TRADING IS MY LIFE

 It is important to know how the index is constructed /calculated especially if one wants to advance as an index trader. As we discussed, the Index is a composition of many stocks from different sectors which collectively represents the state of the economy. To include a stock in the index it should qualify certain criteria. Once qualified as an index stock, it should continue to qualify on the stated criteria. If it fails to maintain the criteria, the stock gets replaced by another stock which qualifies the prerequisites. Based on the selection procedure the list of stocks is populated. Each stock in the index should be assigned a certain weightage. Weightage in simpler terms define how much importance a certain stock in the index gets compared to the others. For example if ITC Limited has 7.6% weightage on Nifty 50 index, then it is as good as saying the that the 7.6% of Nifty’s movement can be attributed to ITC. The obvious question is - How do we assign weights to the stock tha...

Some of the practical uses of Index are discussed below.  Information – The index reflects the general market trend for a period of time. The index is a broad representation of the country’s state of economy. A stock market index that is up indicates people are optimistic about the future. Likewise when the stock market index is down it indicates that people are pessimistic about the future.  For example the Nifty value on 1st of January 2014 was 6301 and the value as of 24th June 2014 was 7580. This represents a change of 1279 points in the index of 20.3% increase. This simply means that during the time period under consideration, the markets have gone up quite significantly indicating a strong optimistic economic future.   The time frame for calculating the index can be for any length of time.. For example, the Index at 9:30 AM on 25th June 2014 was at 7,583 but an hour later it moves to 7,565. A drop of 18 points during this period indicates that the market parti...

Luckily you need not actually track these selected companies individually to get a sense of how the markets are doing. The important companies are pre packaged, and continuously monitored to give you this information. This pre packaged market information tool is called the ‘Market Index’.  There are two main market indices in India. The S&P BSE Sensex representing the Bombay stock exchange and CNX Nifty representing the National Stock exchange.  S&P stands for Standard and Poor’s, a global credit rating agency. S&P has the technical expertise in constructing the index which they have licensed to the BSE. Hence the index also carries the S&P tag.  CNX Nifty consists of the largest and most frequently traded stocks within the National Stock Exchange. It is maintained by India Index Services & Products Limited (IISL) which is a joint venture of National Stock Exchange and CRISIL. In fact the term ‘CNX’ stands for CRISIL and NSE.  An ideal index gives...

Overview If I were to ask you to give me a real time summary on the traffic situation, how would you possibly do it?   Your city may have 1000’s of roads and junctions; it is unlikely you would check each and every road in the city to find the answer. The wiser thing for you to do would be to quickly check, a few important roads and junctions across the four directions of the city and observe how the traffic is moving. If you observe chaotic conditions across these roads then you would simply summarize the traffic situation as chaotic, else traffic can be considered normal.  The few important roads and junctions that you tracked to summarize the traffic situation served as a barometer for the traffic situation for the entire city!  Drawing parallels, if I were to ask you how the stock market is moving today, how would you answer my question? There are approximately 5,000 listed companies in the Bombay Stock Exchange and about 2,000 listed companies in the National S...

Each market participant has his or her own unique style to participate in the market. Their style evolves as and when they progress and witness market cycles. Their style is also defined by the kind of risk they are willing to take in the market. Irrespective of what they do, they can be categorized as either a trader or an investor. A trader is a person who spots an opportunity and initiates the trade with an expectation of profitably exiting the trade at the earliest given opportunity.  A trader usually has a short term view on markets. A trader is alert and on his toes during market hours constantly evaluating opportunities based on risk and reward. He is unbiased toward going long or going short. We will discuss what going long or short means at a later stage.  There are different types of traders :   a.Day Trader – A day trader initiates and closes the position during the day. He does not carry forward his positions. He is risk averse and does not like taking ov...

Now, everything in markets boils down to one thing. Generating a reasonable rate of return!  If your trade generates a good return all your past stock market sins are forgiven. This is what really matters.  Returns are usually expressed in terms of annual yield. There are different kinds of returns that you need to be aware of. The following will give you a sense of what they are and how to calculate the same…  Absolute Return – This is return that your trade or investment has generated in absolute terms. It helps you answer this question – I bought Infosys at 3030 and sold it 3550. How much percentage return did I generate?  The formula to calculate the same is [Ending Period Value / Starting Period Value – 1]*100  i.e [3550/3030 -1] *100  = 0.1716 * 100  = 17.16%  A 17.6% is not a bad return at all!  Compounded Annual Growth Rate (CAGR) – An absolute return can be misleading if you want to compare two investments. CAGR helps you answer this...

Holding period is defined as the period during which you intend to hold the stock. You may be surprised to know that the holding period could be as short as few minutes to as long as ‘forever’. When the legendary investor Warren Buffet was asked what his favorite holding period was, he in fact replied ‘forever’.  In the earlier example quoted in this chapter, we illustrated how Infosys stocks moved from 3000 to 3016 in a matter of 5 minutes. Well, this is not a bad return after all for a 5 Minute holding period! If you are satisfied with it you can very well close the trade and move on to find another op-portunity. Just to remind you, this is very much possible in real markets. When things are hot, such moves are quite common.

After you buy the shares, the shares will now reside in your DEMAT account. You are now a part owner of the company, to the extent of your share holding. To give you a perspective, if you own 200 shares of Infosys then you own 0.000035% of Infosys.  By virtue of owning the shares you are entitled to few corporate benefits like dividends, stock split, bonus, rights issue, voting rights etc. We will explore all these shareholder privileges at a later stage.

You have decided to buy 200 shares of Infosys at 3030, and hold on to it for 1 year. How does it actually work? What is the exact process to buy it? What happens after you buy it?  Luckily there are systems in place which are fairly well integrated.  With your decision to buy Infosys, you need to login to your trading account (provided by your stock broker) and place an order to buy Infosys. Once you place an order, an order ticket gets generated containing the following details:     a. Details of your trading account through which you intend to buy Infosys shares – therefore your identity is reveled.      b. The price at which you intend to buy Infosys      c.The number of shares you intend to buy Before your broker transmits this order to the exchange he needs to ensure you have sufficient money to buy these shares. If yes, then this order ticket hits the stock exchange. Once the order hits the market the stock exchange (through their ...

Let us continue with the Infosys example to understand how stocks really move. Imagine you are a market participant tracking Infosys. It is 10:00 AM on 11th June 2014 ,and the price of Infosys is 3000. The management makes a statement to the press that they have managed to find a new CEO who is expected to steer the company to greater heights. They are confident on his capabilities and they are sure that the new CEO will deliver much more than what is expected out of him. Two questions – a.How will the stock price of Infosys react to this news? b.If you were to place a trade on Infosys, what would it be? Would be a buy or a sell? The answer to the first question is quite simple, the stock price will move up. Infosys had a leadership issue, and the company has fixed it. When positive announcements are made market participants tend to buy the stock at any given price and this cascades into a stock price rally. Notice, whatever prices the seller wants the buyer is willing to pay for it. ...

Like we discussed in chapter 2, the stock market is an electronic market place. Buyers and sellers meet and trade their point of view. For example, consider the current situation of Infosys. At the time of writing this, Infosys is facing a succession issue, and most of its senior level management personnel are quitting the company for internal reasons. It seems like the leadership vacuum is weighing down the company’s reputation heavily. As a result, the stock price dropped to Rs.3,000 all the way from Rs.3,500. Whenever there are new reports regarding Infosys management change, the stock prices react to it. Assume there are two traders – T1 and T2. T1’s point of view on Infosys - The stock price is likely to go down further because the company will find it challenging to find a new CEO. If T1 trades as per his point of view, he should be a seller of the Infosys stock. T2, however views the same situation in a different light and therefore has a different point of view – According to h...

Before we wrap up the chapter on IPO’s let us review few important IPO jargons. Under Subscription – Let’s say the company wants to offer 100,000 shares to the public. During the book building process it is discovered that only 90,000 bids were received, then the issue is said to be under subscribed. This is not a great situation to be in as it indicates negative public sentiment Over subscription – If there are 200,000 bids for 100,000 shares on offer then the issue is said to be oversubscribed 2 times (2x) Green Shoe Option - Part of the underwriting agreement which allows the issuer to authorize additional shares (typically 15 percent) to be distributed in the event of over subscription. This is also called the over allotment option Fixed Price IPO –Sometimes the companies fix the price of the IPO and do not opt for a price band. Such issues are called fixed price IPO Price Band and Cut off price –Price band is a price range between which the stock gets listed. For example if t...

During the bidding process (also called the date of issue) investors can bid for shares at a particular price within the specified price band. This whole system around the date of issue where one bids for shares is referred to as the Primary Market. The moment the stock gets listed and debuts on the stock exchange, the stock starts to trade publicly. This is called the secondary markets. Once the stock transitions from primary markets to secondary markets, the stock gets traded daily on the stock exchange. People start buying and selling the stocks regularly. Why do people trade? Why does the stock price fluctuate? Well, we will answer all these questions and more in the subsequent chapters.

Needless to say each and every step involved in the IPO sequence has to happen under the SEBI guidelines. In general, the following are the sequence of steps involved. • Appoint a merchant banker. In case of a large public issue, the company can appoint more than 1 merchant banker • Apply to SEBI with a registration statement – The registration statement contains details on what the company does, why the company plans to go public and the financial health of the company • Getting a nod from SEBI – Once SEBI receives the registration statement, SEBI takes a call on whether to issue a go ahead or a ‘no go’ to the IPO • DRHP – If the company gets the initial SEBI nod, then the company needs to prepare the DRHP. A DRHP is a document that gets circulated to the public. Along with a lot of information, DRHP should contain the following details.. a.The estimated size of the IPO b.The estimated number of shares being offered to public c.Why the company wants to go public and how does the compa...

Having decided to go public, the company must now do a series of things to ensure a successful initial public offering. The first and foremost step would be to appoint a merchant banker. Merchant bankers are also called Book Running Lead Managers (BRLM)/Lead Manager (LM). The job of a merchant banker is to assist the company with various aspects of the IPO process including… • Conduct a due diligence on the company filing for an IPO, ensure their legal compliance and also issue a due diligence certificate • Should work closely with the company and prepare their listing documents including Draft Red Herring Prospectus (DRHP). We will discuss this in a bit more detail at a later stage • Underwrite shares – By underwriting shares, merchant bankers essentially agree to buy all or part of the IPO shares and resell the same to public • Help company arrive at the price band for the IPO. A price band is the lower and upper limit of the share price within which the company will go public. In ca...

We closed the previous chapter with few very critical questions. One of which – Why did the company decide to file for an IPO, and in general why do companies go public? When a company decides to file for an IPO, invariably the main reason is to raise funds to fuel their Capex requirement. The promoter has 3 advantages by taking his company public.. 1. He is raising funds to meet Capex requirement 2. He is avoiding the need to raise debt which means he does not have to pay finance charges which translates to better profitability 3.Whenever you buy a share of a company, you are in essence taking the same amount of risk as the promoter is taking. Needless to say, the proportion of the risk and its impact will depend on the quantity of shares you hold. Nonetheless, whether you like it or not, when you buy shares you also buy risk. So when the company goes public, the promoter is actually spreading his risk amongst a large group of people. There are other advantages as well in going for an...

THE BANKER Three more years pass by and the company is phenomenally successful. The company decides to have a retail presence in at least 3 more cities. To back the retail presence across three cities, the company also plans to increase the production capacity and hire more resources. Whenever a company plans such expenditure to improve the overall business, the expenditure is called ‘Capital Expenditure’ or simply ‘CAPEX’. The management estimates 40Crs towards their Capex requirements. How does the company get this money or in other words, how can the company fund its Capex requirements? There are few options with the company to raise the required funds for their Capex… 1. The company has made some profits over the last few years; a part of the Capex requirement can be funded through the profits. This is also called funding through internal accruals 2. The company can approach another VC and raise another round of VC funding by allotting shares from the authorized capital – this is ...

Overview The initial three chapters has set the background on some of the basic market concepts that you need to know. At this stage it becomes imperative to address a very basic question – Why do companies go public? A good understanding of this topic lays down a sound foundation for all future topics. We will learn new financial concepts during the course of this chapter. Origin of a Business Before we jump ahead to seek an answer as to why companies go public, let us spend some time figuring out a more basic concept - the origins of a typical business. To understand this concept better, we will build a tangible story around it. Let us split this story into several scenes just so that we get a clear understanding of how the business and the funding environment evolves. Let us imagine a budding entrepreneur with a brilliant business idea – to manufacture highly fashionable, organic cotton t-shirts. The designs are unique, has attractive price points and the best quality cotton is...

Stock Market Participants and the need to regulate them The stock market attracts individuals and corporations from diverse backgrounds. Anyone who transacts in the stock market is called a market participant. The market participant can be classified into various categories. Some of the categories of market participants are as follows: 1. Domestic Retail Participants – These are people like you and me transacting in markets 2. NRI’s and OCI – These are people of Indian origin but based outside India 3. Domestic Institutions – These are large corporate entities based in India. Classic example would be the LIC of India. 4. Domestic Asset Management Companies (AMC) – Typical participants in this category would be the mutual fund companies such as SBI Mutual Fund, DSP Black Rock, Fidelity Investments, HDFC AMC etc. 5.Foreign Institutional Investors – Non Indian corporate entities. These could be foreign asset management companies, hedge funds and other investors Now, irrespective of the ca...

Investing in equity is one of the important investments we make to generate inflation thrashing returns. This was the conclusion we drew from the previous chapter. having said that, How do we invest in Equity? Obviously before we delve into this topic, it is extremely important to understand the ecosystem in which equities operate. Just like the way we go to the neighborhood grocery store or super market for our daily purchases need, similarly we go to the stock market to buy (read as transact) for equity investment. Share market is the place where everyone wants to transact in shares. transact in simple words Means buying and selling. For all practical purposes, you cannot buy/sell shares of a public company like Infosys without transacting through stock exchanges. The main objective of the stock market is to help you facilitate your transactions. so if you a The stock market helps you meet the seller of a share, the buyer and vice versa. Now unlike supermarkets, the stock market does...

Commodity – Bullion Investments in gold and silver are considered one of the most popular investment avenues. Gold and silver over a long-term period has appreciated in value. Investments in these metals have yielded a CAGR return of approximately 8% over the last 20 years. There are several ways to invest in gold and silver. One can choose to invest in the form of jewelry or Exchange Traded Funds (ETF). Going back to our initial example of investing the surplus cash it would be interesting to see how much one would have saved by the end of 20 years considering he has the option of investing in any one – fixed income, equity or bullion.By investing in fixed income at an average rate of 9% per annum, the corpus would have grown to Rs.3.3 Crs 1.By investing in fixed income at an average rate of 9% per annum, the corpus would have grown to Rs.3.3 Crs 2.Investing in equities at an average rate of 15% per annum, the corpus would have grown to Rs.5.4 Crs 3. Investing in bullion at an average...

Real Estate Real Estate investment involves transacting (buying and selling) commercial and non commercial land. Typical examples would include transacting in sites, apartments and commercial buildings. There are two sources of income from real estate investments namely – Rental income, and Capital appreciation of the investment amount. The transaction procedure can be quite complex involving legal verification of documents. The cash outlay in real estate investment is usually quite large. There is no official metric to measure the returns generated by real estate, hence it would be hard to comment on this. Com

Equity Investment in Equities involves buying shares of publicly listed companies. The shares are traded both on the Bombay Stock Exchange (BSE), and the National Stock Exchange (NSE). When an investor invests in equity, unlike a fixed income instrument there is no capital guarantee. However as a trade off, the returns from equity investment can be extremely attractive. Indian Equities have generated returns close to 14% – 15% CAGR (compound annual growth rate) over the past 15 years. Investing in some of the best and well run Indian companies has yielded over 20% CAGR in the long term. Identifying such investments opportunities requires skill, hard work and patience. You may also be interested to know that the returns generated over a long term period (above 365 days, also called long term capital gain) are completely exempted from personal income tax. This is an added attraction to investing in equities.

Fixed Income Instruments These are investable instruments with very limited risk to the principle and the return is paid as an interest to the investor based on the particular fixed income instrument. The interest paid, could be quarterly, semi-annual or annual intervals. At the end of the term of deposit, (also known as maturity period) the capital is returned to the investor. Typical fixed income investment includes: 1. Fixed deposits offered by banks 2. Bonds issued by the Government of India 3. Bonds issued by Government related agencies such as HUDCO, NHAI etc 4. Bonds issued by corporates As of June 2014, the typical return from a fixed income instrument varies between 8% and 11%.