What is Equity Market? Meaning, Types & How it Works

The equity market, also known as the stock market, is a platform where shares of publicly traded companies are bought and sold. It allows investors to own a portion of a company and participate in its growth and profits. The equity market plays a vital role in the economy by facilitating capital formation and wealth creation.

This blog will explain what the equity market is, its different types, how it works, and the benefits and risks associated with equity investments. Understanding the equity market helps investors make informed decisions and grow their wealth.

What is EMA in the Stock Market?

The equity market is a financial platform where investors buy and sell shares of publicly listed companies, gaining ownership stakes. Unlike other markets, such as debt or commodity markets, the equity market specifically deals with equity instruments, including common and preferred shares.

Equity markets allow companies to raise capital by issuing shares to the public, helping them fund expansion, research, and development. In return, shareholders participate in the company’s growth through dividends and capital appreciation.

The equity market is divided into two main segments: the primary market, where new shares are issued through Initial Public Offerings (IPOs), and the secondary market, where investors trade existing shares. This ecosystem ensures liquidity and price discovery, reflecting the company’s performance and investor sentiment.

Types of Equity Markets

Equity markets are classified into two main types: the primary market and the secondary market. Each serves a unique purpose in the financial ecosystem, facilitating capital formation and enabling investors to buy and sell shares. Here’s how they work:

1. Primary Market

• Purpose: In the primary market, companies issue new shares to the public for the first time to raise capital. This process is known as an Initial Public Offering (IPO).
• How It Works: Companies sell shares directly to investors, allowing them to become shareholders and participate in the company’s growth. The funds raised are used for expansion, debt repayment, or other business needs.
• Example: When a startup goes public through an IPO, it offers new shares in the primary market to raise capital for scaling its operations.

2. Secondary Market

• Purpose: The secondary market is where investors buy and sell existing shares that were initially issued in the primary market. It provides liquidity, enabling shareholders to exit their investments.
• How It Works: Shares are traded among investors through stock exchanges such as the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). The issuing company is not involved in these transactions.
• Example: If you buy shares of a company listed on NSE, you are participating in the secondary market, purchasing shares from another investor, not from the company itself.

3. Over-the-Counter (OTC) Market

• Purpose: In the OTC market, shares are traded directly between buyers and sellers without being listed on formal exchanges. It typically involves smaller companies or unlisted securities.
• How It Works: Transactions occur through a dealer network, providing flexibility but with less regulation and transparency compared to exchanges.
• Example: Penny stocks and shares of private companies are often traded in the OTC market.

4. Equity Derivatives Market

• Purpose: This market involves trading financial contracts based on the value of underlying equity shares, such as futures and options.
• How It Works: Traders speculate on price movements without owning the actual shares, enabling hedging and leveraged trading.
• Example: An investor buying a call option on a stock is speculating that its price will rise, allowing them to purchase shares at a fixed price in the future.

How Does the Equity Market Work?

The equity market operates as a platform where investors buy and sell shares of publicly traded companies. It facilitates capital formation for businesses while allowing investors to participate in a company’s growth and profitability. Here’s how the equity market works:

1. Issuance of Shares

• Primary Market: Companies raise capital by issuing new shares through Initial Public Offerings (IPOs). In this process, the company offers shares directly to investors for the first time.
• Purpose: Funds raised are used for business expansion, debt repayment, or other corporate needs.
• Example: When a tech startup goes public through an IPO, it raises funds from investors in exchange for ownership stakes.

2. Trading of Shares

• Secondary Market: After the IPO, shares are traded among investors on stock exchanges like the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE).
• Mechanism: Investors buy and sell shares through brokerage accounts, and transactions are facilitated by market makers who provide liquidity.
• Example: If you buy shares of a listed company on NSE, you’re purchasing them from another investor, not from the company itself.

3. Price Determination and Market Dynamics

• Price Mechanism: Share prices are determined by supply and demand. If more investors want to buy a stock (high demand) than sell it (low supply), the price goes up, and vice versa.
• Influencing Factors: Prices are influenced by factors such as company performance, industry trends, economic conditions, geopolitical events, and investor sentiment.
• Example: A positive earnings report can lead to increased demand for a company’s stock, driving the price up.

4. Settlement Process

• T+2 Settlement Cycle: In India, equity trades follow the T+2 settlement cycle, meaning transactions are settled two working days after the trade date.
• Process: On the settlement day, the buyer receives the shares in their Demat account, and the seller gets the payment.
• Example: If you buy shares on Monday, they will be credited to your Demat account by Wednesday.

5. Role of Regulatory Bodies

• Securities and Exchange Board of India (SEBI): SEBI regulates the equity market to ensure transparency, investor protection, and market integrity.
• Functions: It monitors trading activities, prevents market manipulation, and enforces compliance with regulations.
• Example: SEBI’s surveillance systems detect insider trading or unusual price movements, maintaining a fair trading environment.

6. Participation and Access

• Investors: Retail investors, institutional investors, Foreign Institutional Investors (FIIs), and Domestic Institutional Investors (DIIs) participate in the equity market.
• Trading Platforms: Investors access the equity market through online trading platforms, mobile apps, or traditional brokerage firms.
• Example: Using a trading app, you can buy or sell shares, track market trends, and manage your investment portfolio.

Advantages of Investing in the Equity Market

1. Capital Appreciation

• Equity investments provide the opportunity for capital appreciation as stock prices increase over time.
• Investors benefit from the growth of the company, leading to higher share values and capital gains.
• Example: An investor who bought shares at ₹100 and sold them at ₹150 gains ₹50 per share as capital appreciation.

2. Dividend Income

• Companies distribute a portion of their profits as dividends to shareholders, providing a regular income stream.
• Dividend payments can be reinvested to buy more shares, compounding wealth over time.
• Example: A company paying an annual dividend of ₹5 per share provides passive income to long-term shareholders.

3. Portfolio Diversification

• Investing in different sectors and companies diversifies risk, reducing the impact of poor performance in a single stock.
• A well-diversified equity portfolio balances risk and return by spreading investments across industries.
• Example: Holding shares in technology, healthcare, and financial companies minimises sector-specific risks.

4. Liquidity and Flexibility

• Equity markets provide high liquidity, allowing investors to buy or sell shares quickly.
• This flexibility helps investors manage their portfolios according to market trends and financial goals.
• Example: Investors can exit positions during market rallies or cut losses in downturns.

5. Ownership and Voting Rights

• Equity shareholders are part-owners of the company, giving them voting rights in corporate decisions.
• Investors influence key matters like board elections, mergers, and acquisitions.
• Example: Shareholders vote on dividend policies, board appointments, and strategic changes.

Risks of Investing in the Equity Market

1. Market Volatility and Price Fluctuations

• Stock prices fluctuate due to market sentiment, economic changes, and geopolitical events.
• High volatility can lead to significant losses if the market moves against investors’ expectations.
• Example: A stock that loses 20% of its value due to negative news impacts investor portfolios.

2. Risk of Capital Loss

• Investments in equity are not guaranteed, and there’s a risk of losing the invested capital.
• If a company underperforms or goes bankrupt, shareholders may lose their entire investment.
• Example: Investors in a failing company face substantial losses or may receive nothing in liquidation.

3. Economic and Political Risks

• Changes in economic policies, interest rates, or political instability affect market performance.
• Economic downturns, inflation, or currency fluctuations can impact stock prices.
• Example: Changes in trade policies or geopolitical tensions influence investor sentiment.

4. Dividend Risk

• Companies are not obligated to pay dividends, especially during financial difficulties.
• Dividend cuts or cancellations reduce the income stream for investors relying on passive income.
• Example: A company suspending dividend payments impacts income-focused investors.

5. Emotional Decision-Making

• Investor psychology, including fear and greed, leads to impulsive decisions during market volatility.
• Emotional trading results in buying high during rallies and selling low during market crashes.
• Example: Panic selling during market corrections locks in losses.

How to Participate in the Equity Market

Participating in the equity market allows investors to buy and sell shares, benefiting from capital appreciation and dividend income. Here’s how to get started:

1. Open a Demat and Trading Account

• Demat Account: A Demat (Dematerialised) account holds shares electronically, eliminating the need for physical certificates.
• Trading Account: A trading account facilitates buying and selling shares on stock exchanges.
• How to Open: Choose a registered broker or financial institution, submit required documents (like PAN card, Aadhaar card, and bank details), and complete the Know Your Customer (KYC) process.

2. Choose a Reliable Broker

• Types of Brokers:
  • Full-Service Brokers: Offer research, advisory services, and portfolio management, suitable for beginners and long-term investors.
  • Discount Brokers: Provide low-cost trading with no advisory services, ideal for experienced traders.
• How to Select: Compare brokerage fees, trading platforms, research support, and customer service.

3. Research and Analyse Stocks

• Fundamental Analysis: Evaluates a company’s financial health, earnings, revenue, debt levels, and growth potential.
• Technical Analysis: Uses historical price charts, patterns, and technical indicators to predict future price movements.
• Sources for Research:
  • Financial websites like Moneycontrol and Economic Times.
  • Annual reports and financial statements of companies.
  • Streetgains provides research-driven insights and data for informed decision-making.

4. Place Orders and Execute Trades

• Types of Orders:
  • Market Order: Buy or sell shares at the current market price.
  • Limit Order: Set a specific price to buy or sell shares. The order is executed only when the market reaches that price.
  • Stop-Loss Order: Set a price to automatically sell shares to limit losses.
• How to Place Orders: Use a trading platform or mobile app provided by the broker. Enter the stock name, quantity, and order type.
• Example: Placing a limit order to buy shares at ₹100 ensures the purchase only if the price drops to ₹100 or lower.

5. Monitor Portfolio and Market Trends

• Portfolio Management: Track investments regularly, reviewing stock performance and dividend payments.
• Market Analysis: Monitor broader market trends, economic news, and geopolitical events that influence stock prices.
• Example: Using stock market apps or financial news platforms to stay updated on market movements.

6. Risk Management and Exit Strategy

• Diversification: Spread investments across sectors and asset classes to reduce risk.
• Stop-Loss Orders: Protect investments by limiting potential losses.
• Exit Strategy: Define profit targets and exit points to lock in gains or cut losses.
• Example: Setting a stop-loss at 5% below the purchase price limits losses if the stock price drops.

Equity Market: A Path to Wealth Creation and Financial Growth

The equity market plays a crucial role in wealth creation, offering investors the opportunity to own shares in companies and participate in their growth and profitability. By understanding the types of equity markets, how they work, and the advantages and risks involved, investors can make informed decisions to achieve their financial goals.

Successful participation in the equity market requires strategic planning, research, and disciplined risk management. Whether you are a beginner or an experienced investor, the equity market provides diverse investment opportunities to grow wealth over time.

Streetgains provides research-driven insights, educational resources, and strategic guidance to help investors navigate the equity market with confidence and make well-informed investment decisions.