Indian Stock Markets With Joygopal Podder: Savage correction

Thursday, August 16, 2007

Savage correction - how to trade this market?

The markets had recovered over 100 points from morning lows but have gone down again in deep red on account of huge sell off. Earlier in the day the Sensex lost 600 points, trading at 14,000.

The pattern of trade over the last couple of days has been playing out in phases. Markets paused until the next panic wave hit - the latest bout of panic selling has arrived.

The possibility of another big cut was anticipated. The cut has come in and savagely, but there is no element of surprise there. There is still talk of another 4-5% of correction in the market, which may pan out over the next few days.

The crisis is no more sub-prime; it has spread to commercial paper. As long as there are players in India, who have exposure to other markets irrespective of how strong the Indian fundamentals are, markets will take a hit in the short run.

Some experts have suggested that investors should stay in a bit of cash and when there are substantial sell offs like today, buy a little bit hoping to average the next time it falls some more. That would be the best way to approach this market.

Stock Market Terminology...

Stock market terms you must know (this article is for new entrants to the dizzy world of stocks and stock market trading):

As a stock market investor, you will regularly come across words like Sensex, Nifty, correction, rally et al...

Also, as a regular reader of business newspapers you will come across these and a host of other terms that describe the stock market activities.

You will also come across research reports from brokerage houses that talk of buying, selling and holding of a company's share.

Let us go through a few of these terms used in routine stock market parlance.

Sensex

It is an index that represents the direction of the companies that are traded on the Bombay Stock Exchange, BSE. The word Sensex comes from sensitive index.

The Sensex captures the increase or decrease in prices of stocks of companies that it comprises. A number represents this movement. Currently, all the 30 stocks that make up the Sensex have reached a value of 14,355 points.

These companies represent the myriad sectors of the Indian economy. A few of these companies and the sector they represent are: ACC (cement), Bajaj Auto, Tata Motors, Maruti (automobile), Infosys, Wipro, TCS (information technology), ONGC, Reliance (oil & gas), ITC, HUL (fast moving consumer goods) etc.

Each company has a weight assigned to it. Companies like Reliance, Infosys, and HLL have higher weightages compared to others like HDFC, Wipro, or a BHEL.

The increase or decrease in this index, the Sensex, is the effect of a corresponding increase or decrease in the stock market price of these 30 companies.

Nifty

It is the Sensex's counterpart on the National Stock Exchange, NSE.

The only difference between the two indices (the Sensex and Nifty) is that the Nifty comprises of 50 companies and hence is more broad-based than the Sensex.

Having said that one must remember that the Sensex is the benchmark that represents Indian equity markets globally.

The Nifty 50 or the S&P CNX Nifty as the index is officially called has all the 30 Sensex stocks.

The NSE Nifty functions exactly like (explained above) the BSE Sensex.

Bull

A particular kind of investor who purchases shares in the expectation that the market price of that company's share will increase.

S/he sells her/his stock at a higher price and pockets the profit. Simply put, the bulls buy at a lower price and sell at a higher price.

For instance, if a bull buys a company's share at Rs 100, s/he would prefer selling the same stock at Rs 120 or any price higher than Rs 100 to make a profit.

Usually, a bull buys first at a lower price and sells later at a price higher than her/his cost of purchase.

Bulls are happy when the markets (the Sensex and Nifty) move upwards. A falling market takes bulls into hibernation.

Bear

Bull's counterpart is the bear.

A bear sells stocks first that s/he owns or borrows from, say a friend, and then purchases the same quantity of shares at a lower price.

If a bear sells first, say 100 shares of Ranbaxy at Rs 400, and later purchases the same number of shares at Rs 375, then her/his profit is Rs 25 (400-375) per share.

This way s/he has got back the 100 shares of Ranbaxy and simultaneously made a profit of Rs 2500. The shares can later be returned to the bear's friend if s/he had borrowed the same from a friend.

There are bears in the market that sell shares first without actually owning them unlike in the above example. Such selling is called naked short selling or going short on a stock.
Bears are happy in a falling market.

While individual investors can engage in selling first and buying later (also referred to as short selling), mutual funds and foreign institutional investors are not allowed this luxury in India yet.

Squaring off

A process whereby investors/traders buy or sell shares and later reverse their trade to complete a transaction is called squaring off of a trade.

Indian equity markets remain open between 9:55 am and 3:30 pm normally (At times there are sun outages when satellites fail to link with ground infrastructure of the two exchanges (the servers where buy and sell orders are matched). During these times the trading period is extended till 4:15 pm to compensate for the time lost in between).

If you purchase 50 shares of say Infosys and sell them later before the market closes then you have squared off your buy position.

Similarly, if you sell 100 shares of Maruti and purchase them later then you have squared off your sell position.

Equity market rules in Indian allow investors/traders to engage in day trading.

Day trading is a mechanism whereby investors/traders can buy, say 100 shares of a company as soon as the BSE, NSE opens (the working hours are 9:55 am to 3:30 pm in normal times) and sell the same amount of shares later (bulls) before the two stock exchanges close. However, a stock bought on the BSE cannot be sold on the NSE and vice-versa.

Similarly investors/traders can also sell first and buy later (bears) during the course of the day to square off their sell positions.

Rally

The word suggests the gain made by the Sensex or Nifty during the course of the day. If such gains are made on a regular basis then market participants like investors, brokers etc call it as a market rally.

If the Sensex moves from 14,000 points to 15,000 points in a span of say 14 or for that matter 20 trading sessions (the stock markets remain closed on Saturdays, Sundays and other bank holidays) then the phenomenon is referred to as a rally.

Bulls are always said to be active during a market rally.

Crash

As the word suggests, crash refers to a sudden and steep fall in the value of Sensex and Nifty.

Bears are said to be active and happy during the market crash as their style of trading (sell first and buy later) helps them make good money during a crash.

Correction

A correction (or a measured fall) in the Sensex and Nifty takes place when these indices rise for a few days and then retrace or shave off some of these gains.

Say if the markets rally from 13,000 to 14,000 points in 10 days and the again fall to 13,700 points in the next five-six days then this action is termed as a market correction.

It is like a woman/man resting for some time after running a long distance race. Like human beings the market too needs to take rest after a smart rally.

Market experts consider such corrections healthy because during this period the ownership of shares moves from weak hands (short-term investors) to strong hands (long-term investors). Corrections are generally considered as signs of strength after which the markets (the Sensex and Nifty) gets once again poised for a further rally.

Bonus shares

These are the free shares that a listed company gives its shareholders.

A bonus is declared after a discussion amongst the board members that make up the management of a company.
A bonus issue is looked upon as a way of rewarding shareholders.

For instance, let us take a company A that has made a profit of Rs 100 crore in the financial year 2007 (April 1, 2006 to March 31, 2007).

Out of this amount the company may need Rs 50 crore for say buying machinery or constructing a new warehouse. And the remaining Rs 50 crore the company puts into its reserve pool or idle cash that the company has no plans to spend.
It can then issue bonus shares out of these Rs 50 crore.

When a company declares a bonus issue it converts this idle cash into shares that are then distributed amongst its shareholders. This process is called capitalising of reserves.

A bonus is usually declared as a ratio. A bonus issue in the ratio of 1:1 means you will get one free share for every one share of the company you own.

A 2:1 bonus issue (or two for every one held) means you will get two free shares of a company for every one that you own. Similarly, a 5:1 bonus issue will give you five free shares for every one share that you own.

Dividend

It is again a way of rewarding a company's shareholders. A dividend is generally issued as a percentage of the face value of a share. Face value is the nominal price of a company's share.

A share can have different face values like Re 1, Rs 2, Rs 5, Rs 10 or Rs 100. An 80% dividend on a share of face value Rs 2 (Rs 1.6) will always be less than a dividend of 20% declared on share of face value Rs 10 (Rs 4).

Like bonus shares, dividend amount also comes from a company's free cash reserves.

Book closure date

This is the date on which a company closes its books for business after it announces a bonus or dividend. The company's registrar keeps a track of who owns how many shares of that particular company.

Any investor having shares in his/her demat account before this date becomes eligible for the bonus issue or the dividend declared.

Say a company A announces a 1:1 bonus issue and the book closure date is February 28, 2007. If you don't own this company's share and want to avail of the bonus offer then you must not only buy this share before February 28 but also make sure that the number of shares purchased by you are transferred to your account from the seller before this date.

If the ownership of shares is reflected in your account after February 28 then you will not get any bonus shares. The same is also true for dividend announcements.

This just sums up a few (but regularly applyed) terms used by stock market participants.