1) Why do stock prices go
up and down ?
2) What on earth are circuit breakers ?
3) Buying and Selling stocks
4) Settlement of a trade
5) Margin Trading : The long and short of it
6) Badla ? whats that ?
7) Who sets badla rates ?
8) Hawala, shawala, kya hota hai ?
Why do stock prices go up and down ?
Fluctuations in a stock�s
price occur partly because companies make or lose money. But that is not
the only reason. There are many other factors not directly related to the
company or its sector. Interest rates, for instance. When interest rates
on deposits or bonds are high, stock prices generally go down. In such a
situation, investors can make a decent amount of money by keeping their
money in banks or in bonds. Why should they face the extra risks of the
stockmarket?
Money supply may also affect stock prices. If there is more money floating
around, some of it may flow into stocks, pushing up their prices. Other
factors that cause price fluctuations are the time of year, and publicity.
Some stocks are seasonal; they do well only during certain parts of the
year and worse during other parts. Publicity affects stock prices. If a
newspaper story reports that Zee Television has bought a stake in Asianet,
odds are that the price of Zee�s stock will rise if the market thinks it�s
a good decision. Otherwise it will fall. The price of Asianet stocks may
also go up because investors may feel that it is now in better hands.
Conversely, if an article says that a company's president is a crook and
has used the money raised to build a palatial bungalow for himself, then
it is a good bet that the price of that company�s stock will fall.
Thus, many factors affect the price of a stock. The behaviour of the price
movement of a stock is said to predict its future movement. The behaviour
is analysed by plotting on a graph the price movement against any standard
index. This is called technical analysis. It tells you when to buy a
stock. Analysis of the fundamentals of a company, on the other hand, tells
you which stock to buy.
Ek-ka-do. Stocks also go for splits. One fine day if the company whose 50
stocks you own and having a current market price of Rs 40, declares a
2-for-1 split, you will now own 100 stocks of the company. The market will
then halve the price, unless it has reasons to be more bullish, to around
Rs 20. Stock splits should not normally raise the value of your stocks,
since the prices fall to compensate for the larger number of shares held.
The main advantage of a stock split is that it improves liquidity. You can
sell 50 shares and retain the other 50.
Usually companies go for stock splits when the stock's price zooms up to
some phenomenal level and hence, becomes out of reach of many investors.
Splits in such cases make stocks affordable and usually lead to increased
buying and, hence, also increase liquidity. Naturally, it is expected that
the stock's value will make an upward ascent soon after the split and
investors will stand to gain.
We can also have a do-ka-ek. Companies sometimes declare to retire their
stocks in a certain proportion of their outstanding stocks. Hence, a
1-for-2 reverse split would mean that any shareholder will now own half
the number of shares with the price of each being double as before the
reverse split. However, the total value of the holding will remain the
same on the day of the split. Reverse splits are currently not allowed in
India though companies can buy back their shares upto a certain percentage
of the outstanding number of shares.
Companies usually go for reverse splits to boost up the stock's price,
which might be performing badly for a long time. A hiked price might
invite more investors.
What on earth are
circuit breakers ?
A circuit breaker is a tool
to control trading of shares by setting a limit on price movement. It is
like a red signal for speeding shares. Regulatory bodies are generally
wary when stock prices rise or fall too fast. In order to give time to the
markets to recover their poise, stocks that rise (or fall) above a certain
percentage are stopped from trading. As of now the two main exchanges, The
BSE and the NSE, have two upper and two lower limits. If a stock prices
hits the first upper limit of 8%, i.e. the stock�s prices rises by 8% from
the price at which it started trading for the day, the exchange halts
trading of the stock for half an hour, which is called the cooling period.
And if even after the cooling period the stock maintains its upward climb
and hits the second upper limit of 16%, trading of the stock is stopped
for the day and resumed the next day. Similarly, for falling stocks there
are lower limits set at 8% and 16%. The circuit is thus the band between
the lower and upper limits. Circuits are built to check the volatility in
the market, to arrest panic and to keep the market under some control.
Buying & Selling stocks
Till 1995, the Bombay Stock
Exchange, India�s oldest stock exchange and also Asia�s oldest, worked on
the open out-cry system of stock trading. The out-cry system followed a
system of public auctions in which verbal bids and offers are made for
stocks on the trading floor. Remember those frantic scenes -- men running
around, shouting at the top of their voices and exchanging signs. Things
have got a bit more civilised since then! In 1995 the operations and
dealings of the BSE were fully computerised and the out-cry system was
replaced by the fully automated computerised mode of trading known as BOLT
(BSE On Line Trading) System.
Settlement of trade
A buyer of a stock has to
pay the seller and get the stock in return, exactly like buying vegetables
in the local market. Well, the problem is unlike a vegetable market,
buyers and sellers are not physically present in the stockmarket. India
does not yet have the infrastructure to facilitate the transfer of stocks
and money between buyers and sellers on a daily basis. Therefore, we have
a settlement period. If the settlement period is seven days, the actual
transfer of stocks and money will take place at the end of the period,
i.e. every seven days. The BSE and NSE both follow a settlement period of
one week.
The trade date is the date the deal was struck or the trade of stocks was
executed. Settlement date is the date on which a trader is supposed to
give delivery of shares or give money for the shares he has purchased. On
the BSE the settlement date is Friday and on the NSE the settlement date
is on Tuesday.
Margin Trading: The long
and short of it
Let�s say you strongly feel
that the price of a stock will go up and so much so that you don't mind
taking some risk or added expense. You can make money by buying the stock
now and selling it later when the price has increased. But what if you
don�t have the money to buy? Well, you could "go long" on that stock, i.e.
you ask your broker to buy the stock without paying him the full amount
now. Instead, you can pay him a token amount called the margin money. When
you buy on margin you are actually buying stocks on credit.
Your broker will lend you the part money if you have enough collateral in
the form of adequate stocks in deposit with the broker. Since it�s a loan
the broker is giving you he will also charge an interest. You could have
also borrowed money from some other sources to buy those stocks. But
usually brokers try to offer interest rates lower than other sources.
When the stock's price has indeed gone up, you sell the stock, pay the
broker the price at which you had purchased it and pocket the difference
(less the interest cost of the broker's loan and the transaction cost).
Buying long allows you to buy more shares than you can afford. And, if
your hunch about a stock's price rise turns out to be correct, you stand
to gain more than what you could have without a margin buy. But the longer
it takes for the stock to rise to the price level you had expected less
will be your gain. To be safe the stock price should rise enough to pay
off the loan amount, the interest incurred and the transaction cost.
Buying long becomes risky if your calculations go wrong. If it takes a
much longer time for the stock price to reach the level than what you had
estimated, your profits will reduce because by that time the interest cost
on the borrowed money would have also risen. And if your estimate
completely goes wrong and the stock's price falls you immediately start
making losses. To be safe the stock price should rise enough to pay off
the loan amount, the interest incurred and the transaction cost.
The other type of margin trading is short-selling. "Going short" is the
opposite of buying long and investors do it when they expect the price of
a stock to fall in the short run and profit from this drop. Lets say, you
tell your broker you want to short-sell 100 shares of Tata Tea which are
currently priced at Rs 40 each. This quarter's results of the company
aren't encouraging enough and you are convinced the stock price will take
a beating within a few days. The broker looks for someone who has 100
shares of Tata Tea and borrows them on your behalf for a short period and
with the guarantee that you will return them in few days. You in turn sell
these borrowed shares at Rs 40 each and hence get Rs 4,000. Now, if what
you had hoped for does happen, and the price of the stock falls to say, Rs
20 after two days, you will do what is called "cover the short position".
That means you buy back the 100 shares by spending Rs 2,000 and your
broker in turn returns them to the person borrowed from. So, by
short-selling you have earned Rs 2,000 (of course, slightly less after
adjusting for the transaction costs and expenses for borrowing the stock).
The advantage of selling short is that you get to sell borrowed stocks
without putting in your money.
Short selling can be perilous. Suppose if the Tata Tea shares fall but
only do so marginally, you might just be able to recover your money. Or if
the shares take a much longer time to reach the Rs 20 level than you had
hoped for, your interest on the money with which the broker had borrowed
those shares will surmount. Additionally, there will be constant pressure
from the lender to return the stocks. Worse still if instead of falling
the stock price rises, you will immediately enter into a loss.
Both short-selling and buying long require a good reading of the market
and correct timing.
In both cases of margin trading you are actually trading shares on credit
that you have taken from the broker. If you have bought or sold a stock on
margin and the stock's price reaches a level that makes it difficult for
your broker to recover the credit, your broker will give you what is
called a margin call. The broker might ask you for more collateral in the
form of stocks or ask you for additional funds. If it becomes worse the
broker will sell the stocks, in case you had gone long, and ask you to
repay the loan.
Badla? What's that?
Badla means
something in return, for instance, interest. It is a common expression in
Indian stockmarkets for the Carry Forward system under which one postpones
the delivery of or payment for the purchase of securities from one
settlement cycle to another. The BSE allows the badla mechanism
only on a hundred stocks and a badla session happens every
Saturday. The NSE allows a form of badla known as the ALBM segment
(Automated lending and borrowing mechanism) which takes place every
Wednesday.
Under this system, a buyer and seller have the option to carry forward
their trades to the next settlement without effecting delivery of shares
sold or making payment for shares bought. Simply put, badla is the
price payable by the buyer to carry over his speculative purchases to the
next settlement. The system helps build large volumes on the exchanges and
imparts liquidity to stocks. The positions at the end of a settlement
period are carried forward to the next period.
Who sets badla
rates?
The demand and supply of
money determine badla rates. There are two types of badla: vyaj badla and
undha badla.. Vyaj badla ("vyaj" means "interest" in Gujarati, Hindi and
Marathi) is a financing mechanism on the BSE where money is provided for
financing carry-forward deals. There is no physical buying or selling
involved in badla. The vyaj badla financier enters into the system to lend
money for a return. This is measured as interest on the funds made
available for one settlement cycle.
Undha badla is the return
paid by a stock borrower to the stock lender. When the seller doesn't want
to deliver shares sold, he pays the charges for carrying over his position
to the next settlement period. This is known as undha badla or reverse
badla. These situations crop up when there is a substantial oversold
position in the market, or when there are more sellers selling who do not
have the shares in hand than there are buyers who do not make payments.
Generally, this occurs when the market players expect prices to fall, and
they sell speculatively.
The demand for money is, in
turn, determined by the net outstanding position, which is the difference
between the long purchases and short sales. Long purchases arise from vyaj
badla and short sales from undha badla. The net of these positions, at the
end of the settlement period, is carried forward. If this figure is large,
badla rates will be higher.
As the settlement is done
on a weekly basis, badla is allowed for one week at a time. At the end of
the cycle, the stockbroker has to either deliver the shares sold, or pay
money for the shares bought. Normally, badla charges are levied on a
weekly basis. However, when a company announces the closure of its books
(to determine dividends, rights or bonus), the stock enters a no-delivery
period for two weeks. In such cases, "book closure badla" is levied, which
is for the two week period.
Hawala, Shawala, kya
hota hai?
Hawala is another important
ingredient in Indian stockmarkets. The hawala rate is a making-up price at
which buyers and sellers settle their speculative transactions at the end
of the settlement period on any stock exchange. This becomes the basis for
the investor (opting to carry-forward) to buy or sell during the next
settlement. The hawala rate is the standard rate for settling and carrying
forward the trade to the next settlement period. This price is significant
for a speculative buyer or seller.
Let�s take an example.
Tarun buys ITC stocks at Rs 150 on Monday, the first day of the new
trading cycle. By Friday, which is the settlement day on BSE and the end
of that particular trading cycle, if Rs 160 were the closing price of the
stock, Tarun would have to carry-forward his trade at this price of Rs
160. Therefore, Tarun will get a credit of Rs.10 per share in his account.
For the following week, Tarun�s cost of the share (or referred as the
contracted price) would be Rs.160 plus badla charges. Similarly, if the
closing price had been Rs 140, Tarun would have been debited Rs.10 and the
contracted price would be Rs.140 plus badla charges. He could therefore,
carry forward for the next settlement without selling off the shares.