How Does The Stock Market Work? What Are Its Primary Functions?

By Author: NiravSinghaniya
Total Articles: 27
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A stock market refers to the platform where investors trade in financial instruments such as stocks/shares, derivatives and bonds. Investors, also known as buyers and sellers, trade their existing shares while the stock exchange functions as the facilitator of the transactions. The buyer basically places a market order and purchases a particular share or stock at the current price and sells the stock when he derives a profit from his investment. While the open outcry method of stock trading was formerly popular, with the digital revolution, investors today conduct stock trading electronically. Let’s find out how the share market works and the primary functions of the same.

How stock trading works

Listing of the company: Any company looking to raise funds from the public must enter the primary market through an initial public offering or IPO. Interested investors must register for the IPO. They are allotted shares when they list for the IPO.

Secondary Market trading: ...
... After the IPO is released the company goes public and enters the secondary share market. The company can now issue stocks in the secondary market which is the marketplace for all buyers and sellers.

The role of stock brokers: Brokerage firms and stock brokers can help investors choose from the thousands of shares listed on the BSE, NSE and other stock exchanges. Brokerage firms serve as intermediaries between an investor and the exchange. Your brokerage firm processes your purchase/sale order even if you place your order through online trading. When you finalise the purchase/sale price, the stock exchanges facilitates the transfer of share ownership known as a settlement. Typically a settlement is conducted in T+2 days i.e. the shares are reflected in your trading account in 2 days.

Primary functions of the stock market

Now that we know how the share market functions, let us look at its functions:

Providing liquidity

The primary function of the stock market is providing ready markets for buying and selling securities. The stock market assures investors that they can liquefy their investment whenever they wish. In fact, one can invest in long-term instruments and convert them into short and medium term due to the liquidity function of the stock market.

Pricing of securities

A stock market determines the value of stocks based on demand and supply in the market. Stocks of profitable, growth oriented firms are assigned a higher value since there is a huge demand for them.

Mirroring the economy

The prices of shares reflect the major changes in an economy. The rising prices of shares indicate an economic boom whereas the falling prices can indicate a recession cycle. As such, the share market reflects a country’s economic conditions.

Safe transactions

The stock exchange permits the trade of a company’s shares or stocks only after verifying that a company is worthy of being listed on the exchange i.e. it checks if a company is economically sound. The listed companies too, must adhere to the rules, regulations and guidelines laid down by the stock exchange.