Disclosure
The contents of this article are primarily intended for those who have no idea about stocks, Indian stock markets, technical analysis, fundamental analysis etc. These are meant to be basic guidelines only. Detailed information can be obtained from Securities and Exchange Board of India , Bombay Stock Exchange , National Stock Exchange of India and brokerage houses. Readers have to understand that we do not recommend any brokerage houses, web sites, etc. for their investment or trading purposes.
Stocks and Stock Exchanges:
Stock markets are obviously the talk of the town these days. Everyone wants to invest in Indian stock markets. With the advent of Internet, this has become much easier. It is now possible to invest even while travelling. Before we actually begin to invest we need to know certain basic things about stocks and stock markets.
Stock is the capital raised by a company from general public, institutions, etc. through allottment of shares. Derivatives like futures and options are contracts which may be exercised on or before an expiry date. The underlying instrument of derivatives can be stocks or indices. Futures contracts have to be necessarily exercised i.e. if a person has bought 1 lot of Nifty, it will be sold in the market on the expiry date; if a person has sold 1 lot of Nifty, it will be bought back from the market. This is called squaring off. Option contracts may or may not be exercised depending upon the profit. For a detailed description of Futures & Options, read my earlier article “India's Futures & Options Market : An outlook”.
Stock exchanges (also called share market, bourse) are organizations that facilitate trading of the equity shares, derivatives etc. using their systems and terminals.
At any given point of time, many investors and traders will be present in a market for trading. They may be long term/medium term/short term investors, day traders, futures and options traders, financial institutions, foreign institutional investors, mutual funds, speculators, punters etc. They are the people who normally decide the price of a stock on a given day.
For a detailed description of short, medium and long term investing, please read my earlier article, “Psychology of investing and trading”.
The stock market, like any other financial market, is governed by the basic principles of demand and supply. Prices will go up when more people want a stock; prices will fall when people don’t want a stock. There may not be too much price fluctuation if people are not much interested in strong buying or selling.
In India, there are two major stock exchanges. The Bombay Stock Exchange (BSE) is more than 100 years old and located at Dalal Street, a very famous land mark in the business district of Mumbai. National Stock Exchange is also at Mumbai and is in existence since 1990’s. More than 3000 companies are being actively traded at BSE whereas around 1150 companies are traded at NSE. But the F & O market turnover is about 3 times that of cash market (equity share) at NSE.
Reason for investing in stocks:
People get more return for the money invested in a stock over a period of time. Usually, a fixed deposit account in India may not yield more than 10% returns in a year but in stock market, it can happen in a single trading day. Reverse is also true, it can wipe out 10% of the investment in a single day.
For example, Infosys Technologies Limited has appreciated nearly 330 times since 1994. This is just impossible with any other type of business.
Having said that, stock prices simply do not always go upwards. They do fall. Sometimes the fall can be so heavy that it erodes investor wealth by more than 5 or 10% in a session.
Investors will ideally want to buy a stock when demand is about to pick up for the stock and sell when it slowly disappears. But that has to be estimated using some analytical techniques. These are called fundamental analysis and technical analysis. Fundamental analysis focuses on company’s business model, earnings forecast, demand and supply scenario for the company’s products and services and so on. Technical analysis uses price and volume analysis for predicting future price movements.
Procedures for investing in India:
An Indian resident, a non-resident Indian or person of Indian origin (PIO) can invest or trade in Indian stock markets. The rules are slightly different for NRI’s and PIO’s.
Prior to 2001, securities were being traded in physical form i.e. paper certificates were in use. This resulted in delays, loss in transit, signature mismatch, theft etc. With the online trading system, shares are held in electronic form very much like money is held in a bank. This is called a ‘demat’ account. (Demat stands for dematerialization.) It is now compulsory for all securities to be traded under demat segment only. The IPO’s or the initial public offerings insist that the applicant needs to have a demat account.
There are two depositories in India, National Securities Depository Limited (NSDL) and Central Depository Services (India) Limited (CDSL). They hold the equity shares for a fee.
All transactions in the stock exchanges are through brokerage houses only. Some of them offer internet trading facility too.
Demat Account:
This accounts holds the shares in electronic form. Sold shares will be debited by the Depository Participant (DP). Similarly, bought / bonus shares will be credited to this account.
To open an Indian resident demat account, one has to approach a brokerage house. The person(s) will have to:
- Fill out demat account opening form
- Provide PAN (Permanent Account Number) card issued by Income Tax department
- Provide proof of identity (such as passport, driving license etc.)
- Provide proof of residence (such as passport, telephone bill, etc.)
- Provide a working savings bank account number for credit of dividends
It may take approximately 2 to 5 working days for opening a demat account. The broker may also issue depository instruction slips which should be filled when stocks are bought or sold. Both client and broker need to have account with the same DP in order to transact. In case of online trading, no such slips are needed; in some cases, depository participant and trading member (broker) may be the same.
Trading Account:
A trading account monitors the cash transactions of the client. Based on his delivery/intraday transactions, the broker will debit/credit the amount due in his trading account. If a client wants to purchase stocks for which he needs funding from broker (also known as margin) he needs to enter a margin trading agreement with broker. The broker may allow purchase of securities depending upon the market value of clients’ holding and cash balance. In case of delivery (i.e. buying from the market and holding it for sale later) the broker needs to be paid within settlement date i.e. two working days from trade date. However, some brokers may allow a day or two extra.
The procedure for opening a trading account is similar to opening a demat account. A POA (Power of Attorney) agreement needs to be signed by the client and broker. In case the client fails to pay the margin, the broker at his descretion, may square off the transaction.
Procedures for Non Resident Indians and Persons of Indian origin:
Both NRI’s and PIO’s can invest in Indian stock markets under PIS (Portfolio Investment Scheme). They must take delivery of stocks; no intraday trading is permitted for them. Apart from this, they should have NRE account (Non Resident – External) in which foreign exchange can be credited or debited; and NRO (Non Resident – Ordinary) in which rupee can be credited or debited. NRI’s and PIO’s need to give these details, work permit or visa copy, proof of local and permanent addresses, PIS form, account opening form, photos etc. to the broker for opening the demat and trading accounts.
Brokerage, Service Tax, STT:
- “Brokerage” means a certain percent of transacted value (like 0.1%, 0.5% etc.) which is charged by the brokers for buying as well as selling. Some brokers may charge a fixed brokerage per month or minimum brokerage per month. Brokerages vary for intra day trading and delivery trading.
- “Service tax” means tax levied by Central Government on the services provided by brokers and currently it is 12.36% on brokerage amount.
- Securities Transaction Tax (STT) is the tax levied by Central Government on the total value of transaction. Currently the rates (% of turnover) are 0.125% for buy/sell delivery trades, 0.025% (only for sale) of non delivery transaction of equity shares, 0.017% (only for sale) of derivative transactions.
A client will have to pay taxes on his/her transactions as per above details.
Before investing:
- Try to gain some knowledge on stock markets by visiting web sites, reading books, etc. A visit to the stock exchange web site will be useful.
- Do your research on companies, their business profile, earnings, annual reports, etc. This will give some idea on company’s business prospects.
- Discuss investment strategies with some knowledgeable person who has stock market exposure
- The management of the company should have reasonable experience in the field that they venture into. The qualifications of key personnel may not matter much, but experience will.
- Nearly all listed companies have web sites. So its prospects, financials, business dealings can be found from those sites.
- Read some books/visit some sites on fundamental analysis and technical analysis. Though one can’t become expert in few days, it will help making good investment decisions.
- Never transact based on “hot” tips.
- Always invest/trade with the money you can afford to LOSE.
There are some licenced portfolio managers who are registered with SEBI. They are authorized to manage the clients’ portfolio as well as offer buy and sell recommendation to the clients.
Finally, investing/trading is inherently risky. Never invest or trade a stock unless you are convinced from all aspects viz. your risk profile, holding time, profit margin, etc.