The ChoosaBroker Trading Academy

6.1. How Equity Markets Work

Despite the air time that equity markets receive, and the relentless spotlight on the ups and downs in the endless list of stocks, financial illiteracy is still wide spread. This lesson is intended to serve as an introduction to equity markets, and will cover the below listed topics –

Equity Capital Markets explained

An equity capital market is the place where buyers and sellers meet to transact in shares of both publicly listed and privately traded companies. Buyers “bid” for stocks by offering a certain price, while sellers “ask” for a specific price. When these two prices match, the stock sale occurs.

Equity markets are one of the most vital areas of a market economy because it gives a company access to capital to grow its businesses. Investors, in return, secure a slice of ownership in the company with the potential to realize capital gains based on how the company performs financially, which ultimately gets reflected in its share price.

Equity markets can be broadly classified in to 2 categories:

  • 1. Primary Market – It is that part of the equity market that deals with issuance of new securities. Every company that wants to go public has to first come out with an Initial Public Offering (IPO). The company offers a certain portion of its equity to the public. After the IPO process is completed, the shares get listed on a stock exchange.
2. Secondary Market – Post the listing through an IPO, a company’s shares trade on the secondary market. Investors who failed to procure shares during the initial offering can purchase them from the secondary market. It is important to note that in the primary market, an investor gets shares directly from the company, while in the secondary market; the shares are purchases from other investors willing to sell.

Equity Market - Key Concepts

Let us now try to understand some of the basic concepts surrounding equity markets; knowledge about which is imperative if you intend to start trading in shares.

  • Stocks and Shares:

    In general, a “stock” is used to describe a company that is publicly traded on an exchange. On the other hand, a share is a unit of that stock. For example, if you think the time is right, you may buy 100 shares of the stock, Apple Inc. (NASDAQ:AAPL).
  • Stock Exchange:

    It is an organized and regulated marketplace where shares of companies are bought and sold. The New York Stock Exchange is by far the world’s biggest stock exchange, with market capitalization of its listed companies exceeding US$23 trillion at the end of 2018.
  • Market Prices:

    In the equity market, participants buy and sell shares. Prices of these shares are governed by the laws of demand and supply. All things being equal, if the demand for a particular stock is high, its price will rise. Contrarily, if supply is greater, prices will fall.

     

  • Indices:

    A stock index is computed from the prices of selected stocks, generally from within an exchange. It is widely used by investors to get a sense of the broad direction within the market.

     

  • Sectors:

    The equity market is made up of stocks of companies in diverse sectors of the economy. The most important sectors include banking, technology, consumer staples, consumer discretionary, telecommunication, energy, and mining.
  • Stock Broker:

    A broker is an individual or an entity, which buys and sells shares on your behalf. Brokers function as intermediaries between you and the stock exchange. There is a review of the best online brokers available.
  • Contract Notes:

    When you buy and sell shares, the transactions are recorded by way of contract notes. It specifies the price at which you bought or sold the shares, and the day of transaction. You should save the contract notes for future tax purposes.

     

  • Dividend:

    It is a sum of money periodically paid by some companies to their shareholders out of their profits, or cash reserves. A company’s dividend is decided by its board of directors and it requires the shareholders’ approval.
  • Reinvesting:

    Companies can suggest that you reinvest the dividends they pay to buy more of their shares.
  • Tax:

    You will need to pay tax on any profits that you earn from the equity market. You can also seek deductions for the losses you incur.

Equity Market and Stock Market differences

The terms “equity market” and “stock market” are often used interchangeably. Both refer to the equity interest in publicly held companies, represented in the form of stock shares that trade either on exchanges or in over the counter markets.

The only notable difference between the two terms has its roots in accounting. “Equity” by definition signifies ownership of assets after the debt is paid off, while “stocks” denote equity that can be traded.

Equity Market Trading - How it works

For the sake of simplicity, the entire process of equity market trading from the point of view of the average, retail investor has been summarized in 3 steps.

Step 1

The first thing you need to decide is if you are okay with “risk.” Equity markets, by definition, involve a certain degree of risk, which get even more heightened every time a major unforeseen event unfolds. If you are “risk loving”, equities are suitable for you. For the “risk averse,” fixed income assets are the ideal alternative.

Step 2

Decide whether you would like to trade on your own through a discount online broker, or you would like to hire the services of an advisor, who can guide you about what to buy and what to sell. Most such advisory services charge considerable sums of money, and there’s no guarantee to their performance.

Step 3

Assuming you have decided to venture on your own with an online broker, you will then need to open an account with the same. This will require you providing identification documents, and linking your bank account to your equity trading account. Once the account has been set up, transfer the funds, and you are good to go.

Final Few Words

Equity market investing can be a roller-coaster ride. Sometimes your money will grow by the day, while on others, you may witness your wealth disappear.

For success in any field, you need a plan. Select your investment time horizon. If you have decided to hold on to your shares for years, day-to-day stock price movements are irrelevant to you.

On the other end of the spectrum lay the majority of retail participants who are in the market to make a “quick buck.” For them, it’s important to remember that there are no free lunches. You may get lucky once, even twice. But if you don’t know what you are doing, the market will happily take away your money.

Want to start trading? Check out these excellent brokers for day trading or these great CFD brokers!

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