Fundamental Part Two

Market Related Concepts

You will frequently come across terms like Market Capitalization, Small-Cap Stocks, Mid-Cap Stocks and Large-Cap Stocks. Understanding of what these terms mean in the context of stock markets.

MARKET CAPITALIZATION

"Cap" is short for capitalization, the market value of a stock, indicating the size of the stock available.

Calculating a stock's capitalization

Market Capitalization = Market Price of the stock x The number of the stock's outstanding* shares

Outstanding means the shares held by the public

Say, if Stock X has a Current Market Price of Rs 200 per share, and there are 1,00,00 shares in the hands of public investors, then Stock A has a capitalization of 20,00,000.

The company's capitalization is an effective parameter to group corporate stocks.

In the US, mid-cap shares are those stocks that have a market capitalization ranging from Rs 9,000 crore to Rs 45,000 crore. In India, these shares would be classified as large-cap shares.

Thus, classification of shares into large-cap, mid-cap, small-cap is made on the basis of the relative size of the market in that particular country. The total market capitalization of US markets is $15 trillion. In India, the market capitalization of listed companies is around $600bn.

SMALL-CAP STOCKS: The stocks of small companies that have the potential to grow rapidly are classified as small-cap stocks. These stocks are the best option for an investor who wishes to generate significant gains in the long run; as long he does not require current dividends and can withstand price volatility. Generally companies that have a market Capitalization in the range of up to 250 Crore are small cap stocks. As many of these companies are relatively new, it is difficult to predict how they will perform in the market. Being small enterprises, growth spurts dramatically affect their values and revenues, sending prices soaring.

On the other hand, the stocks of these companies tend to be volatile and may decline dramatically.

Most Initial Public Offerings are for small-cap companies, although these days large companies do tend to source the capital markets for expansion plans. Aggressive mutual funds are also enthusiastic about adding small-cap stocks in their portfolios. Because they have the advantage of being highly growth oriented, small-cap stocks can forego paying dividends to investors, which enables the profits earned to be reinvested for future growth.

 

MID-CAP STOCKS: Mid-cap stocks are typically stocks of medium-sized companies. These are stocks of well-known companies, recognized as seasoned players in the market. They offer you the twin advantages of acquiring stocks with good growth potential as well as the stability of a larger company. Generally companies that have a market Capitalization in the range of 250-4000 crores are mid cap stocks

Mid-cap stocks also include baby blue chips; companies that show steady growth backed by a good track record. They are like blue-chip stocks (which are large-cap stocks) but lack their size. These stocks tend to grow well over the long term.

 

LARGE-CAP STOCKS: Stocks of the largest companies (many being blue chip firms) in the market such as Tata, Reliance, ICICI are classified as large-cap stocks. Being established enterprises, they have at their disposal large reserves of cash to exploit new business opportunities.

The sheer volume of large-cap stocks does not let them grow as rapidly as smaller capitalized companies and the smaller stocks tend to outperform them over time. Investors, however gain the advantages of reaping relatively higher dividends compared to small- and mid-cap stocks while also ensuring the long-term preservation of their capital.

 

Bull and Bear markets

The uses of "Bull" and "bear" to describe markets have been derived from the manner in which each of these animals attacks its opponents. A bull thrusts its horns up into the air, and a bear swipes its paws down. These actions are metaphors for the movement of a market: if the trend is up, it is considered a Bull market. And if the trend is down, it is considered a Bear market.

The supply and demand for securities largely determine whether the market is in the Bull or Bear phase. Forces like investor psychology, government involvement in the economy and changes in economic activity, commodity prices also drive the market up or down. These combine to make investors bid higher or lower prices for stocks.

Bull and Bear markets signify relatively long-term movements of significant proportion. Hence, these runs can be gauged only when the market has been moving in its current direction (by about 20% of its value) for a sustained period. One does not consider small, short-term movements, lasting days, as they may only indicate corrections or short-lived movements.

Stock symbols

A stock symbol is a unique code that is given to all participating companies in securities trading. Once you know the stock code/symbol of the company (sometimes referred to as a ticker symbol) you can easily obtain information about the company. This is important, as a wise investor will always do a financial analysis before purchasing a stock.
For ex- tcs stands for Tata Consultancy Services Infy stands for Infosys

Rolling settlements

Let us understand Rolling Settlements

After you have bought or sold shares through your broker, the trade has to be settled. Meaning, the buyer has to receive his shares and the seller has to receive his money. Settlement is just the process whereby payment is made by all those who have made purchases and shares are delivered by all those who have made sales.

A Rolling Settlement implies that all trades have to settle by the end of the day. Hence the entire transaction, where the buyer has to make payments for securities purchased and seller has to deliver the securities sold, have to complete in a day.
In India, we have adopted the T+2 settlements cycle, which means that a transaction entered into on Day 1 has to be settled on the Day 1 + 2 working days, when funds pay in or securities pay out takes place.  'T+2" here, refers to Today + 2 working days. For instance, trades taking place on Monday are settled on Wednesday, Tuesday's trades settled on Thursday and so on. Hence, a settlement cycle is the period within which the settlement is made. For arriving at the settlement day, all intervening holidays -- bank holidays, Exchange holidays, Saturdays and Sundays are excluded. From a settlement cycle taking a week, the Exchanges have now moved to a faster and efficient mode of settling trades within T+2 Days.

Selling short

An investor sells short when he anticipates that the price of the shorted stock will fall from the existing price. He borrows a share and sells it. As the share price dips, he buys the same share at a lower price and returns it back, while pocketing a profit in the bargain. An adage that describes short selling is ("selling high and buying low'.) Selling Short (Shorting) is an effective tool for traders as it allows us to profit from declining stock and index prices.

A definition of "Selling Short"

Selling short implies establishing a market position by selling a security one does not own, in anticipation that the price of the security will fall.

Margin trading

Margin trading is trading with borrowed funds/securities. It is almost like buying securities on credit.

Margin trading can lead to greater returns, but can also be very risky. While it lets you actively seize market opportunities it also subjects you to a number of unique risks such as interest payments charged for the borrowed money.

Circuit filters & trading bands

In order to check the volatility of shares, SEBI has come up with the concept of Circuit Filters. Under this, Sebi has specified the fixed price bands for different securities within which they can move on a given day.

Recently, in a bid to check the rampant price manipulation in small-cap stocks (known as penny stocks), stock exchanges reduced the circuit filter maximum permissible rise in prices in a day to 5 per cent. Earlier, stocks were allowed to rise up to 20 per cent in a session.

The NSE has also reduced the circuit filter in all the stocks, which are traded on a trade-to-trade basis to 5 per cent. As the closing price on BSE and NSE can be significantly different, this means that the circuit limits for a share on BSE and NSE can be different.

Badla financing

As the term itself signifies, 'Badla' means 'something in return'. Badla is the charge, which the investor pays for carrying forward his position. This hedge tool lets the investor take a position in scrip without actually taking delivery of the stock, thus carrying forward his position on the payment of small margin. The Badla system of transactions has been in practice for several decades in the Stock Exchange, Mumbai and serves 3 needs of any stock exchange:

A) Quasi-hedging: If an investor feels that the price of a particular share is expected to go up or down, without giving or taking the delivery he can participate in the possible volatility of the share.

B) Stock lending: If a stock lender wishes to short sell without owning the underlying security, he employs the Badla system and lends his stock for a charge.

C) Financing mechanism: If he wishes to buy the share without paying the full consideration, the financier steps into the CF system and provides the finance to fund the purchase the scheme is known as "Vyaj Badla" or "Badla" financing.

How the Badla system works?

On every Saturday, a CF system session is held at the BSE. The scrip’s in which there are outstanding positions are listed along with the quantities outstanding. The CF rates are determined depending on the demand and supply of money. There is more demand for funds when the market is over bought, and consequently the CF rates tend to be high.

However, when the market is oversold the CF rates are low or even reverse i.e. there is a demand for stocks and the person who is ready to lend stocks gets a return for the same.

The scrip that have been put in the Carry Forward list are all 'A' group scrip, which have a good dividend paying record, high liquidity and are actively traded. The scrip is not specified in advance, as it then gets difficult to get maximum return. The Trade Guarantee Fund of BSE guarantees all transactions; hence, there is virtually no risk to the Badla financier except for broker defaults. Even if the broker through whom you have invested money in Badla financing defaults, the title of the shares would remain with you and the shares would be lying with the "Clearing house". However, the risk of volatility of the scrip will have to be borne by the investor.

Insider Trading

In your dealings with the stock world, you will often come across the term 'insider trading'. In simple words, the meaning of insider trading is 'the trading of shares based on knowledge not available to the rest of the world.

Insider trading has 2 connotations.

Corporate personnel of a company buying and selling stock in their own company when corporate insiders trade in their own securities, they must report their trades to the exchange Illegal insider trading refers to buying or selling a security after receiving 'tips' of confidential securities information. Thus it is considered as a breach of confidence while in possession of non-public information about the company.

Examples of insider trading
· Corporate officers, directors, and employees who traded the corporation's securities after learning of significant, confidential corporate developments;
· Employees of law, banking, brokerage and printing firms who were given such information to provide services to the corporation whose securities they traded;
· Government employees who learned of such information because of their employment by the government; and
· Other persons who misappropriated, and took advantage of, confidential information from their employers.

Various types of the risks once you start trading

Market Risk

This is the risk of investing in the stock market in general. It refers to a chance that a securities value might decline. Although a particular company may be doing poorly, the value of its stock can go up because the stock market value is collectively going up. Conversely, your company may be doing very well, but the value of the stock might drop because of negative factors inflation, rising interest rates, political instability etc that are effecting the whole market. All stocks are affecting by market risk.

Industry Risk

This is risk that affects all companies in a certain industry. For e.g. Utility companies are often viewed as relatively low in risk because the utility industry is stable and operates in a predictable environment with relatively little change. In contrast, internet and other technology industries are usually viewed as high in risk because the industry is changing so quickly and unpredictably. The dotcom bubble burst in the 90s affected the valuation of all stocks in that industry.

All stocks within an industry are subject to industry risk.

Regulatory Risk

Virtually every company is subject to some sort of regulation. It refers to the risk that the government will pass new laws or implement new regulations, which will dramatically affect a business.

Business Risk

These are the risks unique to an individual company. It refers to the uncertainty regarding the organizations ability to perform business or provide service Products, strategies, management, labor force, market share, etc., which are among the key factors investors consider in evaluating the value of a specific company.