How Stock Market Works – Behind the Scene?

The front end of the stock market is very smooth and seamless. Buying and selling of stocks happens with just a few clicks on a mobile trading app or on a web-based terminal but this is not what all happens behind the scenes. To put it in simple words, there’s a lot that happens at the backend of the stock markets, right from the time an investor like you place your order to the time it’s executed and settled.

To begin this interesting journey backstage, let’s first look at a real-life example to understand the concept of how the stock market works completely and the timeline of a trade.

For Instance, there are two users Ravi and Kishan who have been monitoring company A’s stock for a while.

Currently, company A is trading at a price of ₹500. Suddenly, there was big news in the market when the CEO of the company resigned from his position due to some internal conflict. This thrashed the stock price of the stock by 10% of its overall valuation.

Now there are 2 different viewpoints here.

1. Ravi, who is currently holding 100 shares of company A, sees this as a bearish trend in the days to come. He thinks that it will be hard for the company to see anything positive and the stock is going to tank even further. He wants to exit his holdings at the current price before he loses out even further. He sets his stop-loss at ₹400 and will exit off all his 100 shares at this price.
2. On the other hand, Kishan is eyeing this as a rare market opportunity. He is confident that this stock will be back to its valuation of ₹500 and more in 6-8 months’ time. That is promising. He decides to buy and places an order of 50 stocks at a price of ₹400 each.
3. Now, since both of these users are eyeing the price of ₹400. There is a possibility that their orders get executed together where Ravi gets rid of and Kishan gets into the holding of 100 shares of company A.

And this is what happens in the stock market and is the basic principle of how the stock market works. One user buys stocks and the other sells. Stock market provides an ecosystem to both buyers and sellers where they can carry out their transactions smoothly and easily.

Buying Timeline –

The day when you place an order on the stock exchange is called the trade date and it is represented as ‘T Day’, then subsequent days will be known as T+1 day, T+2 day, and so on.

• Let’s assume Kishan buys 1 share of Company A at Rs. 400 on T day.
• So, when he did this, an amount of Rs. 400 was deducted from his trading account on T day.
• The broker he is trading through will issue a contract note to Kishan by the end of T day. This document contains the details of all the trades Kishan has made that day.
• On T+1 day, the internal processing for the trade Kishan carried out on T day happens.
• Then, on T+2 day, the share of Company A that Kishan purchased on T day is credited into his Demat account.

Selling Timeline –

• Conversely, let’s assume Ravi sells 1 share of Company A at Rs. 400 today, that is, T day.
• The share, which Ravi would have held in his Demat account prior to this trade, is blocked to minimize the chances of default.
• Before T+2 day, the share is moved out of Ravi’s account and given to the exchange.
• On T+2 day, Ravi receives the sale proceeds of Rs. 400 in your trading account.

So this is how the buying and selling of shares happens.

Phases in the process of transfer of shares –

First phase : Execution-

In this phase, a trader or investor places a buy or a sell order and the stockbroker completes the requirements of the corresponding order. This takes place on the T day.

Second phase : Clearance-

This phase occurs on T+1 day. Here clearing houses identify the amount of money that needs to go to the seller and the number of shares that need to be transferred to the buyer.

Last phase : Settlement-

During this phase, which takes place on the T+2 day or last day, shares are credited to the buyer’s Demat account and the money is paid into the seller’s trading account.

Participants involved –

Clearing corporations – The entire process of clearance and settlement of trades happens by clearing corporations.

Clearing members (custodians) – They identify the amount of funds and the number of shares needed to be transferred to the corresponding traders.

Clearing Banks – Settlement of funds happens through banks only.

Depositories – On the last day or settlement day, clearing members transfer the concerned securities to the clearing pool account which is a specialized account maintained by the clearing members with the depositories.

Conclusion –

So this is the entire process that happens on the stock market on a daily basis within seconds in and day out in perfect synchronization, without any hiccups whatsoever. This seamless process ensures that the stock market functions efficiently.