How Does the Stock Market Work in India

The stock market is one of the many avenues for long-term wealth creation. If you’re planning to invest in it, having a proper understanding of how the stock market works is crucial. It can help you make informed investment decisions that are in line with your financial objectives. 

How Does the Stock Market Work in India? 

The way the stock market in India works varies depending on whether you invest in the primary market or the secondary market. Here’s a comprehensive overview of how each of the two types of markets work. 

Primary Market 

Also known as the new issue market, the primary market is where companies offer securities to the public for the first time. Investors in the primary market get to purchase shares and other securities directly from the issuer. 

An Initial Public Offering (IPO) and a New Fund Offer (NFO) are two examples of the primary market. An IPO is the process through which a company issues its shares to the public for the first time. An NFO, meanwhile, is the process through which an Asset Management Company (AMC) or a mutual fund house launches a new mutual fund scheme.  

To invest in an IPO, you need to make an application to the company specifying details like the number of shares and the price per share. Once the public issue closes, the company considers all the bids received from interested investors and sets a cut-off price. If the price that you bid for the shares is on or above the cut-off price, you will be deemed eligible for share allotment. If not, then your application will be rejected. If you’re eligible for share allotment, the company will transfer the shares to your demat account. 

The application process for an NFO is highly similar to that of an IPO. However, the only difference is that there’s no cut-off price determining the eligibility of investors. All the investors who apply for an NFO are allotted mutual fund units.  

Secondary Market 

The way the secondary market works is vastly different from the primary market. The secondary market is where securities that have already been issued are traded amongst investors. The purchase and sale of securities happen between investors with no involvement from the issuer. Stock exchanges and Over-The-Counter (OTC) platforms are two examples of the secondary market.

To purchase or sell shares or other financial assets from a stock exchange, you need to open a trading and Demat account with a stockbroker. Once your trading and Demat account is opened, you can use it to place a buy or sell order for your preferred financial asset. Once the order is placed via the trading account, your stockbroker immediately forwards it to the stock exchange. The exchange then matches your buy or sell order with a corresponding order from another investor. The trade will be executed once your order is matched. The Demat account linked to your trading account will either be credited or debited depending on whether you bought or sold the asset respectively.   

In the case of the Over-The-Counter (OTC) stock market, the trade happens directly between the buyer and the seller without the involvement of an exchange. The interested parties are free to negotiate the terms between them. That said, the seller needs to manually transfer the shares to the buyer’s demat account. 

What are the Different Financial Assets That Can be Traded in the Indian Stock Market? 

In addition to equity shares, you can also trade several other financial assets in the stock market. This includes debt securities like bonds and debentures, equity derivative contracts and mutual funds. Let’s get a closer look at each of these financial assets. 

• Stocks 

Also known as shares or equities, stocks are financial assets that represent ownership in a company. When you purchase the shares of a company you become its shareholder. As a shareholder, you get certain benefits such as the right to vote on certain company matters and the eligibility to receive dividends. 

• Equity Derivative Contracts 

Equity derivative contracts, such as futures and options, are agreements whose value is dependent on the underlying asset’s value. The underlying asset can either be the stock of a company or an equity index such as the SENSEX or NIFTY. 

• Bonds 

The stock market in India also lets you invest in bonds. Bonds are debt securities issued by governments and corporations. When you invest in a bond by purchasing it, you essentially lend money to the issuing entity. In exchange, the issuing entity pays interest periodically until the end of the bond’s tenure. The principal amount you invest is repaid once the bond matures. 

• Mutual Funds 

Mutual funds are unique investment vehicles that pool money from multiple investors and invest the same in a basket of different assets. There are three primary types of mutual funds that you can invest in - equity funds, debt funds and hybrid funds. As the name implies, equity funds primarily invest in equity shares of companies, debt funds predominantly invest in debt securities and hybrid funds invest in a mix of both debt and equity. 

Conclusion

With this, you must now have a good understanding of how the stock market works. If you’re new to investing, it is advisable to start investing through a stock exchange. Compared to the primary market and the OTC market, a stock exchange offers a host of benefits such as a transparent price discovery mechanism, liquidity, standardized trading and better access to pricing and volume information. Using the wealth of advantages that an exchange offers, you can make an informed investment decision.