Intro to Stock Markets

Stock Markets

Welcome to our Chapter on the Stock Market.

Here, we look at how the Stock Market came about, why is there so much hype surrounding it and then try to briefly understand the different types of investing styles.

Before we move on, here is a list our recommended brokers if you want to invest in the stock market:

History of the Stock Market

The basis of the modern stock market lies in two types of trading that started in Europe 8-9 centuries ago. The first was commodity trading in France and in the Netherlands in the 12th and 13th centuries, and the second was trading in government securities in Italy during the same time.

These were not stock markets in the strictest sense but rather groups of people who came forward to transact in certain assets. But it had a market where people who were not the first buyers and sellers could come and transact in the assets – what is known as the secondary market.

The first stock market of the world has a very important connection with India.

In the 16th and 17th centuries, Europe emerged as the key driver of global trade.

The first country to exploit these trade opportunities on a global scale was the Netherlands. Its merchants ventured far beyond its shores to other corners of the world. And the company that pushed this trade ahead was – the Dutch East India Company. It was a government-directed amalgamation of several Dutch trading companies which were rivals and it was established with the sole purpose of trading with Mughal India.

In the early part of the 17th century, this Dutch East India Company was the first company in the world to issue bonds and shares of its stock to the public. It was also the first joint-stock company to get a fixed capital stock and as a result was able to trade in the Amsterdam Exchange, the world’s first important stock exchange.

Speaking of India, the first stock exchange in Asia was the Bombay Stock Exchange, and was established in 1875. It was established by a group of brokers who had started to trade between themselves in the 1850s in Bombay.

Currently, the Bombay Stock Exchange is 10th largest stock exchange in the world with an overall market capitalization of more than $2.1 trillion. The National Stock Exchange is right behind at number 11 with an overall market capitalization of more than $2 trillion.

How Does a Stock Market Work?

Understanding the technical nature of how a stock market works will take a few weeks to explain and we will, therefore, look at how it works in the simplest of terms.

The stock market comprises of different companies who choose to raise money from the public by listing their securities in the market.

The raising of money using shares for the first time in the stock market is called an Initial Public Offering or an IPO.

Once the IPO is over, the company’s shares are traded on the stock market. Here the people who own the shares sell it to those who want to buy it. This trading in shares is called the secondary market and forms the basis for what you see mostly in newspapers, TV channels and online.

The share price of a company fluctuates due to demand and supply. When there are more sellers than buyers then the price falls as demand is low, and when there are more buyers than sellers, then the price rises.

The stock market may allow trading between people to happen across many other securities besides company shares. These can be bonds, debentures, derivatives, exchange-traded funds and mutual funds.

Those who look for short-term gains opt for methods such as Day Trading, Scalping, Swing Trading and Momentum Trading.

These types of trading are for seasoned investors and detailed explanation on these types of trading will be provided in another chapter.

Let’s now try to understand the hype around it.

The Stock Market Hype

You have probably heard something or the other about the stock market in the last few weeks. All newspapers and news channels would have had put some spotlight on the latest happenings in the stock market.

But if you think about it, the stock market does not form the centre of our lives for most of us. Then why this focus?

The answer is: “That is Where the Money Lies.”

The stock market gives ample opportunities for everyone to make money.

All you need are a trading account and a demat account, and you can buy stocks and start to make money.

Of course, it is not so easy. The stock market is a complex marketplace and you will need more than a few months to master it so you are able to make decent money on a regular basis.

The stock market is not an area for speculation, though there are people who take it as such. Speculation is not a smart way to invest. Speculators make all sorts of mistakes from having the herd mentality to looking for quick gains by using the latest tips.

This speculation is the reason why you hear of people losing all their investments or the market wiping off all gains.

But if you invest for the long term, then you get a return of around 12-14%.

If you want to get these kinds of returns from the stock market, then you have to either invest in mutual funds – which we will cover next week – or learn the different ways of investing.

There are three primary ways of investing. They are Value Investing, Growth Investing and Income Investing.

Types of Investing

Value Investing

Value Investing is a popular investment strategy largely because one of the richest persons in the world, Warren Buffet, used this principle to make his money. The principle behind value investing is simple: buy stocks that are cheaper than they should be.

It takes a lot of research to find stocks that are under-priced and which have strong financials and growth prospects.

And once you’ve found them, it takes a long time for their price to rise. This is a long-term way to make money and requires a lot of patience. But if you stay invested for the long-term, then you can get very good returns.

Growth Investing

Growth investing focuses on capital appreciation. Here the investors look for companies that show strong growth in revenues or sales and profits. The price may be a bit on the higher side and is therefore sometimes seen as a riskier strategy as the future prices may fall despite strong growth.

In this strategy, you invest in smaller companies that have high potential for growth, in industry leaders called blue-chip stocks and in emerging markets.

Income Investing

In Income Investing, you buy securities that pay returns on a steady schedule. These can be dividends or interest income.

Here the focus is on having a reliable income stream with low risk.

These type of investing focuses on debt investments or as they are known fixed-income security, on dividend-paying stocks, on exchange-traded funds called ETFs, on mutual funds, and other investments.