Share trading: How Does It Work? with examples

The stock is bought and sold on various exchanges. Once the trades are made, they are then processed by the market makers and the brokers. They make sure that the transactions go through and settlement is done in a timely manner. 

You have chosen to invest in 100 shares of Reliance Industries at 3030 for one year. But what does this involve, and what happens after you’ve made the purchase? Let’s look at how it works. 

Systems are designed to ensure your transactions progress without difficulty.

To purchase Reliance Industries, log into your trading account and place an order. Your details will then be verified by the system. 

The information about your trading account you will use to purchase Reliance Industries shares.

After you place the order, here’s what is validated: 

• The price at which you intend to buy Reliance Industries
• The number of shares you intend to buy

Prior to submission, your broker verifies that you have sufficient funds to purchase the Reliance Industries shares at 3030 each. Once cleared, the order is sent over to the exchange and their algorithm searches for a willing seller of 100 shares.

The seller of the 100 Reliance Industries shares at 3030 could be one person or a combination of individuals. It doesn’t matter how many there are as long as you can get what you need. Your order is placed and this will be fulfilled if the stock exchange finds sellers in the market.

Once the trade is executed, the shares will be credited to your DEMAT account and debited from the seller’s.

What happens after you own stock?

Once you have acquired shares, you need to monitor them carefully. Keep an eye on how the company is performing and their financials. Consider other factors that might influence the price of your stock as well. Make sure to track your stock portfolio in order to stay informed of any changes, ups and downs in the market, or any news affecting the company.

Once you purchase the shares, they will be kept in your DEMAT account. You now become a shareholder of the company, according to the extent of your holdings. As an example, if you own 100 shares of Infosys, it would constitute 0.000030% of the total.

By owning the shares, you gain access to corporate benefits such as dividends, stock splits, bonuses, rights issues and voting rights. We’ll discuss these shareholder advantages later.

Please note- The holding period is the length of time that you hold an asset before selling it. Holding periods can vary depending on the asset and your investment objectives.

The holding period is your expected duration of ownership for the shares. It might surprise you to learn that it can range from a few minutes up to, as Warren Buffet famously stated, “forever”.

As demonstrated in the earlier example in this chapter, Reliance Industries stocks moved from 3000 to 3016 within 5 minutes, which is not an insignificant return given the short time period. If you are satisfied with that, close the trade and look for another opportunity. It should be noted that such movement is entirely possible in the real market, particularly when things start getting heated.

How to calculate returns?

To understand how to compute returns, one needs to learn a few calculations. Working out returns involves adding together any income received – such as dividends or interest – and noting any capital gains that have been made by selling investments at a higher rate. Subtracting the original investment amount reveals the return figure.

Generating a reasonable rate of return is the essence of markets, and all past share market errors will be overlooked if your trade yields a solid profit. Typically measured in annual yield, familiarizing oneself with the various types of returns and how to work them out is key.

Absolute Return- This allows you to calculate the percentage growth from a particular purchase, such as how much money was gained when selling Infosys at 3550 after buying it at 3030.

We can use this formula to find the percentage change in value between two periods: divide the Ending Period Value by the Starting Period Value, subtract 1 and then multiply by 100.

– [Ending Period Value / Starting Period Value – 1]*100

i.e. [3550/3030 -1] *100

= 17.16%

The amount of 17.16% is a significant amount. It’s quite remarkable that this much was achieved. 

Rather than relying solely on an absolute return to compare two investments, Compounded Annual Growth Rate (CAGR) can help you gain a better understanding. With CAGR, you are able to calculate the rate at which an investment has grown over a period of time. For example, if you purchased Infosys shares at 3030 and sold them after two years at 3550, what was the growth rate? CAGR provides an answer for this very question.

Rather than disregarding the time element, CAGR takes this into account when calculating the overall return.

To calculate CAGR, one would use the following formula…

This can be used to answer the query.

{[3550/3030]^(1/2) – 1} = 8.2%

The rate of growth for this investment was 8.2% over the course of two years, which is still quite good compared to the 5.5% offered in bank fixed deposits with capital protection.

When evaluating returns over multiple years, CAGR should be employed. The absolute return should be utilized when the time period is one year or less.

Buy Reliance Industries at 3030 and sell it at 3550 after six months and you’ve earned a 17.16% return over 6 months – this is equivalent to 34.32% for an entire 12-month period!

It is most beneficial to compare returns when the amount is given for a year.