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Rediff.com  » Business » Dummies' guide to the stock market

Dummies' guide to the stock market

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Last updated on: August 21, 2003 15:41 IST

Loukesh Pandarkar, 27, like many Indians his age, has dreams: To own a house, get married and find the proverbial pot of gold. But working at a junior level in a Mumbai-based company does not help matters much.

Yet some of his friends seem to be making money -- on the stock markets. They talk about the stock markets being in the 'bull phase.'

Maybe this is the time to step in and make some more money.

But where does he start? Does he call up his friend's broker/sub-broker or simply log on to the Net?

How much information and records will he have to maintain besides his personal tax papers? And who will guide him on making the right investments?

Life is not easy in the complex world of trading in securities, but help is at hand.

rediff.com provides a step-by-step guide to how to trade on the stock markets.

There are two basic ways to trade in shares listed on the Indian stock markets:

  • Through a broker/sub-broker.
  • Online: Through an Internet site, where bank and demat (explained later) accounts are electronically integrated. Many banks offer this facility: ICICI Bank, HDFC Bank, etc.

Choosing a stockbroker

So you plan to buy stocks through a stockbroker, is it?

This often becomes the biggest hurdle for a first-time investor. Retail investors in smaller cities and towns have suffered at the hands of dubious brokers and sub-brokers.

Over the past decade, with the strengthening of guidelines by the Securities and Exchange Board of India (the main regulator for the Indian financial markets), it is difficult for the broker to vanish from the scene or commit fraud.

Being a registered member of the stock exchange, the broker carries out 'buy' and 'sell' transactions on behalf of his client (the investor) and charges a small fee.

His books and transactions are checked periodically. Further investors can take penal action against the broker, if required.

It is prudent for small and/or first time investors to approach a broker who is known (through family or peers). Do ensure he is a member of a major stock exchange and also registered with the SEBI.

Preferably look for a broker who not only execute trades, but also offers investment advice and some form of research. It is prudent to give clear directions to the broker -- this is after all your money.

Do not try and pick brokers through the stock exchange member directory (several of them are inactive and some prefer dealing with large companies).

A safe option for first-timers may be to approach a brokerage which has an online trading site (discussed in detail later). The procedures for registration and transfer of funds/shares are simple. These brokers also offer additional services like research, depository services and products to track your portfolio.

If you have decided to invest in stocks (equity shares), then the first issue would be whether to trade in physical shares or paperless (dematerialised) shares. SEBI has ensured that compulsory demat trading is introduced for most shares and if one were to trade in the major 'A' group and 'B1' group stocks, you can only trade these through compulsory demat trading.

Demat --  or dematerialisation -- is a process of converting physical (paper) shares or securities into electronic form and storing in computers by a depository. Securities present in physical form are surrendered to the respective company which will then nullify them and credit the depository account.

This does not mean one cannot hold physical shares. Investors can do so, but then trading would be in 'odd lots' (small quantity of shares where buying or selling a share at a specific price becomes difficult).

Most brokers today deal in demat shares.

In these technology-driven times, it is advisable to trade in demat shares (shares which have been 'dematerialised;' you will own or transfer these shares in electronic form through a book entry, not in physical form).

There are several advantages of trading in demat shares.

  • Earlier, shares would not be transferred easily due to problems of bad deliveries, difference in signatures, theft, fire, and mutation of shares. (When physical share certificates along with transfer deeds are delivered in the market there are certain details to be filled in the transfer deed. Any improper execution of these details results in a bad delivery).
  • There is no stamp duty incurred while trading in demat shares.
  • Brokers charge lower brokerage fees (due to less paperwork).
  • There is a status report provided to the client, and there is periodic inspection of depository participants records/books (who operate the demat account for you).
  • No minimum balance is required in demat accounts.
  • One can choose the Depository Participant based on its history, charges and services provided. The DP is an authorised body who is involved in dematerialisation of shares and maintaining of the investors accounts.

 Trading

 A person wishing to deal with a broker/sub-broker will have to fill up a client registration form.

This adds to the broker's database and is an agreement between the broker and his client. For the investor it means that s/he wishes to trade in shares listed at the stock exchange through the broker after being assured about his capabilities.

For the broker it means he is sure of his client's financial standing and has informed him of his own liabilities.

The typical client registration form will include your name, address, educational qualifications, occupation, residential address, details of bank account, income tax number (PAN/GIR), proof of identity (photocopy of your passport number/driving license/ration card/voters identity card).

Placing orders with the broker/sub-broker

One can either go to the broker's /sub-broker's office or place an order on the phone.

Do keep track of instructions given to your broker/sub-broker.

Execution of trade

The automated trading systems at the stocks exchanges (the Bombay Stock Exchange, the National Stock Exchange, etc) assign a unique order code number to each transaction, which the broker gives the investor.

Once the order is executed (shares bought or sold at a specific price), this order code number is printed on the contract note.

Investors can either place a trade at the market price (the current trading price which is shown on the trading terminal of the broker at the exchange) or a limit order (a specific price band or level decided by the investor at which the shares should be bought or sold).

Brokerage charged

While executing the transaction at the stock exchange, the broker charges a brokerage fee based on the transaction.

Most brokers charge between 0.50 per cent and 1 per cent of the total value of the transaction. For sub-brokers, the SEBI stipulates that the sub-broker cannot charge from his clients a commission more than 1 per cent of the value mentioned in the respective purchase or sale note.

He may also charge penalties arising out of specific default on behalf of the client (the investor) and service tax as stipulated.

Documents you receive from the broker on execution of the transaction

If dealing with a broker, it is mandatory for him to issue to you a contract note within a stipulated period of time. If dealing with a sub-broker, he will issue a purchase or sale note (confirmation memo) to you.

These documents ensure a contractual obligation for both parties and hence must be insisted upon.

These documents also provide for the recourse before an arbitrator for settlement of disputes arising out of a transaction.

The contract note

It will contain the name, address and the SEBI registration number of the member broker, contract number, date and settlement number.

It will also include the client code, order code, all details of the trade (shares bought/sold, quantity, price and time of trade), brokerage charged, service tax rates and authorised signatures.

The sub-broker's purchase/sale note includes name, SEBI registration number of sub-broker, corresponding contract note issued by the broker for relevant trade number along with the date of contract.

Purchase obligations/sale of shares

Investors should ensure delivery of securities/payment of money to the broker immediately upon getting the contract note for sale/purchase and in any case, before the prescribed pay-in day.

While purchasing shares, the cheque/draft payment is required to be made prior to the pay-in date for the relevant settlement.

In case of sale of shares, the delivery of shares has to be done prior to the pay in date for the relevant settlement.

What happens if you do not get your money or shares on the due date?

In case a broker fails to deliver the timely and proper payment of money/shares or you have a complaint against the stockbroker's conduct, you can file a complaint with the respective stock exchange.

The exchange is required to resolve all the complaints. To resolve the dispute, the complainant can also resort to arbitration as provided on the reverse of contract note/purchase or sale note.

How the trade/settlement takes place

The process for order execution and transfer of shares/payments is a complex one. Investors must, however, have some information of the trading cycles.

The stock exchange has a scheduled pay-in and pay-out day. Based on these, the payment of monies (to buy shares) or delivery of securities (to sell shares) takes place.

The pay-in day is when the broker makes payment or delivery of securities to the exchange. The pay-out day is when the exchange makes payment or delivery of securities to the broker.

With the new settlement cycle at T+2 (settlement on the second day from trading), the pay-out of funds and securities to the clients, is done by the broker within 24 hours of the payout.

While selling demat shares

You sell your demat securities through the broker at a stock exchanges (which is linked to a depository).

You must give instructions to your DP to debit of your depository account and credit of your broker's clearing member account at least 24 hours prior to the pay-in date.

This should be done so that your broker's clearing account is credited at the time arranged with him.

On the pay-in day, your broker gives instruction to his DP for delivery to the clearing corporation/house of the relevant stock exchange.

The broker receives payment from the clearing corporation/house. Following this, you receive payment from the broker for the sale.

While buying demat shares

You purchase securities through a broker at any of the stock exchanges connected to the depository and make payment to your broker.

The broker arranges payment to clearing corporation/clearing house of the stock exchange.

The broker receives credit in his clearing account with his DP on the pay-out day. He can immediately transfer these securities to your depository account, provided your account is already active.

The broker gives instructions to his DP to debit his clearing account and credit your depository account.

To get quicker delivery of shares into your account

Investors/clients can get direct delivery of shares in their beneficiary accounts.

To ensure this, you have to give details of your beneficiary account and the DP-identity of your depository participant to your broker.

Give him instructions for 'Delivery-In' to your depository participant to accept shares in your beneficiary account.

Given these details, the clearing corporation/house will send pay-out instructions to the depository so that you receive pay-out of securities directly into the beneficiary account.

The following details will have to be given:

  • Details of the pool account of the broker to which the shares are to be transferred; and
  • Details of the scrip and quantity involved.

Opening a demat account

As seen above, there are distinct advantages of trading in demat shares. Broker-members and the clearing houses of exchanges are connected with the two leading depositories National Securities Depository Ltd and the Central Depository Services Ltd.

To avail of trading in demat shares, you have to open an account with the depository participant.

However, one must understand that there are several DPs registered with depositories, who seek your membership and offer various services for a fee.

Investors should keep in mind that depository fees charged by DPs are high.

With effect from April 2003, the depositories charge a flat rate, which works out costlier for retail investors dealing in few shares.

The demat account works like a bank passbook where entries are credited and debited based on the demat shares bought or sold through a registered broker.

To open a DP account

  • Fill up an account opening form (available with the DP).
  • Give your DP the filled up account opening form with introduction documents.
  • Sign an agreement with the DP (agreement will state rights and obligations of both the parties). This will contain the fee structure of your DP and one signed copy remains with you.
  • The DP would give you a 'Client ID' account number once your depository account is opened. This 'Client ID' number along with your 'DP ID' number should be quoted in all future dealings with the DP and/ or depository, issuing company/their registrar & transfer (R&T) agent.
  • Your DP would give you instruction slips for depository services -- dematerialisation, delivery instruction for trades, etc. Preserve these.
Directions to demat shares

You have to fill up a Demat Request Form which is obtained from the DP with whom your depository account is opened.

Then deface the share certificates you want to dematerialise by writing across 'Surrendered for dematerialisation.'

Submit the DRF and the share certificates to the DP.

The DP would forward them to the issuer/their R&T agent.

After dematerialisation, your depository account with the DP would be credited with the dematerialised securities.

Note: Look for a depository participant who is registered with one or more depositories.

Also see if he can offer additional services.

Ideally select a DP which is an established financial market player -- either a bank (public sector, private sector or foreign), or a financial institution or a full service brokerage.

Online trading

In a paper and documentation crazy country like India, carrying out sensitive financial transactions through the Internet appears incredible. When online trading first came to India in the mid-1990s, market players and experts were sceptical of its role and success.

While most online brokerage firms are still to make profits, they do command a growing client base and offer wide ranging products and services which the average Dalal Street broker would not be able to offer to investors.

It is the mindset which has kept first-time investors away from tapping the Internet to trade at the stock markets.

Investors do not seem to accept a faceless financial advisor and would prefer a constant dialogue with the broker (even if it were fruitless).

Is online trading through the Internet safe?

The safety of transactions on the Internet depends on the encryption system used.

Most leading online trading sites, including those in India, offer the 128-bit encryption, which is considered safe and difficult to hack into.

Secondly, most online trading sites provide a secure user ID and password, so that secrecy is maintained.

Is there security of funds/money, demat shares and transaction documents?

In systems where the broking, banking and demat accounts are completely integrated, your money remains in your own bank account, and does not get transferred to the broker's pool account.

Most leading online broking sites provide a system wherein your broking account, bank account and demat account are linked electronically.

So while buying/selling shares, the system checks the funds/ shares availability and automatically credits/debits the accounts once the order is executed by the exchange.

And you don't have to be a computer genius

Trading on an established financial portal makes online trading easy. One does not need to be an expert.

Most portals offer a free demonstration of the online trading site. And online trading sites are not very costly, as brokerage fees are low due to less back-office cost and paperless trading.

Accuracy is maintained

The advantage in online trading is that one is not at the mercy of the broker to see the latest buy/sell quotes.

The stock prices through the ticker are available with most online trading sites and the good ones offer live quotes (having direct data feeds from the stock exchange). Hence accuracy is maintained.

Note: Considering the networking and constant contact which one needs to keep with one's broker, a first-time investor who has other interests should look at online trading as a simple and safe solution.

It is important to look for an Internet site which belongs to an established financial market intermediary -- whether a private sector bank, financial institution or a full service Indian brokerage.

The advantage is that these financial portals provide various products and services, including equity research, demat trading, financial market news and reports and a comprehensive learning centre.

Leading online trading sites offer alternatives like investing in mutual funds and government securities.

The only risk factor to watch for is for technology outages (slowdown) and Internet site glitches which could make placing of trading orders difficult and investors may lose on making investments at the right time or price.

The next part of this series will look at the principles of investment, do's and don'ts for first-time investors and how to tackle various risk factors at the Indian stock markets.

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Buying shares? Assess your risk quotient first

Salil Panchal/ Morpheus Inc. in Mumbai
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