Internal Operations of Stock Markets

 

Hey there guys, hope you’re doing great amid the second lockdown phase and today I will be picking the topic of internal operations of stock markets up. I am writing this blog down so that before you actually enter the actual markets, you will be well aware of how they (Stock markets) operate internally.

So basically, Stock markets have two types of players

  1. The Big Players
  2. The Small Players

As the term suggests, big players are generally those individuals or institutions who invest a very huge sum of money in the stock markets, these big players generally are known as Q.I.B’s (Qualified Institutional Buyers) or FII’s (Foreign Institutional Investors) or DII’s  (Domestic Institutional Investors) or “The Big Bulls”. There are relatively fewer big players in the market, but the amount invested by them is generally cosmic in nature.

Small players are generally also known as retail investors, and they are abundant in numbers in the market i.e. there are more number of retail investors in the market with a generally lesser amount of funds.

So to sum up in a few words, we can state that there are fewer big players in the market, but the amount of funds invested by them is more and the number of retail investors in the market are more, but the amount of funds invested by them is less.

Now let’s understand how the stock prices are decided with the help of an example

Suppose, there is a person, say “A” and he wants to buy apples from the market, so the obvious thing that he would do is to go to the market and buy apples from its seller. So when he visited the market to buy apples, he found a seller selling the apples at Rs.100. Now as a buyer, A has 2 options

  1. To buy the apple at Rs.100
  2. To not buy the apples at Rs.100

In case if “A” buys the apple at Rs.100, then the accepted price of the apple would be Rs.100, which means that the price proposed by the seller is accepted by “A” and when this happens, a trade/exchange takes place and the price at which it is exchanged is known as traded price and the prices that you see in the stock markets is nothing but the “Last Traded Price” (LTP), which means that this is the latest price at which the buyer has acquired the shares from the seller.

For example: If the price of Yes Bank as on 1200 Hrs is Rs.40, it means that a buyer has recently acquired the shares of Yes Bank at Rs.40 from the seller (Most Competitive Transaction).

Now if we assume that ”A” would not have agreed to buy the apple at Rs.100, then 100 would not have been the accepted price(Traded Price).

Now this has a simple meaning that for the price of the apple to be Rs.100, both the parties must agree to execute the contract at that price i.e. the buyer must agree to buy the apple at 100 and the seller must agree to sell the apple at 100.

Let’s say that he again visits the market and tells the seller to sell him the apple at Rs.90 instead of Rs.100.  So in this case, instead of the seller, the buyer places a proposal and if the seller accepts it, then the price of the apple would be Rs.90.

So this is how the trade takes place in the stock markets, in reality, i.e. the shares are bought and sold at a determined price within a specified time frame.

Now that you have understood how the stock prices change, let’s now understand that is it possible to manipulate the stock prices? Yes, you heard it right, Can we manipulate the prices of stock?

So the answer to this would be that it depends, which company’s stock are you buying i.e. is that company a small-cap company, mid-cap company or a large-cap company, because generally the stocks of a small-cap company are traded less on the stock exchange, and the simple reason to it is that trading in such classes of the company is generally way riskier than trading in a mid-cap company or a large-cap company. So the volume of trade in such type of company is less (small cap) and hence manipulating their stock price is comparatively easier. In simple words, manipulation of stock prices can be done with only those shares that have a very low trade volume (LTV).

In case if you want to influence the price of a blue-chip (Large-cap) company, then you will have to buy shares in cosmic volumes. You need more shares to manipulate the movement of that share price.

Now let us understand something about what is “MARKET DEPTH” with an example

Suppose you go to the market to buy a few apples and as a buyer, your objective would be to buy at a bargained price, and to do so you perform the following activity

Price Inquiry*
Sr.No Name of the seller Prices in Rs.
1 Seller 1 100
2 Seller 2 120
3 Seller 3 140
4 Seller 4 150
5 Seller 5 160

After performing this activity and as a rational buyer, you will buy the apples at Rs.100, yes or no?

(*Price Inquiry refers to the process of enquiring prices from the sellers for the same share)

Similarly, in stock markets, our objective as a buyer would be to find the most competitive seller and as a seller, our motive would be to find the most competitive buyer

 Now a “most competitive seller” is the one who sells the stock at the lowest price (referred by the buyer before buying the stock) and a “most competitive buyer” is the one who buys the stock at the highest price (referred by the seller before selling the stock).

The system of price inquiry is generally automated in nature and it looks somewhat like this

Market Depth

So;

Now as a buyer, you will always refer to the right side of the market depth and as a seller, you will always refer to the left side of the market depth. On the top of both the sides of market depth, you find the most competitive party (Buyer and Seller) and the least competitive party (Buyer and seller) at the bottom of market depth.

Sometimes, apart from the price, the number of shares traded also matters.

Buying or selling of stocks takes place in chronological order and not as per the desired order. For example:

In case if you want to buy 7 shares at 160, then, in that case, the maximum number of shares that you can acquire is 5 and the remaining 2 shares would be bought at 170.

Basically, there are 2 types of market depths

  1. Level 2 market depth
  2. Level 3 market depth

Level 2 market depth consists of top 5 competitive buyers and sellers

Level 3 market depth consists of top 20 competitive buyers and sellers

Now as you can see, there is no such major difference between level 2 and level 3 market depth.

Which level of market depth is to be chosen depends on the quantity you are planning to trade (sell or buy)

Most of the brokers in India generally offer level 2 data and level 3 data is quite famous amongst the big players or QIB’s

With this, I conclude the first part of this wonderful blog on “Internal Operations of Stock Markets”. I will soon be back with the second part of this blog. Till then stay safe, and see you soon guys.


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