We hear of a markets going up & down all the time,and many times Iam asked a question.What the hell are these stocks?
For the benefit of people who do not understand what is a stock or equity or a share,let me tell you a story.
I have a friend Anita. She is an excellent Art teacher and was forever talking about her desire about starting an art class.. Once while we were in sipping coffee in a cafe she said she was ready to strike out on her own but the prospect of buying or renting a place and running the overheads expense was daunting.
She did not have the funds to kickstart her venture.
I had great belief in her ability and her diligence. Just at at that time I had come into some money and I looked at it as a opportunity to support a friend as well get a good business deal.
I offfered to lend some money to her at a low rate of interest. She was grateful and said she would think about it.
After a few days we met again and again she broached the topic. It was evident that an Art Class was her dream project.
I immediately enquired, what was the problem? What was blocking her from starting an Art Studio? It couldnt be finance.I was willing to fund her dream. She hesitated and said that was worried about the interest burden and her ability to pay back my loan.
She said it was her first business venture and was not sure about whether it will take off and did not want to lose a friend as well as a dream.
I got where she was coming from.
Also I did not just want to gift cash away to her.
So I asked her what if we became partners and I put in the money in the venture and we share profits? We would work out the details.
The idea appealed to her and she readily agreed.
The Studio opened soon 🙂
I knew for a fact that she was a great artist and a teacher and would make the venture a success. I was happy to be a partner to this as I felt the possibility of me losing money was miniscule.
So now lets come to the point..
When I offered to lend money to Anita to start her venture it was debt.
My principal was protected which would come back after the date we agreed upon and she would give me interest too.
But finally I agreed to be a part owner of the business. I agreed to share a part of profits and losses of the business. So it was share or equity capital.
If her Art class fails.
I lose my principal.
But if it does it very well, then I stand to make a packet.
Hence Equity/Stock is part ownership of a business.
Debt is lending money to a person or a business. The returns maybe lower than equity but they are certain and there is an implicit guarantee of Principal.
In its very basic form this is Equity as opposed to Debt.
I have explained now what is a Stock or a Share is but how does that explain the huge Stock Market? And why does it bounce around so much?
To recapitulate a share is a part ownership of the business. If an enterpreneur wants to start a business he or she will give away part ownership of the business to a friend or a relative so that the business takes off.
All this works if the business is small. But say if the project is big like a big chemical factory or a garment factory.Then a single or a couple of friends who are investors may not be able to satisfy the full need of the project.
That is where a Capital Market comes in. It is the market which provides capital to a business owner to start a business and for additional needs.
Iam from India so there is government agency called SEBI — Securities Exchange Board of India who has laid down rules for a business man / aka a promoter on how to access the Capital Markets.
In every country there is an body like SEBI lik SEC in the US.
That is how they companies who want capital comes out with a initial public offer — IPO to access capital from the public. People look at the business venture, ask their advisor and choose to invest in the business or not.
This does not explain the bouncing around ? Why does the stock prices in the market go up and down so much?
This requires a slightly longer answer.. But lets take baby steps..
Lets go back to my investment in my friend Anita’s Art Class. Say the class works wonderfully for two years and I get a decent share of the profit.
But now I have decided to buy a bigger house and want the money back from Anita. She understands my situation but is stuck.Her business is doing well.
Why should she close it down just to pay me back my original investment?
So she talks to another friend Sara. She was willing to buy my share out.
Wonderful, Problem solved!
All are happy. 🙂
But if the project was bigger and had many shareholders then to work one on one and find buyers for every share holder who wants to sell is impossible.
That is why an exchange comes in . It transfers shares from one person to another at a moments notice. Shares issued in Capital markets are freely transferable. It is anonymous and anyone can invest through it.
A Stock market facilitates these transactions. This is the market in its simplest form.
Now , why do the prices move around so much?
And let me break down in parts..
All of you must have gone and shopped in a mall or online. When we go to a mall there are products lined up and prices displayed.
Sometimes there are markdowns and you may get a good deal.
Its straightforward , walk into a showroom, if you like something and the price fits your pocket just swipe your credit card and walk out with your shiny new thing.
Prices don’t move up & down crazily.
After shopping the mall , say you go to a Indian vegetable market. You will walk in ask for the price of a kilo of Okra.. The vendor will quote Rs.70 a kilo, you will feign shock , state that I want 3 kilos, give me for Rs. 50 a kilo. The vendor will shoo you away .
After some haggling you will strike a bargain maybe at Rs.50 a kilo.
Similarly there are lots of buyers and sellers in the stock market ready to buy and sell shares.
Say there are 10,000 shares of company called Reliance Industries available to sell at Rs.1200 per share.
Multiple sellers with this aggregate quantity. But the buyers are there only for 5000 shares. There are people who are interested but want shares at Rs.1180.
So a deal for 5000 shares get struck at Rs. 1200 as the price and quantity are matching.
Now for the rest of 5000 shares either the seller has to come down to Rs.1180 or the buyers have to agree to Rs. 1200.
After a while the seller gets tired and tries to sell at 1195 per share.
500 shares gets sold. The seller keeps lowering the price till the full quantity gets sold at Rs.1180 per share.
In a while the quantity of 10,000 shares get transacted .
Now there are fresh new buyers who emerge for 25,000 shares.
Some fresh new sellers emerge at Rs.1225.Again deal gets struck at from Rs 1205 to Rs 1208 per share.
So in a matter of minutes price moved from 1200 to 1195 to 1180 to 1225 to 1205 & 1208.
Based on the compulsions of buyers or sellers prices move up and down gently or violently.
This is a very simplistic explanation of stock and a stock market.