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Chapter 1 Module 4 - Basics On The stock Market. |
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What Is Dematerialization? Dematerialization in
short called as 'demat is the process by which an investor can get physical
certificates converted into electronic form maintained in an account with the
Depository Participant. The investors can dematerialize only those share
certificates that are already registered in their name and belong to the list
of securities admitted for dematerialization at the depositories. |
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Going Short: If you do not have shares and you sell them it is known as going short on a stock. Generally a trader will go short if he expects the price to decline. In a rolling settlement cycle you will have to cover by end of the day on which you had gone short. |
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Concept Of Margin Trading: Normally to buy and sell shares, you need to have the money to pay for your purchase and shares in your demat account to deliver for your sale. However as you do not have the full amount to make good for your purchases or shares to deliver for your sale you have to cover (square) your purchase/sale transaction by a sale/purchase transaction before the close of the settlement cycle. In case the price during the course of the settlement cycle moves in your favor (risen in case of purchase done earlier and fallen in case of a sale done earlier) you will make a profit and you receive the payment from the exchange. In case the price movement is adverse, you will make a loss and you will have to make the payment to the exchange. Margins are thus collected to safeguard against any adverse price movement. Margins are quoted as a percentage of the value of the transaction. Important facts for NRI customers: Buying and selling on margin in India is quite different than what is referred to in US markets. There is no borrowing of money or shares by your broker to make sure that the settlement takes place as per SE schedule. In Indian context, buying/selling on margin refers to building a leveraged position at the beginning of the settlement cycle and squaring off the trade before the settlement comes to end. As the trade is squared off before the settlement cycle is over, there is no need to borrow money or shares. Buying On Margin : Suppose you have Rs 1,00,000 with you in your Bank account. You can use this amount to buy 10 shares of Infosys Ltd. at Rs 10,000. In the normal course, you will pay for the shares on the settlement day to the exchange and receive 10 shares from the exchange which will get credited to your demat account. Alternatively you could use this money as margin and suppose the applicable margin rate is 25%. You can now buy upto 40 shares of Infosys Ltd. at Rs 10,000 value Rs 4,00,000, the margin for which at 25% i.e. Rs 1,00,000. Now as you do not have the money to take delivery of 40 shares of Infosys Ltd. you have to cover (square) your purchase transaction by placing a sell order by end of the settlement cycle. Now suppose the price of Infosys Ltd rises to Rs. 11000 before end of the settlement cycle. In this case your profit is Rs 40,000 which is much higher than on the 10 shares if you had bought with the intent to take delivery. The risk is that if the price falls during the settlement cycle, you will still be forced to cover (square) the transaction and the loss would be adjusted against your margin amount. Selling On Margin : You do not have shares in your demat account and you want to sell as you expect the prices of share to go down. You can sell the shares and give the margin to your broker at the applicable rate. As you do not have the shares to deliver you will have to cover (square) your sell transaction by placing a buy order before the end of the settlement cycle. Just like buying on margin, in case the price moves in your favor (falls) you will make profit. In case price goes up, you will make loss and it will be adjusted against the margin amount. |
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Types Of Orders: There are various types of orders, which can be placed on the exchanges: Limit Order : The order refers to a buy or sell order with a limit price. Suppose, you check the quote of Reliance Industries Ltd.(RIL) as Rs. 251 (Ask). You place a buy order for RIL with a limit price of Rs 250. This puts a cap on your purchase price. In this case as the current price is greater than your limit price, order will remain pending and will be executed as soon as the price falls to Rs. 250 or below. In case the actual price of RIL on the exchange was Rs 248, your order will be executed at the best price offered on the exchange, say Rs 249. Thus you may get an execution below your limit price but in no case will exceed the limit buy price. Similarly for a limit sell order in no case the execution price will be below the limit sell price. Market Order : Generally a market order is used by investors, who expect the price of share to move sharply and are yet keen on buying and selling the share regardless of price. Suppose, the last quote of RIL is Rs 251 and you place a market buy order. The execution will be at the best offer price on the exchange, which could be above Rs 251 or below Rs 251. The risk is that the execution price could be substantially different from the last quote you saw. Please refer to Important Fact for Online Investors. Stop Loss Order : A stop loss order allows the trading member to place an order which gets activated only when the last traded price (LTP) of the Share is reached or crosses a threshold price called as the trigger price. The trigger price will be as on the price mark that you want it to be. For example, you have a sold position in Reliance Ltd booked at Rs. 345. Later in case the market goes against you i.e. go up, you would not like to buy the scrip for more than Rs.353. Then you would put a SL Buy order with a Limit Price of Rs.353. You may choose to give a trigger price of Rs.351.50 in which case the order will get triggered into the market when the last traded price hits Rs.351.50 or above. The execution will then be immediate and will be at the best price between 351.50 and 353. However stock movements can be so violent at times. The prices can fluctuate from the current level to over and above the SL limit price, you had quoted, at one shot i.e. the LTP can move from 350…351…and directly to 353.50. At this moment your order will immediately be routed to the Exchange because the LTP has crossed the trigger price specified by you. However, the trade will not be executed because of the LTP being over and above the SL limit price that you had specified. In such a case you will not be able to square your position. Again as the market falls, say if the script falls to 353 or below, your order will be booked on the SL limit price that you have specified i.e. Rs. 353. Even if the script falls from 353.50 to 352 your buy order will be booked at Rs. 353 only. Some seller, somewhere will book a profit in this case form your buy order execution. Hence, an investor will have to understand that one of the foremost parameters in specifying on a stop loss and a trigger price will have to be its chances of executionability as and when the situation arises. A two rupee band width between the trigger and stop loss might be sufficient for execution for say a script like Reliance, however the same band hold near to impossible chances for a script like Infosys or Wipro. This vital parameter of volatility bands of scrips will always have to be kept in mind while using the Stop loss concept. |
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Circuit Filters And Trading Bands: In order to check the volatility of shares, SEBI has come with a set of rules to determine the fixed price bands for different securities within which they can move in a day. As per Sebi directive, all securities traded at or above Rs.10/- and below Rs.20/- have a daily price band of ±25%. All securities traded below Rs. 10/- have a daily price band of ± 50%. Price band for all securities traded at or above Rs. 20/- has a daily price band of ± 8%. However, the now the price bands have been relaxed to ± 8% ± 8% for select 100 scrips after a cooling period of half an hour. The previous day's closing price is taken as the base price for calculating the price. As the closing price on BSE and NSE can be significantly different, this means that the circuit limit for a share on BSE and NSE can be different. |
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Badla financing In common parlance the carry-forward system is known as 'Badla', which means something in return. Badla is the charge, which the investor pays for carrying forward his position. It is a hedge tool where an investor can take a position in a scrip without actually taking delivery of the stock. He can carry-forward his position on the payment of small margin. In the case of short-selling the charge is termed as 'undha badla'. The CF system serves three needs of the stock market : Quasi-hedging: If an investor feels that the price of a particular share is expected to go up/down, without giving/taking delivery of the stock he can participate in the volatility of the share. ? Stock lending: If he wishes to short sell without owning the underlying security, the stock lender steps into the CF system and lends his stock for a charge. ? Financing mechanism: If he wishes to buy the share without paying the full consideration, the financier steps into the CF system and provides the finance to fund the purchase The scheme is known as "Vyaj Badla" or "Badla" financing. For example, X has bought a stock and does not have the funds to take delivery, he can arrange a financier through the stock exchange 'badla' mechanism. The financier would make the payment at the prevailing market rate and would take delivery of the shares on X's behalf. You will only have to pay interest on the funds you have borrowed. Vis-à-vis, if you have a sale position and do not have the shares to deliver you can still arrange through the stock exchange for a lender of securities. An investor can either take the services of a badla financier or can assume the role of a badla financier and lend either his money or securities. On every Saturday a CF system session is held at the BSE. The scrips in which there are outstanding positions are listed along with the quantities outstanding. Depending on the demand and supply of money the CF rates are determined. If the market is over bought, there is more demand for funds and the CF rates tend to be high. However, when the market is oversold the CF rates are low or even reverse i.e. there is a demand for stocks and the person who is ready to lend stocks gets a return for the same. The scrips that have been put in the Carry Forward list are all 'A' group scrips, which have a good dividend paying record, high liquidity, and are actively traded. The scrips are not specified in advance because it is then difficult to get maximum return. All transactions are guaranteed by the Trade Guarantee Fund of BSE, hence, there is virtually no risk to the badla financier except for broker defaults. Even in the worst scenario, where the broker through whom you have invested money in badla financing defaults, the title of the shares would remain with you and the shares would be lying with the "Clearing house". However, the risk of volatility of the scrip will have to be borne by the investor. |
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Securities lending Securties lending program is from the NSE. It is similar to the Badla from the BSE, only difference being the carry forward system not being allowed by the NSE. Meaning this is a where in a holder of securities or their agent lends eligible securities to borrowers in return for a fee to cover short positions. |
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Insider trading: Insider trading is illegal in India. When information, which is sensitive in the form of influencing the price of a scrip, is procured or/and used from sources other than the normal course of information output for unscrupulous inducement of volatility or personal profits, it is called as Insider trading. Insider trading refers to transactions in securities of some company executed by a company insider. Although an insider might theoretically be anyone who knows material financial information about the company before it becomes public, in practice, the list of company insiders (on whom newspapers print information) is normally restricted to a moderate-sized list of company officers and other senior executives. Most companies warn employees about insider trading. SEBI has strict rules in place that dictates when company insiders may execute transactions in their company's securities. All transactions that do not conform to these rules are, in general, prosecutable offenses under the relevant law. |
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