and they demand the shares of the company thus opting for bidding that results in the prices going high and eventually resulting in massive growth in the company’s market cap. In the same way, a company’s share falls when the demand decreases.
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