16 August, 2007

Stock Exchange Basics

Stock Exchanges – BSE and NSE

There are two national stock exchanges in the country, the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). Most large brokers hold membership cards in both exchanges, offering investors a choice of placing their trades on either bourse.

Bombay Stock Exchange (BSE)

The BSE is the oldest stock exchange in the country, established in 1875. It was structured as a membership based firm, an Association of Persons. It is now a demutualised and corporatised entity, falling in line with Sebi's guidelines on demutualization of stock exchanges. The purpose is to separate ownership and management to prevent any conflicts of interest.

The BSE is managed by a Board of Directors, comprising professionals, trading member representatives and has a managing director too. The Board formulates larger policy issues and exercises overall control. The managing director takes care of daily operations. The exchange is present in 417 cities in India.

Source : www.bseindia.com, as of Feb’07

Business Transacted on the BSE
There were 7639 scrips that are listed on the BSE. Not all are actively traded, with the number of scrips traded in Feb’07 at 2602. The average cash segment daily turnover on the BSE was Rs 4,675 crore in Feb’07 and the market capitalization of scrips listed on the BSE was Rs 34.9 lakh crore. The derivatives segment turnover in the month of Feb’07 was Rs 13,189 crore in Feb’07.

These statistics keep changing, to get an update on the latest statistics, go to www.bseindia.com. This link in particular may give you current information : http://www.bseindia.com/about/st_key/volumeofturnoverbusiness_tran.asp.

BSE Indices
The BSE maintains several stock indices that are popular among investors. The following are some of the closely watched indices.

Frame2Apart from these, there are a host of other indices which focus on certain sections of stocks like small cap and mid-cap stocks. Then there are various other indices that are focused on sectors. These indices are updated on a real time basis in market hours.
The most popular index is the BSE Sensitive Index, the Sensex.

BSE Sensitive Index (Sensex)

National Stock Exchange of India Limited (NSE)

The NSE was set up in 1992 by leading financial institutions (IDBI, LIC, UTI, ICICI, SBI and others) and was the first one to offer screen based trading all over India. Though the impetus for its establishment came from policy makers in the country, it has been set up as a public limited company.
NSE is different from most other stock exchanges in India where membership on an exchange also meant ownership of the exchange. At the NSE, the ownership and management of the exchange are completely separate.

Governing body

There are 789 members (as of Feb 28 ’07) who can trade on both the capital market and derivatives segments. There are 150 members who can trade only on the capital market segment. There are 47 members who can trade on the capital market, wholesale debt market (WDM) and derivatives’ segments. There are 9 members who can trade on WDM and capital market segments, and 7 who can trade only on WDM. In all, there are 1002 members.

Number of listed companies

Frame5Classification of Listed Securities
On NSE, securities for account period settlement are classified as ‘EQ’ segment or ‘Normal’ segment. For book entry i.e. rolling settlement, the securities are traded in two separate segments known as ‘AE Segment’ and ‘BE Segment’. In case of AE segment, dematerialised securities are traded only in market lots, whereas in BE segment these can be traded in multiples of one share.

NSE Indices
The popular indices of NSE are :

Frame6Method of Computation of Indices

Frame7Method of Computation of Indices
The CNX Indices are computed using a market capitalization weighted method wherein the level of the Index reflects the total market value of all the stocks in the index relative to a particular base period. The method also takes into account constituent changes in the index and importantly corporate actions such as stock splits, rights, etc without affecting the index value.

Index Maintenance
The Index Maintenance Sub-committee of NSE ensures that the guidelines for index maintenance are adhered to, for example: -

Frame9Adjustments for corporate actions are carried out in a timely manner to ensure that the value of the index is not affected by the corporate action, and remains comparable over a period of time. Each index has a replacement pool comprising companies that meet all criteria for candidacy to that index. All replacements of companies in the index take place from this pool. The replacement pool is monitored continuously and at all times includes only those companies that meet the selection criteria.

S&P CNX Nifty
It is the most popular index, which represents about 58% of the total market capitalization of NSE.
The salient features of the S&P CNX Nifty are :

Frame10Impact Cost Definition – The cost of executing a transaction in a security in proportion to the weight of its market capitalization against the index market capitalization at any point of time.

Impact Cost Calculation - This is the percentage mark up suffered while buying or selling the desired quantity of a security compared to its ideal price
(best buy + best sell) / 2, e.g.
Bids and Offer at a particular time

To Buy 1500 Shares IDEAL PRICE = (99 + 98)/2 = 98.5
ACTUAL BUY PRICE = (1000 X 99 + 500 X 100)/1500 = 99.33
(FOR 1500 SHARES) IMPACT COST = (99.33 - 98.5)/98.5 X 100 = 0.84%

Base Date and Value
The base period selected for S&P CNX Nifty index is the close of prices on November 3, 1995, which marks the completion of one year of operations of NSE’s Capital Market Segment. The base value of the index has been set at 1,000 and a base capital of Rs. 2.06 trillion.

Types Of Market Transactions

You will find it easier to transact in the stock market once you attain a basic understanding of market mechanics. Before a share is purchased or sold, the investor must instruct his broker about the order. This means clearly specifying how the order is to be placed. Sending proper instructions to your broker – either by phone or online- is the first step to avoid hassles later on.

Basically, two types of share transaction exist -buy orders and sell orders. Technically sell orders can be further classified as either selling long or selling short.

Buy Orders
Buy orders are placed when you anticipates a rise in prices. The investor enters a buy order when he finds the price appropriate, after deciding the number of shares he wants to purchase and ensuring that he has the requisite funds to take delivery, if needed.

Sell Orders
When you wish to sell shares of a company you own at present, either because the investment target has been met or you expect a decline in price, you place a sell order with your broker.

Various types of orders that you can put through to exchanges are as follows:

Price Limit Orders
An investor can have his order executed either at the best prevailing price on the exchange or at a pre-determined price.

Market Order
A market order is one you place to sell shares at the prevailing price, when your order is entered in the system. They are executed as fast as possible at the best prevailing price on the exchange. It means that your order quantity will be executed the moment it reaches the exchange provided the required quantity is available. This order type is accepted by both the exchanges i.e. BSE and NSE.

The obvious advantage of a market order is the speed with which it is executed. The disadvantage is that the investor does not know the exact execution price until after the execution. This advantage is potentially most troublesome when dealing in either very inactive or very volatile securities.

Limit orders
Limit type orders refer to a buy or sell order with a price limit. Limit orders overcome the disadvantage of the market order, namely not knowing in advance the price at which the transaction will take place. It means that if the order gets executed, them it will be within the limit specified or at a better rate than that. This order type is accepted by both the exchanges i.e. BSE and NSE.

When using a limit order, the investor specifies in advance the limit price at which he wants the transaction to be carried out. It is always understood that the price limitation includes an "or better" instruction. In the case of a limit order to buy, the investor specifies the maximum price he will pay for the share; the order can be carried out only at the limit price or lower. In the case of a limit order to sell, the investor specifies the minimum price he will accept for the share; the order can be carried out only at the limit price or higher.

Use of Market and Limit order

When do you use a limit order? To safeguard against extreme volatility, you can put a limit on the price at which you want your order to be executed. Generally, limit orders are placed "away from the market." This means that the limit price is somewhat removed from the prevailing price (generally, above the prevailing price in the case of a limit order to sell, and below the prevailing price in the case of a limit order to buy).

Obviously, the investor believes his limit price will be executed during the trading day. That, however, is also the chief disadvantage of a limit order. It may never be executed at all. If the limit price is set very close to the prevailing price, there is little advantage over the market order. Moreover, if the limit is considerably removed from the market, the price may never reach the limit – even because of a fractional difference. Also because limit orders are filled on a first come first basis, it is possible that so many of them are in ahead of the investor’s limit at a given price that his order will never be executed. Thus, selecting a proper limit price is a delicate exercise.

On the other hand a market order is filled at the best possible price as soon as an investor places the order and it will not be even possible to cancel the order. However, a limit order may be cancelled or modified at any time prior to execution.

Various types of specific orders

So far orders have been classified by type of transaction (buy or sell) and by price (market or limit). Now differences stemming from the time limit placed on the order will be examined. Orders can be for either a day or until canceled.

Day Order or End of Day Order
A day order is one that remains active only for the normal trading time on that day. Unless otherwise requested by the investor, all orders are treated as day orders only. Market orders are almost day orders because they do not specify a particular price. One key rationale for the day order is that market conditions might change overnight, and thus a seemingly good investment decision one day might seem considerably less desirable the following day.

Special Types of Orders

Stop Loss Order
A stop loss order allows investor to place an order which gets activated only when the last traded price of the share is reached or crosses a predefined threshold price also called as trigger price. It means that if investor feels that any particular share will be worth buy or sell only after it crosses some threshold rate then this type of order gets activated. For example, a buy order at Rs 100 with a stop loss of Rs 90, will mean that if the share falls to Rs 90, the shares will be sold, limiting the loss to Rs 10.

Several possible dangers are inherent when using this type of order. First, if the stop is placed too close to the market, the investor might have his position closed out because of a minor price fluctuation, even though his idea will prove correct in the long run. On the order hand, if the stop is too far away from the market, the stop order serves no purpose.

Further classification of this type of orders can be defined depending upon the price limit of orders, i.e. the price on which the order should execute, as explained under:

Stop Loss Market Order
A stop loss market order is a special type of limit order. A stop loss market order to sell is treated as a market order when the stop price or a price below is "touched" (reached); a stop market order to buy is treated as a market order when the stop price or a price above it is reached. Thus, stop market order to sell is set at a price below the current market price, and a stop order to buy is set at a price above the current market price.

The possible inherent danger associated with this type of order is that because they become market orders after the proper price level has been reached, the actual transaction could take place some distance away from the price the investor had in mind when he placed the order. The reason may be prior queuing up of other orders or order quantity not being available.

Stop Loss Limit Order
The stop loss limit order overcomes the uncertainty associated with the stop loss market order, of not knowing what price the order will be executed at. The stop limit order gives the investor the advantage of specifying the limit price: the maximum price on which the buy order should filled or minimum price on which the sell order should filled. Therefore, a stop limit order to buy is activated as soon as the stop price or higher is reached, and then an attempt is made to buy at the limit price or lower. Conversely, a stop limit order to sell is activated as soon as the stop price or lower is reached, and then an attempt is made to sell at the limit price or higher.

The danger is that, in a volatile market, the order may not get executed because the difference between the execution limit and the stop price may be too low. However, if things work out as planned, the stop limit order to sell will be very effective.

Disclosed Quantity (DQ) order
The system provides a facility for entering orders with quantity conditions: DQ order allows you to disclose only a part of the order quantity to the market.

Price Bands
Also known as circuit filters or circuit breakers, price bands set the upper and lower limit within which a stock can fluctuate on any given day. A price band for the day is a function of previous trading day’s closing.
Currently the both BSE and NSE has fixed price bands for different securities within which they can move within a day.
Price bands are supposed to prevent extreme price movements, reducing the scope of price manipulation. Price bands do slow things down and make it that much harder for operators wanting to quickly manipulate prices in huge leaps. When there is general euphoria or panic in the market that seems fundamentally unwarranted, price bands give wary investors the benefit of a cooling period.
Operators with access to large funds, shares and time at their disposal, however can manipulate the price bands to their advantage by blocking exit/entry of other investors from a particular counter by placing huge orders. For example when a stock touches the lower circuit in a sharp downtrend, ordinary buyers would wait for the next trading session believing that the stock will be available at a still lower price. As a result, investors wanting to sell the stock won’t find buyers at the lower circuit price but would have to offload at a much lower price due to the volume-led manipulation executed by operator. The operator would thus be able to batter the stock down by a large gap created by his own sell orders.
Much larger volume of the battered stock would then be accumulated by the same operator at a much lower price as panic-stricken ordinary investors would happily exit the stock.


Once you have bought or sold shares, the transaction is complete only when you have got the shares you purchased, or received money for the shares you sold. This is called settlement in stock market parlance. The stock exchanges have a complex mechanism in place to ensure that every trade is properly matched, and shares are received or delivered properly. In case of a shortfall of securities, an auction is resorted to close out the difference.

The mechanism through which all parties to a transaction get their receivables i.e. either funds or shares is known as ‘clearing and settlement’ or simply ‘settlement’.

Settlement agents

On each of the exchanges, thousands of orders get matched with each other during the course of a trading cycle. Even though for each trade there is a buyer broker and a seller broker, they never interact with each other for the settlement of that trade. Their interaction is only with the settlement agency of their exchange.
When an investor enters into a transaction with a broker, either the shares or funds have to be delivered to the broker. In turn, the broker delivers these to the settlement agent on ‘pay-in day’ (explained in the next section). Having made sure that it has received shares and funds from all brokers, it processes the deliveries and earmarks the shares for delivery to the buyer broker. So on the pay-out day (explained in the next section) it is able to deliver shares to the respective buyer broker and funds to the respective seller broker.
For trades on BSE, the settlement agent is called as ‘Clearing House (CH)’ while on NSE it is ‘National Securities Clearing Corporation Ltd. (NSCCL)’

Clearing House – Settlement Agent of the BSE
The clearing and settlement operations of the BSE is managed by a company called BOI Share Holding, which is a subsidiary of Bank of India and BSE and is known as ClearingHouse. All settlements for securities are through the ClearingHouse on a delivery versus payment (DVP) basis.

National Securities Clearing Corporation – Settlement Agent of NSE
The clearing and settlement operations of the NSE are managed by its wholly owned subsidiary, the National Securities Clearing Corporation Limited, also known as Clearing Corporation.

Common settlement processes on both exchanges

Frame12Settlement Cycle on the BSE

The settlement cycle on the BSE is Trade plus two days, or T+2, as per a Sebi directive implementing this new cycle from April 1, 2003. Under rolling settlement, trades done on one day are settled after a certain number of days. So, T+2 will mean that the final settlement of transactions done on the Trade day, will be settled by exchange of money and securities on the second business day (excluding Saturday, Sundays, Bank and Exchange Trading Holidays).

Pay-in and Pay-out for 'A', 'B1', 'B2', ‘T’, ‘S’, ‘TS’, 'C', "F", "G" & 'Z' group of securities
Settlement is done on a T+2 basis. The pay-in/pay-out process will be settled on the T+2 day.

Summary of the Settlement Cycle

Source : www.bseindia.com

NSE Settlement Cycle

The NSE too follows a rolling settlement cycle of T+2.

The stock exchange sends to NSCCL the details of trades at the end of the trading day. The clearing corporation determines the total obligations of each member and transfers the data to clearing members (CM). All the trades done during a particular trading session are clubbed together and settled. NSCCL then determines the net obligations of members in terms of deliveries of securities and funds, and the settlement is completed when the funds and securities are paid out.
On the securities pay-in day, members bring in securities to NSCCL whereas on the pay out day, securities are delivered to members. If there is a shortfall in securities, then an auction is conducted to meet it.

This table makes the process clearer :

Source : www.nseindia.com

Courtesy -- http://www.hdfcsecurities.com/KnowledgeCenter/


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