Module No 4: Stock Markets and Stock Selection
Stock Markets
The stock market is a platform where shares of publicly listed companies are bought and sold.
It allows investors to trade ownership in companies (in the form of stocks or shares), giving
businesses a way to raise funds and enabling investors to own a part of the company.
Key Components:
1. Stocks (Shares): Ownership units in a company. Owning a stock means having a small
part of the company's equity.
2. Stock Exchanges: Organized marketplaces (like NSE and BSE in India) where stocks
are traded.
3. Investors: Participants who buy and sell stocks. This includes:
o Retail Investors: Individual investors.
o Institutional Investors: Large organizations like banks, mutual funds, etc.
4. Brokers: Intermediaries who facilitate buying and selling of stocks on behalf of
investors.
Types of stock markets
Primary Market
Definition: The primary market is where securities (like stocks and bonds) are created
and sold for the first time. Companies raise capital here by issuing new shares to
investors.
IPO (Initial Public Offering): A company issues shares to the public for the first time.
FPO (Follow-on Public Offering): Issuance of shares by a company already listed on
a stock exchange.
Functions of Primary Market:
o Facilitates capital formation
o Encourages long-term investments
o Provides opportunities for the public to invest in new ventures.
Secondary Market
Definition: The market where existing securities are traded among investors. This is
where investors buy and sell shares from each other.
Stock Exchanges: Organized platforms where secondary market trading takes place.
Examples: NSE (National Stock Exchange) and BSE (Bombay Stock Exchange).
Functions:
o Provides liquidity to securities
o Determines market prices of securities
o Offers a continuous and regular market.
Stock Exchanges and Operations
Trading: Process of buying and selling securities on stock exchanges.
o Types of Orders: Market order, limit order, stop-loss order.
o Trading Participants: Retail investors, institutional investors, brokers.
o Trading Platforms: Trading is mostly electronic through platforms like NSE’s
National Exchange for Automated Trading (NEAT) and BSE’s BOLT.
Settlement: The process of transferring securities and funds after a trade is executed.
Typically, the T+2 cycle is followed (trade day + 2 working days).
o Clearing Houses: Ensure smooth settlement of trades, acting as intermediaries.
o Settlement Process: After trade execution, the securities and funds are
exchanged between the buyer and the seller.
Demat Account
Definition: A Demat (Dematerialized) account holds securities in an electronic form,
eliminating the need for physical certificates.
Importance: It simplifies transactions by making them faster and safer.
Opening a Demat Account:
o Requires identity proof, address proof, and a bank account.
o A Demat account is linked to a bank account to enable transactions.
Depository and Depository Participants (DPs)
Depository: An organization that holds securities in an electronic form. In India, there
are two main depositories:
o NSDL (National Securities Depository Limited)
o CDSL (Central Depository Services Limited)
Depository Participants: Intermediaries between the depository and investors. DPs are
typically banks, brokerage firms, and financial institutions.
o Investors need a Demat account with a DP to trade in electronic securities.
Stock Selection
1. Fundamental Analysis
A method used to evaluate the financial health of a company and assess its intrinsic value
based on external factors.
Economy Analysis:
o Assesses the overall economic conditions of a country.
o Factors: GDP, inflation, interest rates, government policies.
Industry Analysis:
o Evaluates the industry where a company operates.
o Factors: Market size, competition, growth rate, government regulations.
Company Analysis:
o Focuses on analyzing the financial and operational aspects of the company.
o Key Ratios:
P/E Ratio (Price-to-Earnings): Reflects market expectations for the
company’s future earnings.
ROE (Return on Equity): Measures the profitability relative to
shareholders' equity.
Debt-Equity Ratio: Shows the proportion of debt used by the company
relative to its equity.
2. Technical Analysis
A method used to forecast future stock price movements based on historical data and market
behavior.
Graphical Patterns:
o Head and Shoulders: Indicates a reversal in an uptrend or downtrend.
o Double Top and Double Bottom: Suggests possible reversal patterns after a
strong trend.
Candle-stick Patterns:
o Doji: Represents market indecision.
o Hammer: Indicates potential reversal in a downtrend.
Indicators and Oscillators:
o Moving Averages: Average price over a set period. Helps identify trends.
o RSI (Relative Strength Index): Measures momentum to identify overbought or
oversold conditions.
o MACD (Moving Average Convergence Divergence): A trend-following
momentum indicator that shows the relationship between two moving
averages.
Stock Return and Risk
Analysing Risk and Return
Risk-Return Trade-Off: Higher potential returns usually come with higher risks.
Types of Risks:
o Systematic Risk: Affects the entire market (e.g., interest rate changes,
inflation). Cannot be diversified.
o Unsystematic Risk: Specific to a company or industry (e.g., management
issues, new competitors). Can be reduced through diversification.
Investment Risk
Beta: Measures a stock's volatility relative to the overall market. A beta greater than 1
indicates more volatility than the market.
Diversification: Reducing risk by investing in a variety of securities from different
sectors and industries.
