We hear of this puzzle every day, but most of us are unable to crack it. Our friends or even our family members have to convey the message that “the stock market has gone up” or “the stock market has gone down”. Instead of imposing the question, “what is the stock market?” we act dumb.
I tried to get the answer from one of my good friends who used to talk about the Stock Market, but he couldn’t explain it well. I, as an economics student, have tried to make it simpler so that even a common student can get it.
What Is The Stock Market?
Many people talk about investing in the stock market to create wealth or financial independence, but what is the stock market and how does it work?
The stock market is a global network of exchange where large sums of money move on a daily basis. The stock market does not trade goods and services but “securities” (securities are rights to financial assets like a business share). A “share” is a portion of ownership in a company. When a person buys a share of a company, they are buying small ownership in that company.
Why are shares traded at all? To build a large business, founders need resources. Imagine the company as a pie. The pie is divided into slices and these small slices are shares of the company. Companies typically sell their shares to raise capital (money) to grow and expand their business.
Many do this through Initial Public Offering (IPO). This is where a company begins selling a portion of their shares to the public and anyone can buy parts of the company. In order to facilitate the trade of these securities (shares) to the public, a company needs a marketplace to make their transactions. This is where the stock market comes into play.
There are many stock exchanges around the world where stocks are traded. In India, we have BSE (Bombay Stock Exchange) and NSE (National Stock Exchange).
What Are NIFTY And SENSEX?
In India, BSE and NSE are the two largest and most popular stock exchanges. BSE was established in 1875 and is currently the world’s 10th largest stock exchange, followed by NSE established in 1992. Both are located in Mumbai. Five thousand five hundred companies are listed on BSE, whereas 1,600 in NSE.
As already mentioned, there are hundreds of companies in BSE and NSE. So it isn’t easy to track the financial conditions (the financial performance of companies shares) of shares of all the companies in the market.
Now, what do we do? We take a sample of the top 30 companies from BSE, which is popularly known as SENSEX. Likewise, we take a sample of the top 50 companies from NSE called NIFTY. Therefore, NIFTY and SENSEX are nothing but indexes/indices of NSE and BSE.
The Pointing System
For instance, let us say there are only two companies in the market (X and Y) and suppose the total shares of company X are 250. Among 250 shares, say 200 are for the general public and 50 are held by the company’s management and the price per share is 200.
The total value of the company is equal to the total number of shares (250) times price per share (200). Therefore, the total value of the company is ₹50,000.
When we subtract the value of shares held by the company’s management from market value, we get the free float market capitalisation. Therefore, ₹40,000 is free float market capitalisation.
And say free float market capitalisation of company Y is ₹60,000, then the entire free float market capitalisation is equal to 1,00,000.
When SENSEX was first calculated, the entire free float market capitalisation was ₹10,000, equal to 100 Sensex points (the base index is then 100). Therefore ₹1,00,000 equals to 1,000 Sensex points.
Now suppose the price per share of company X increases by ₹50. The entire free float market capitalisation equals 1,10,000. This would mean the Sensex surged by 100 points. If prices increase, SENSEX will increase and vice versa.
Likewise, we take the Base Index of NIFTY as 1,000 points.
This is how the stock market works in India. So the basic trick to crack this puzzle is to have eyes on shares and their prices. So whenever you get to hear that Nifty or Sensex has gone up or down, it simply indicates that the price of shares is going up or down.