The way it should be

"It should not escape notice that gold and silver after circulating in every other quarter of the globe, come at length to be absorbed in Hinduston"

                         ~Francois  Bernier

how stock market operates???

Posted by VASUDEVA REDDY on Thursday, January 20, 2011

How does stock market operate????

This is the question posed by myself to me, many times. It is a Greek and Latin for many of us, even me. Still I don’t have the good clarity on this topic. But I felt that many of you have the same problem in understanding the stock markets. So I want to share the views of mine on the stock markets, up to my knowledge. But please keep it in mind that the things you are going to read are the views of me only, not the exhaustive report. Let us start from very basic point.

Let us assume, you wanted to start a firm, for instance let it a garment store, and invested Rs.1000000 to start that one. By the end of the year you earned revenue of Rs.500000. After meeting all the expenses you landed up with a profit of 200000. And also assume by the end of second year you earned a profit of 300000.

Now, you want to sell the firm or business you held. You know that you can earn Rs300000 p.a. by continuing with the business. You are ready to sell the garment store if and only if the interest on the money that you are getting by the firm is more than that of Rs.300000. but how can you decide the price of the firm to sell. Here, the market is going to decide the price but not the owner. A person can be ready to pay Rs.30,00,000 by expecting the 10% annual return. But at the same time another person may be ready to pay Rs.60,00,000 by expecting the 5% annual return. If ten people come forward to buy the firm at Rs.60,00,000, you can increase the price. And if no one comes at a price of 6000000, you need to decrease the price.

You can sell whole firm to a person or you can sell a part of firm to a limited no.of people. If you want to sell the 40% of the firm worth ( Rs.200000 at rs. 5000000 worth) to 10 people, you have to divide the total value into 10 equal parts i.e, 200000 each. That is called a share.

Stock exchange:Stock exchange/market is similar to ordinary market, where the exchange of goods takes place, but the major difference is, in stock market the exchange of shares or stocks takes place.  If you want to sell your firm, you can approach to stock market. Stock market is the place where the buyers and sellers meet together.


 Before going to understand the stock market one needs to understand the offer price and bid price. Offer is the minimum price that a seller wants to sell the stock and the bid price is maximum price that buyer is ready to pay for a stock. Entire stock market operates on these two concepts.

Any business that wants to sell shares of stock to a number of different people does so by turning itself into a corporation. The process of turning a business into a corporation is called incorporating. A corporation is different, and it is a pretty interesting concept. A corporation is a "virtual person." That is, a corporation is registered with the government, it has a social security number (known as a federal tax ID number), it can own property, it can go to court to sue people, it can be sued and it can make contracts. By definition, a corporation has stock that can be bought and sold, and all of the owners of the corporation hold shares of stock in the corporation to represent their ownership. One incredibly interesting characteristic of this "virtual person" is that it has an indefinite and potentially infinite life span.

The reason for forming a corporation is get the capital. A corporation is an easy way to gather large quantities of investment capital -- money from investors. When a corporation first sells stock to the public, it does so in an IPO (Initial Public Offering). Another reason that corporations exist is to limit the liability of the owners to some extent. If the corporation gets sued, it is the corporation that pays the settlement. The corporation may go out of business, but that is the worst that can happen. If you are a sole proprietor who owns garment store and a garment store sued, you are the only one going to suffer and can lose the things what you have.

Stock prices:

A company can put whatever the price/share they want while coming to IPO. But the investors or buyers only buy it, if it is worth enough to buy. Overpricing of a share value ends with the failure of IPO.

Assume that you gathered a capital of Rs4000000 through IPO by selling 400000 shares worth each of Rs.10. With the capital you gathered, you can buy new equipment, can hire more people, can expand business, which in turn add more value to the corporation.

If there are more people to buy a particular stock, the bid price will go up. That will lead to increase in the stock price of a particular share. If the sellers are more and the buyers are less, then the share price will fall down.

Income and growth:

Here one needs to understand the term ‘dividend’. Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business (called retained earnings), or it can be paid to the shareholders as a dividend. If the corporation gives the dividend, the income of the investors will go high and the price per share remains same. And if the corporation wants to reinvest the price per share will go up and it is called growth.

Apart from the benefits it has, the stock market is highly volatile. The moves of share market cannot be easily predicted. The speculations make a huge effect. If a big investor who holds the 1000000 shares of a corporation wants to sell all of his shares, the price/share will come down. Because, there are no sufficient no of buyers to buy the shares he sold. That means even a person can affect the market.

In a publicly traded company, all of the financial information about the company is public. The Securities and Exchange Board of India (SEBI) is in charge of collecting this information and making it available to investors. Shareholders also use a number of other indicators to determine how much a stock is worth. One simple indicator is the price/earnings ratio. This is the price of the stock divided by the earnings per share. There are all sorts of indicators like these, as well as a great deal of other financial information available on any stock. 


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