Last Updated on May 25, 2022 by Neera Bhardwaj
Marketplaces bring sellers and buyers together. They allow sellers to sell their offerings and buyers to buy such offerings. If you need to shop for vegetables, you head to a vegetable market or your local vegetable seller. For groceries, you shop at the local Kirana store or departmental stores. Where do you go if you want to buy stock or bonds?
The answer is a stock exchange. In today’s blog we dive deep into what a stock exchange is and how it works.
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Stock exchange meaning – What is stock exchange?
A stock exchange is a marketplace to buy and sell stock and other financial instruments. It is a platform where shareholders interact with other shareholders to buy or sell shares. Besides shares, stock exchanges also allow trading in commodities, bonds, and Exchange-Traded Funds (ETFs), among other financial instruments.
How do stock exchanges work?
Now that you know the meaning of stock exchange, let’s understand how it works.
Primarily, there are two types of financial markets – the primary market and the secondary market. The primary market is where companies issue their stock to the public for the first time through an IPO. Thereafter, once the stock is allotted to interested buyers, it is listed on the secondary market. The stock exchange is the secondary market where stocks and other instruments are listed and traded.
So, when you buy and sell shares or other instruments on the stock exchange, you don’t transact with the company. You transact with existing shareholders. Investors who wish to sell off their assets look for buyers and buyers looking to invest in such assets look for sellers. The stock exchange offers a platform where these sellers and buyers can come together to conduct trade. The instruments are listed on the stock exchange market and buyers and sellers can place buy and sell orders (respectively).
Importance of the stock exchange
The meaning of stock exchange also highlights its importance. The stock exchange is an important platform both for companies that list their stocks and for investors. Let’s understand why:
From the perspective of a company
If a company wants to list its shares, it needs a stock exchange. So, the exchange is important for the company for the following reasons:
- A source of raising funds
Equity is the most cost-effective way for a company to raise funds for operations and growth. Even though the equity stock is issued in the primary market, it ultimately gets listed on the stock exchange which is the secondary market. Moreover, the company can issue more shares through the exchange for additional capital. So, the stock exchange allows companies to raise funds.
- Better visibility and perception
Companies whose stocks are listed and traded on the stock exchange have better visibility as they are known to investors. Moreover, when the company delivers a good performance, it is reflected in the value of its shares which boosts a favourable market perception and helps the company earn goodwill and grow.
- The facility of ESOPs
Companies can attract talented employees with Employee Stock Ownership Plans (ESOPs) if their stock is listed on the stock exchange. This allows companies to cut down on their acquisition costs, get good employees and also motivate employees to be productive.
- Compliance with the legal framework
The Securities and Exchange Board of India (SEBI) is the regulatory authority of the capital market. As such, companies listed on the stock exchange have to comply with SEBI’s rules and regulations. It ensures corporate governance and weeds out unfair practices.
From the perspective of investors and traders
For investors and traders trading on the stock exchange, the importance of the platform is underlined in the following points:
- Trading opportunities
First and foremost, stock exchanges give traders and investors a platform to trade. Interested investors can invest in potential assets to generate returns on their investments. On the other hand, potential sellers can sell their assets to book profits, realise funds, or cut down on losses. By providing a platform of interaction between buyers and sellers, stock exchanges provide different trading opportunities.
Instruments listed on the stock exchange market are highly liquid. You can sell them and get funds whenever you need them. So, in an emergency, you can sell your holdings to get liquid funds to meet your financial obligations. Moreover, if your investment strategy changes, you can easily reshuffle your portfolio by trading your assets on the exchange.
- Collateral assets
The instruments listed on the stock exchange serve as collateral assets and allow you to raise funds against their value. This is helpful when you need funds for emergencies or other financial obligations.
Leading stock exchanges of India and the world
Here are some of the notable stock exchanges across the world as well as in India:
- International stock exchanges
- New York Stock Exchange
- Shanghai Stock Exchange
- London Stock Exchange
- Tokyo Stock Exchange
- HongKong Stock Exchange
- Stock exchanges of India
Wrapping it up
It is essential to develop an understanding of how the exchange works and the benefits that it holds for you as an investor or trader. Then, choose a suitable exchange wherein you want to trade. The stock exchange offers a variety of instruments so that you can build up a diversified portfolio to minimise risks and increase the potential of returns.