Stock Market Investment, Stock Investing, Stock Investment, Equity Investment

A stock market is where company stocks, bonds, their derivatives and other securities are traded. These investment vehicles arelisted and traded in large quantities on various stock exchanges. Stock market investment represents huge profit making potentialas well as high risk. Stock investing essentially requires detailed knowledge of the stock market, its participants, its functioning and behavior.

Stock Market Investment: Main Participants

Trading in the stock market takes place via brokers. Entities who participate in this market include individuals, banks,insurance companies, mutual funds and pension funds. The stock market has gradually become more ‘institutionalized,’ with largeinstitutions, such as hedge funds and mutual funds and high net worth individuals (HNIs), accounting for the largest tradingvolume.

Stock Market: How It Works

A stock exchange can either be a physical or virtual entity. In physical bourses, transactions take place through auctioning,with sellers quoting prices and buyers making verbal bids. When a buyer’s bid price matches the seller’s ask price, the transaction takes place. Due to the presence of multiple buyers and sellers, market operations are carried on a first-come,first-served basis.

The Contribution of the Stock Market to the Economy

Businesses that need large financing for expansion or improvement can raise capital by participating in the stock market.Investors seeking high liquidity prefer the stock market to the property market, as stocks can be converted to cash more easilyand quickly.

The health of the stock market influences business investment and individual income and consumption. The proper functioning of the stock market impacts a country’s economic growth, through its influence on employment, production of goods and services and inflation. Due to the stock market’s far reaching impact on the economy, every country’s central bank assumes the responsibility of monitoring and tracking the market activities.

Stock Market Investment: Trends and Behavior

The behavior of the stock market and share prices greatly depends upon investor speculation. Overreactions and wrong speculations can result in irrational fluctuations in share prices. The psychology of ‘group thinking’ affects the stock market significantly.

The stock market is also affected by rumors and mass panic. The prices of various stocks can become volatile due to these factors, even if the buzz is not directly related to those specific stocks.

A stock market can witness bearish and bullish trends. The bull market is characterized by high investor confidence and the anticipation of rising prices. A bear market is characterized by steep declines in share prices due to the anticipation of losses and negative investor sentiment.

Evaluating Stock Market Investment

The price of a stock is determined by the market forces of demand and supply. Any positive news (such as a good earnings reportby the company or the government announcing a high GDP growth rate) impacts the demand for a company’s stock.

Here are three techniques for valuing stocks:

Discounted Cash Flow (DCF): This method estimates future cash flows and discounts the same using the concept of the time valuefor money.

Dividend Discount Model (DD): This method estimates future dividend distribution based on the average dividend payout ratio inthe past and discounts the same to reflect the time value of money. This method works best for large-cap and high dividend yield stocks. Penny stocks cannot be evaluated using this method.

Earnings Growth Model (EG): This method aims at predicting future earnings growth rates based on a company’s historicalperformance. This is then discounted using the expected return on investment (ROI).