Imagine a place where businesses raise funds, investors earn inflation-beating returns, and the economy thrives—all in one place. In a nutshell, this is the essence of the stock market, where investors can buy and sell not only company stocks but also bonds, currencies, and other tradable securities. The stock market provides a platform for companies to raise funds while allowing investors to grow their wealth.
A well-performing stock market reflects a growing economy, while a bad-performing stock market reflects pessimism on the part of investors. It provides financialization of savings as investors invest their savings, making it the backbone of the economy.Â
If you are exploring the possibilities of investment online or trading through stocks app, it is essential to understand how the stock market works. This blog explains the meaning of the stock exchange, its benefits, and its primary functions. So let’s get started.
What is a Stock Exchange?
The history of stock exchanges dates back to 1602 when the Dutch East India Company established the first stock exchange in Amsterdam to facilitate trading its stocks. This resulted in the establishment of major stock exchanges, such as the London Stock Exchange in 1802, the Bombay Stock Exchange in 1875, and the New York Stock Exchange in 1792.
In layman’s language, a stock exchange is a regulated market where financial securities such as stocks, bonds, and currencies are traded. It is a centralized platform where buyers willing to purchase these securities meet sellers to exchange them among themselves.
For instance, Suppose a buyer who is willing to invest online places a buy order on the stock exchange. Then, that buy order is matched with the seller’s order price. You pay the seller and receive the securities as consideration. This is how the stock market works.
However, you cannot make transactions in the stock market with the stock exchange. To do this, you need to have a Demat account, and if you don’t have one, you can open free Demat account online. Then, register yourself with a stock broker to buy and sell stocks.
Exchanges provide the infrastructure and regulation necessary for the market to function smoothly. They also promote transparency, fair pricing, and liquidity, making it easier for investors to engage in stock trading in a secure and regulated environment.
Stock exchanges in India include the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE), with the NSE being the biggest stock exchange in India by trading volume. Other popular stock exchanges include the New York Stock Exchange (NYSE), Tokyo Stock Exchange (TSE), and Shanghai Stock Exchange (SSE)
Different types of trading markets in India facilitate trading in various securities. Just like the NSE and BSE connect sellers with buyers willing to trade in stocks, the commodity market facilitates trading in commodities, managed by the National Commodity and Derivatives Exchange (NCDEX) and the Multi Commodity Exchange (MCX). Other markets include the foreign exchange market and the bond market.
  Benefits of a Stock Exchange
- Liquidity: Liquidity refers to how easily an asset can be bought and sold. The liquid markets allow for the immediate buying and selling of assets, while the illiquid markets take time for transactions to be completed, as is the case in real estate.
Since buyers and sellers meet on the stock exchange to trade stocks, it leads to a large volume of transactions, providing high market liquidity. This makes entering and exiting a trading position easier without high price fluctuations.
- Access to Capital: Stock exchanges are a source of capital for companies. Companies can raise capital by getting listed on the exchanges and selling shares in an initial public offering (IPO) to investors interested in participating in their growth story.
Unlike a loan, which requires periodic repayment, raising money by selling shares does not put any financial obligation on the company to repay it. Most companies prefer this route to raise funds in the fast-rising stock market.
- Transparency: Different investors may have different opinions and price estimates about how the price of a security will trade in the future. A buyer may think the price will rise, while the seller thinks the price will fall. Therefore, a potential buyer is always waiting to buy from the seller. This makes the security price reflect the collective wisdom of all market participants.
It promotes transparency and fair pricing and reduces the chances of price manipulation, thereby ensuring an efficient market overall.
- Regulations: Stock exchanges are regulated by regulatory bodies such as the Securities and Exchange Board of India (SEBI) in the Indian stock market or the Securities and Exchange Commission (SEC) in the US.Â
They have set rules and principles for transacting in the market to protect investors and maintain market integrity. Regulation gives investors confidence that they are operating in a well-organized and regulated market.
Functions of a Stock Exchange
- Facilitating Trade: The most crucial role of the stock exchange is to promote the transactions, i.e., buying and selling between investors. This saves investors from finding potential buyers and sellers on their own, making it time-efficient and liquid.
The exchange also acts as an intermediary that ensures all transactions are settled correctly and that no party defaults.
- Ensuring Market Transparency: Stock exchanges give investors access to market data, order books, trading volumes, and other information in real time. Not just investors but companies too need to communicate every piece of information to investors by filing on the stock exchanges.Â
This ensures transparency in pricing and provides investors with meaningful information about the company on time. All these things contribute to making the market transparent.
- Price Determination: Stock exchanges allow the price of a company’s stocks to be determined solely based on demand and supply. The greater the number of buyers than sellers, the higher the prices, and vice versa, thereby helping in price discovery of the security traded.
This price discovery ensures that prices incorporate all information in real time, helping companies’ shares always trade at a fair price.
- Maintaining Market Efficiency: In an efficient market, the stock price reflects all available public information, promoting market efficiency. Companies must also disseminate company-related information, such as earnings reports and news, to investors within a specific time frame.
This ensures that investors get all the information. Their reaction to the company’s share price, in turn, helps the company trade at a fair price.
Conclusion
The role of the stock exchange is an important part of not only a particular economy but also the global financial system. It provides a platform for companies needing capital to connect with investors seeking higher returns in a structured, regulated, and transparent market.
It also promotes economic growth and ensures that financial markets work efficiently. It provides borrowers with access to capital, investors with liquidity, and transparent pricing.If you are also exploring the possibility of online investment, you should first consider opening a free Demat account online through the HDFC Sky App.