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21 September, 2019 10:41 IST
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Buying and Selling
Why do stock prices go up and down?

Fluctuations in a stockís 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 Zeeís stock will rise if the market thinks itís 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 companyís 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 stockís 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 and selling stocks

Till 1995, the Bombay Stock Exchange, Indiaís oldest stock exchange and also Asiaís 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 a 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

Letís 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 donít 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 itís 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? Whatís 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.

Letís 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, Tarunís 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.

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