Equity as an asset class #2 – Stock markets and Indices

In the last post we saw how X has taken his company E-coaching public. It is now listed in the stock markets. Before proceeding further we will need to understand what is a stock market, exchange and index. As I do not believe in re-inventing the wheel, most of the definition in this post are available publicly and are mainly from Investopedia and similar sources.

DEFINITION of ‘Stock Market’

The market in which shares of publicly held companies are issued and traded either through exchanges or over-the-counter markets. Also known as the equity market, the stock market is one of the most vital components of a free-market economy, as it provides companies with access to capital in exchange for giving investors a slice of ownership in the company. The stock market makes it possible to grow small initial sums of money into large ones, and to become wealthy without taking the risk of starting a business or making the sacrifices that often accompany a high-paying career.

The stock markets can be divided into primary market and secondary market. The first is where companies deal with their IPO and the second is where you can buy or sell shares of an existing company.

DEFINITION of ‘Index’

A statistical measure of change in an economy or a securities market. In the case of financial markets, an index is an imaginary portfolio of securities representing a particular market or a portion of it. Each index has its own calculation methodology and is usually expressed in terms of a change from a base value. Thus, the percentage change is more important than the actual numeric value.

With these definitions out of the way let us see what this really means in the Indian context. As all of you know we have 2 main stock exchanges namely the Bombay Stock Exchange ( BSE ) and the National Stock Exchange ( NSE ). Most of the publicly traded shares are available in both these exchanges. There are some other regional exchanges in Kolkata, Jaipur etc but most of us would not be using those.

The Index associated with the BSE is termed the Sensex and it has a portfolio of 30 stocks. The index for the NSE is the Nifty having a portfolio of 50 stocks. The value and trending of Sensex and Nifty gives an idea of how the markets are doing and help us in establishing benchmarks in comparison to earlier times etc. There are other indices for the broader markets such as the Midcap index and the Smallcap index.

Most of the stocks that we deal with are likely to be part of some index or the other. However, you can trade in any stock, irrespective of whether it is a constituent of any index or not. It is quite possible for the indices to move in different directions. The Sensex and the Nifty will normally move in conjunction but the Midcap and Smallcap indices may follow an opposite direction at times. Also individual stocks may follow a different direction from an Index even if it is part of the same. Thus ONGC is part of Nifty but it may be rising when the Nifty has an overall downward trend.

While understanding the movement of Indices gives us valuable background information, investment decisions of buying and selling a particular stock has more to do with that particular industry/sector and of course the company itself. So after E-coaching is listed and the shares are available in the secondary market, your decision to buy it will depend on the future prospects of the industry and more importantly how E-coaching is likely to do potentially in the future.

In the next post we will deal with the likely returns from the markets and the associated risks.

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