What is Stock Market?

A long time ago, humans ran businesses with just their own money. The businesses they ran were small and they grew the businesses only with their own profits. It still happens with a lot of small traders. You will find many small and medium enterprise businessmen around you. However, not all businesses can be built with your own money or can be grown to large scale. What if you wanted to build a new factory that costs more than a million dollars? Banks won't lend money to younger companies or will lend at higher interest rates and your friends won't have that much. Let's now understand the stock and stock market continuing the same example.

Let's say you want to start a company that makes stuffed toys. Before you can make toys, you need to build a factory. You need to buy sewing machines and fabric and thread and boxes to ship them in. You need to hire workers and start production. This money required to start the company is called 'investment capital'. For eg., you need Rs. 2 million to start the company. Of this amount, you have Rs. 1 million and you need additional capital of Rs. 1 million.

So you launch the Initial Public Offer (IPO) to find some hundred people, each of whom is ready to invest Rs. Ten thousand. In exchange, you will sell 50% ownership to these 100 people and they each will own 1/200th of the company. Below will be the shareholding pattern of this company:

You (Owner): 50%

Public: 50%

Here, the market capitalization of this company is said to be Rs. 2 million and the management (or you) holding 100 shares and each of the 100 investors bought 1 share for the price of Rs.10000/-. Of course, they can't physically break off 1/200th part of the factory, but it means they're entitled to a share of the profits. Once you get the factory up and start selling stuffed toys, you will have income every year. Some of that income goes to pay the company expenses (like raw materials, staff salaries and electricity etc) some of it we use to buy better equipment and improve production. But after all that, we have money left over, that's called profit. 

And that gets evenly distributed among the people who invested, who are called the "shareholders", the money they get is called a "dividend". For eg., if the profit was Rs. 50,000/- in the first year then you will get Rs.25000/- (because you hold 50% ownership) and each of the investors(or shareholders) will get Rs.250/- (1/200th of the profit).


Now, if someone else wants to be a shareholder, he goes to one of the existing shareholders and asks to buy his share. They decide how much the buyer is willing to pay, based on how the company's doing now, and how they expect it to do in the future. If the company's making a lot of money and is expected to make a lot more in the future, the share becomes worth more money, because there are good dividends and good growth expected in future. If the company's doing badly, the share becomes worthless. In short, if the company is doing good and expected to do more better, existing shareholder might be willing to sell his share for Rs.11000/- (which he bought in Rs.10000). He would have profit on investment + dividends earned and his realized gains would be 1250. He will be called 'seller' and the one who bought it in Rs.11000/- will be called 'buyer'. This buyer may have done a lot of research on the company and toys sector and hence may have longer investment horizon and he may not sell his shares in near future. This is how investment in the stock market works that involves research, knowledge and conviction.

But people speculate more and research less, and they might invest in a company at higher rates expecting a great season, great management or sometimes just because it is discussed in some WhatsApp group or referred by some analyst ora friend. Since they don't know much about the company, they might buy the shares of this toy company from an existing shareholder for Rs.10500/- and in few days, but after few days other shareholders are willing to sell their shares for Rs.9000/-. So, he is incurring the loss on investment for Rs.1500/-. This is the unrealized loss since he did not sell his shares, only the value of the company has been decreased while he was holding the shares of the company. This is how gambling in the stock market works that one invest only on conviction or luck and not facts.

What is Stock Market?: There's a central market where all the shares are bought and sold. When people are willing to pay more for a company, the stock price goes up. When more people want to sell than want to buy, the price goes down. There are generally always buyers and sellers in the stock market for each company. It is also known as 'Stock Exchange'. In India, we have 2 major exchanges called 'Bombay Stock  Exchange' and 'National Stock Exchange'.


Who Regulates the Stock Market? The Securities and Exchange Board of India (SEBI) is the regulatory body charged with overseeing the Indian stock markets. A federal agency that is independent of the political party in power, the SEBI states its "mission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation."

The reason the stock market is so important to the country is that that's how individuals money gets invested in businesses, which is how businesses get money to start and to grow. If everything works well, the business does well, the stockholders make money and the public is able to buy the things the business produces.