Interesting insights for investors on navigating the Stock Exchange

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Introduction

What does the stock exchange mean?

Every investor has asked this question at the onset of their investment journey. But has there ever been a precise answer?

No.

The lack of clarity is why millions of people lose their money on the stock exchanges every day, and it is also why a chunk of people are scared to invest or trade on these stock exchanges.

Investors with crystal clear fundamentals of the stock exchange and a financial analysis backed by thorough background research of the company are the only ones that can profit off the stock exchange.

In this article, we have provided a detailed yet simple explanation of the stock exchange.

First, we will understand the stock exchange meaning to proceed with the basics.

Stock exchange definition

The stock exchange is an integral part of the stock market, and it is a market for trading financial instruments such as stocks, bonds, and commodities. The stock exchange promotes the exchange of financial instruments between dealers and targeted buyers. 

In India, a stock market must follow a set of rules and regulations set forth by the Securities and Exchange Board of India or SEBI. The said governing body protects investors’ interests while promoting India’s stock market. 

Only companies listed on a stock exchange are permitted to trade. Even if a stock is not getting listings on a reputable stock exchange, one can exchange or trade it in an over-the-counter market. However, such shares will not have a high value in the stock market.

But how did the stock exchange toggle into existence?

History of stock exchange

A quick ride into the history of the stock exchanges would look something like this:

• During the 1300s: Europe and Venice

The money lenders in Europe started selling debt issues to individual investors. The Venetians were the front runners in the field and would carry slate with client information, much like brokers in modern times.

• During the End of 1400s: Belgium 

International trade is picking pace at Antwerp, or Belgium as we know it now. Few bonds are made as merchants anticipate price rises while others buy goods in advance to sell them later at a profit after the price rise.

• During 1611: Amsterdam 

The Dutch East India company became the only company to facilitate trading activity on the exchange leading to the creation of the first modern stock trading in Amsterdam. Later, the Dutch East India Company remained the first publicly-traded company for many years.

• During the End of the 1700s: The buttonwood Tree Agreement

Buttonwood Tree Agreement was formed by a concise group of merchants who used to meet every day to sell stocks and bonds. 

This practice led to the formation of the New York stock exchange.

• During 1790: Philadelphia Stock Exchange

The financial sector of the U.S. started developing due to the formation of the Philadelphia Stock Exchange. It also helps the expansion of the country in the West.

• During 1896: DJIA

Twelve industrial companies were the main components that contributed to the initial development stage after forming the Dow Jones Industrial Average.

• During 1923: Poor Publishing

The Henry Barnum Poor’s company called Poor’s Publishing formed the early version of the Standard and Poor’s index. 

The index was formed in 1926 and tracked 90 stocks in the beginning.

• During 1929: Roaring 20s

The speculators made leveraged bets on the stock market while inflating prices throughout the decade of the Roaring 20s, only to face a stock market crash in the end.

• During 1941: S&P

Henry Barnum Poor’s company called Poor’s Publishing merged with Standard Statistics to form the Standard and Poor’s Index.

• During 1971: Another US Stock Exchange, NASDAQ

Another US Stock Exchange named, The National Association of Securities Dealers Automated Quotations, NASDAQ started trading this year.

• During 1987: Black Monday

Black Monday became a famous term when corporate buyouts in portfolio insurance facilitated price rises in the market till October 19.

• During 2008: The 2008 Recession

The busting of the housing market after a substantial boom and the proliferation of mortgage-backed securities in the financial sector led to a disaster stock market crash.

How does the stock exchange work?

A stock exchange is a platform that facilitates the purchase and sale of financial instruments like equities, commodities, and bonds. 

It is accountable for the interaction of firms and governments with the investors for investment purposes. 

In India, the stock exchange activities are regulated by the security and exchange board of India (SEBI). 

Hence, all the companies and entities have to register with this board in order to start trading on the stock exchange.

The stock exchange aids the availability of financial instruments after a company conducts its initial public offering (IPO).

The shares of a company are sold to the first set of shareholders in the primary market with the help of an Initial Public Offering (IPO).

After the floating of an IPO, the shares of that particular company are traded in the secondary market. 

The stock exchange mechanism for deciding the price of stocks is based on the demand and supply of stocks. 

The market function on an electronic limit order book automatically helps an investor match the market orders. The regulators also limit the buying and selling as per the market situation.

On the other hand, brokers are responsible for the placement of orders and hence play a critical role in the trading structure of the market.

In a primary market, premium investors or institutional investors can benefit directly from the company’s IPO through the benefits of direct market access.

However, in a secondary market, investors purchase shares after communicating with parties like the buyer and the broker. 

But, the ownership of a share is transferred after the mutual agreement on the price. This process is known as settlement, and it is the end step for purchasing securities in a stock exchange.

Functions of a stock exchange

The features of the Stock Exchange are as follows:

Acts as an Economic Barometer

The stock exchange acts as an economic barometer, indicating the state of the economy. 

The prices of shares reflect every major shift in the country and economy, and it keeps track of all significant and minute changes in stock values. 

It is rightly said as the economy’s pulse reflects the state of the economy.

Securities Valuing

The stock market aids in the valuation of securities based on supply and demand variables of the market forces and external economic situations in a country. When profitable and growth-oriented corporations issue listed securities, they are often valued higher. 

Securities valuation aids creditors, investors, and the government in their various roles, valuing creditworthiness, valuing stocks, imposing taxes, etc.

Contributor to Economic Growth

The stock exchange offers a platform for trading securities of multiple companies. This trading process involves continuous disinvestment and reinvestment, which provides opportunities for capital formation.

Increasing public awareness of equity investment 

The stock exchange assists in disseminating information about equity markets. The introduction of new issues attracts people to invest in securities, as various securities are traded on a stock exchange. 

Allows for healthy speculation

The stock exchange ensures demand and supply of securities and liquidity by allowing for healthy speculation of traded securities.

Facilitates liquidity

The stock exchange’s most significant duty is to provide a convenient and trusted platform for securities transactions. It provides investors with the assurance that their precious assets can convert into cash. Or in other words, the stock market offers investment liquidity. Investors need not worry about liquidating their investments as the stock exchange provides a platform where it can break down long-term investments into medium or short-term investments.

Better Cash Allocation

Profitable businesses will have their shares actively traded, allowing them to raise new and fresh capital from the equity market. The stock market assists investors in effectively allocating capital so that they can gain the most profit.

• Transactional Safety: Transactional safety is assured since securities traded on the stock exchange are listed with trusted payment gateways, and securities are listed after the company’s position has been verified. All companies listed must follow the regulatory body’s laws and regulations.
• Encourages saving and investment: The stock market is a significant source of investment in a variety of assets with higher yields. Investing in the stock market is a better option than gold and silver as an investment.

Features of a stock exchange

The features of a stock exchange are as follows:

Securities market

The stock exchange is an ensemble for various securities that corporate companies and government or semi-government companies can issue. The security is our boat and sold on the stock exchange.

Second-hand securities

The company has already issued the shares and securities that experienced trading on the stock exchange.

Regulation of trade

The stock market facilitates trade regulation by ensuring that the broker or exchange members are trading on the company’s behalf. They cannot purchase or sell shares on their accounts.

Restricted only to registered securities

The stock exchange includes securities of only listed companies.

Authorised Transactions

In a stock exchange, one can only make the transactions through authorised brokers and the members involved in the transaction.

Assurance

The stock exchange has stocks only of companies that the central government has recognised, giving the general public assurance.

Gauging metric

The stock exchange index is used to evaluate the performance of the stock of a company.

Rules and regulations

The Securities and Exchange Board of India (SEBI) has provided guidelines that include a set of rules and regulations mandatory to be followed while dealing with securities in the stock exchange.

How are share prices set on a stock exchange?

There are numerous ways to determine the share prices of stock market shares.

The most renowned process is the auction process. In this process, the buyers and sellers execute the bidding and place offers for buying and selling.

In bidding, the buyer needs to bid a price at which they desire to buy the shares. 

In the offer process, the seller places a suggestion or ask, which is the price at which the seller is willing to sell their shares.

The trade can be executed if the bid and ask are the same amount after mutual negotiation.

The stock market comprises millions of investors, and each of them has different ideas about the value of a particular share.

The massive number of purchases and sales made by these investors every minute forms a stock exchange trading day.

The stock exchange provides easy trading, and any average person can access the stock exchange, and all they would need is a stockbroker.

If there is a mutual agreement concerning bid and ask, investors can complete their transactions with the help of a stockbroker.

Merits of being listed on the stock exchange

A company can avail of substantial benefits by getting listed on the Stock Exchange. Some of those benefits are as follows:

Upgrading credibility 

Investors consider stocks listed on a respected stock market to have a higher worth. 

Companies can profit from their stock exchange market reputation by increasing their number of shareholders, which adds to the company’s credibility. A powerful technique for growing the number of shareholders is to issue shares for their purchase. 

Low-cost capital financing

One of the most efficient ways for a firm to obtain low-cost financing is to issue company shares on the stock exchange market for purchase. Listed companies can raise more funds through share issuance due to their stock exchange market reputation, making it a lot easier, which they can leverage to keep their company afloat and activities running.

Backed by collateral 

Almost all lenders accept collateral and provide loans in exchange for securities. Because they see it as more reliable in the stock exchange market, a listed company is more likely to receive a faster clearance for their credit request. 

Also, vendors accept listed securities as a payment method in kind.

Liquidity 

Listing allows stockholders to benefit from greater liquidity than their rivals and provides them with immediate marketability. It enables shareholders to estimate the value of their investments. 

It also allows for share exchanges with a corporation, which helps balance off the risks and aids shareholders in increasing their profits from even the smallest growth in the company’s overall valuation.

Fair prices

In a stock exchange in India, the quoted price also represents the actual worth of a particular security. Because market forces and various external factors also determine the prices of listed securities, they are publicly disclosed. It can assure investors of cracking a good deal at prevailing fair market prices.

Demerits of being listed on the stock exchange

There is also a flip side to getting listed on the stock exchange. The demerits of getting listed on this Stock Exchange for a company are as follows:

Public eye

Public companies are constantly in the public eye because they are under the scrutiny of the public. The general public and investors expect these companies to follow the rules of the markets. They face constant scrutiny and are expected to be accountable for all the actions happening in the company’s name.

Risk of getting undervalued

When a company issues shares, it dilutes its ownership and restricts its liquidity to market forces. A negative drift of market forces concerning the company can affect the fundraising and acquisition activities of the company.

The market can cause this mishap because the company might be experiencing a lack of demand, resulting in a low share price, eventually making the company lose its appeal. In stock exchanges, a company’s share price is not affected by companies performance but by the market and economy’s performance.

Cost

The flotation and ongoing listing can be expensive, and one should not underestimate the management time and cost required during such listings. The whole flotation process is very time-consuming because of its regular and constant administration announcements and labour-intensive dealings.

Different ways to invest in the stock exchange

An investor can invest in the stock exchange in India through two different methods.

The first method is through the primary market, and the second method is through the secondary market.

Primary market

The primary market is a platform where the companies issue new securities that do not previously exist in any other exchange. Companies use the primary market as a platform to float their new stock options and bonds for acquisition by the general public. If a company is investing its shares for the first time, it will be doing that through methods like IPO in the primary market.

Secondary market

The general public commonly refers to the secondary market as the stock market. Investors use the secondary market as a platform to purchase and sell the stocks of other companies. 

The companies have no role in buying and selling stocks in the secondary market.

Brokers facilitate the trading of shares for investors without involving the company that issued them in the first place.

The shares are available in the secondary market only after they have gone for an IPO in the primary market.

After the shares make their way from the primary market to the secondary market, the company does not involve itself in the transactions related to the trading of these shares.

There are two types of secondary markets:

• The auction market and, 
• The dealer market.

What are the notable stock exchanges in India?

There are two significant Stock exchanges in India. The first one is the National stock exchange, also abbreviated as NSE, and the second is the Bombay Stock exchange, also abbreviated as BSE.

National Stock Exchange (NSE)

The National Stock exchange is a stock exchange market established to eliminate the monopoly of the Bombay Stock Exchange on the stock market arena in India.

The establishment of NSE happened in 1992 in Mumbai. The NSE is among the front runners in India’s demutualised electronics stock exchange markets.

The National Stock Exchange market capitalisation as of August 2018 was estimated to be around 2.27 trillion US dollars. The National Stock Exchange is also the 12th largest stock exchange globally.

Nifty 50 is the index of the National Stock Exchange, and it is heavily used by investors worldwide to assess the performance of the Indian capital market.

The National Stock Exchange has a public listing of around 4000 companies.

Bombay Stock Exchange (BSE)

Bombay Stock Exchange is the world’s 10th largest stock exchange, established in Mumbai in 1875 at Dalal Street. This stock exchange is said to be the oldest stock exchange in Asia. The Bombay Stock Exchange market capitalisation as of 31st March 2018 happens to be 2.3 trillion US dollars.

The Bombay Stock Exchange has a public listing of around 6000 companies.

Sensex is the index of the Bombay Stock Exchange and is used by investors to estimate the performance of the Indian capital market.

The Bombay Stock Exchange was at an all-time high in June 2019 at 40,312.07.

What are the criteria for listing in the India Stock Exchanges?

If a new company desires to get listed in the Indian Stock Exchanges, then some requirements that it needs to abide by are as follows:

• The company must be incorporated under the Companies Act, 1956/2013.
• The company should not have more than INR 25 crores as its paid-up capital or face value.
• The net worth of the company should be positive.
• The company should have Net Tangible Assets of at least INR 1.5 crore.
• The firm or the partnership converted into the company should have at least three years of track record.
• The company should have a website.
• There should be an agreement of the company with both the depositories and the company should also aid trading in Demat securities.
• The company should not change its promoters until one year from filing the application in the Bombay Stock Exchange (BSE) or National Stock Exchange (NSE) for its listing.

NOTE – The list only provides an overview of the criteria and is not exhaustive in nature.

Significant stock exchanges worldwide

Some of the most notable stock exchanges around the world are as follows:

New York Stock Exchange (NYSE)

New York Stock Exchange (NYSE) is the largest stock exchange in the World. 

It was founded in 1972 and had a 23.12 trillion US dollars market capitalisation as of March 2018.

The New York Stock exchange is based at 11 Wall Street, New York City, USA. It allows the purchase and sale of various financial instruments like exchange-traded funds (ETFs), equity, bonds, etc.

National Association of Securities Dealers Automated Quotations (NASDAQ)

The NASDAQ is an American Stock Exchange in New York City founded in 1971. It ranks second in the list of stock exchanges sorted by market capitalisation. 

The New York Stock Exchange (NYSE) acquires the first place. The NASDAQ is located at 151 W, 42nd Street, New York City.

The surprising fact about the Nasdaq stock exchange is that there are no companies from the Oil and Gas sector or utility sector on this exchange. This Stock exchange is famous for companies that provide healthcare and consumer services and tech and growth firms.

Shanghai Stock Exchange (SSE)

Founded in 1886, adjourned in 1949, and re-founded in 1990, The Shanghai Stock Exchange (SSE) is the biggest in Asia. It is also the third-largest stock exchange globally, with around 1450 listed companies.

The Shanghai Stock Exchange has a market capitalisation of 7.63 trillion US dollars. This stock exchange is different from other stock exchanges because it does not have market regulators to impose circuit breakers to restrict the price volatility. 

Instead, in case of negative news leading to a market crash, the Chinese government can ban trading for that day. 

Other prominent Stock Exchanges in the list of Top 10 stock exchanges are Euronext, Tokyo Stock Exchange (TSE), Hong Kong Stock Exchange (HKSE), Shenzhen Stock Exchange, and London Stock Exchange (LSE).

The other two on the list happen to be National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) in India.

What do companies need to comply to get listed on the most notable stock exchanges?

All companies that want to go public must comply with specific reporting standards set forth by their respective securities regulators. 

The Securities and Exchange Commission in the United States mandates that firms discuss and publish their financial statements and make other disclosures. These are available in quarterly and annual reports. 

In addition to these requirements, a firm must meet the stock exchange requirements it wishes to be listed. 

Below are some of the stock exchange requirements for a firm to be listed. For initial public offerings, the listing requirements may vary (IPO).

The requirements for listing in the top three stock exchanges of the world are as follows: 

NYSE (New York Stock Exchange)

• For the previous three years, pre-tax income must have been at least US$10,000,000. 
• The market capitalisation of publicly traded securities must be at least $100 million. 
• The number of publicly traded shares must exceed 1,100,000. 

National Association of Securities Dealers Automated Quotations (NASDAQ)

• For the previous three years, pre-tax income must have been at least US$11,000,000. 
• A public company’s market capitalisation must be at least US $45,000,000. 
• The number of publicly traded shares must exceed 1,250,000. 

 Shanghai Stock Exchange (SSE) 

• The Shanghai Stock Exchange requires a minimum capital stock of RMB 50,000,000. 
• The company must issue at least 25% of all shares in case the company’s capital stock exceeds RMB 400,000,000. Else, it must publicly issue 10% of all shares. 
• There have been no significant legal violations or fake records in the company’s financial reports in the last three years.

Note: This is an overview of the requirements, and the list is not exhaustive in nature.

Final thoughts

A stock exchange is the essence of a country’s economy. Investment experts and financial analysts often use insights into the stock exchange’s performance to gauge the financial health of a nation.

The stock exchange allows millions of investors to purchase shares from premium companies. 

Overall, the stock exchange is the backbone of public companies for capital generation and the go-to option for investors.