The Stock Markets

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The Stock Markets

6.1 - Overview

By virtue of being a public company, the company is now liable to disclose all information related to the company to the public. The shares of a public limited company are traded on the stock exchanges on a daily basis.

The stock market is a place where market participants can access any publicly listed company and trade from their point of view, as long as there are other participants who have an opposing point of view. Afer all, different opinions are what make a market.

6.2 - What really is the stock market?

The stock market is a place where market participants can access any publicly listed company and trade from their point of view, as long as there are other participants who have an opposing point of view. Afer all, different opinions are what make a market.

The stock market is an electronic market place. Buyers and sellers meet and trade their point of view.

6.3 - What moves the stock?

Scene-1

The management makes a statement to the press that they have managed to find a new CEO who is expected to steer the company to greater heights.

The answer to the first question is quite simple, the stock price will move up.

Infosys had a leadership issue, and the company has fixed it. When positive announcements are made market participants tend to buy the stock at any given price and this cascades into a stock price rally.

Scene-2

NASSCOM says that the customer’s IT budget is likely to shrink by 15%. This means the revenues and the profits of IT companies are most likely to go down soon.

By 12:30 PM let us assume Infosys is trading at 3030. Few questions for you..

a.How does this new information impact Infosys?

b.If you were to initiate a new trade with this information what would it be?

c.What would happen to the other IT stocks in the market?

Let us now try and answer the above questions..

a.Infosys being a leading IT major in the country will react to this news. The reaction could be mixed one because earlier during the day there was good news specific to Infosys. However a 15% decline in revenue is a serious matter and hence Infosys stocks are likely to trade lower

b.At 3030, if one were to initiate a new trade based on the new information, it would be a sell on Infosys

c.The information released by NASSCOM is applicable to the entire IT stocks and not just Infosys. Hence all IT companies are likely to witness a selling pressure.


what if there is no news today about a particular company? Will the stock price stay flat and not move at all?

For example let us assume there is absolutely no news concerning two different companies..

1. Reliance Industries Limited

2. Shree Lakshmi Sugar Mills

As we all know, Reliance is one the largest companies in the country and regardless of whether there is news or not, market participants would like to buy or sell the company’s shares and therefore the price moves constantly.

The second company is a relatively unknown

6.4 - How does the stock get traded?

You have decided to buy 200 shares of Infosys at 3030.

With your decision to buy Infosys, you need to login to your trading account (provided by your stock broker) and place an order to buy Infosys.

Once the trade is executed, the shares will be electronically credited to your DEMAT account. Likewise the shares will be electronically debited from the sellers DEMAT account.

6.5 - What happens afer you own a stock?

 You are now a part of ownership of the company.

If you own 200 shares of Infosys then you own 0.000035% of Infosys.

6.6 - A note on holding period

You may be surprised to know that the holding period could be as short as few minutes to as long as ‘forever’.

6.7 - How to calculate returns?

Returns are usually expressed in terms of annual yield.

Absolute Return – This is return that your trade or investment has generated in absolute terms. It helps you answer this question – I bought Infosys at 3030 and sold it 3550. How much percentage return did I generate?

The formula to calculate the same is [Ending Period Value / Starting Period Value – 1]*100

i.e [3550/3030 -1] *100

= 0.1716 * 100

= 17.16%

A 17.6% is not a bad return at all!

Compounded Annual Growth Rate (CAGR) – An absolute return can be misleading if you want to 

compare two investments. CAGR helps you answer this question - I bought Infosys at 3030 and held the stock for 2 years and sold it 3550. At what rate did my investment grow over the last two years?

CAGR factors in the time component which we had ignored when we computed the absolute return.

The formula to calculate CAGR is ..

 

Applying this to answer the question..

{[3550/3030]^(1/2) – 1} = 8.2%

This means the investment grew at a rate of 8.2% for 2 years. Considering the fact that Indian fixed deposit market offers a return of close to 8.5% return with capital protection an 8.2% return suddenly looks a bit unattractive.

So, always use CAGR when you want to check returns over multiple years. Use absolute return when your time frame is for a year or lesser.

What if you have bought Infosys at 3030 and sold it at 3550 within 6 months? In that case you have generated 17.16% in 6 months which translates to 34.32% (17.16% * 2) for the year.

So the point is, if you have to compare returns, its best done when the return is expressed on an annualized basis.

6.8 - Where do you fit in?

Each market participant has his or her own unique style to participate in the market.

a.Day Trader – A day trader initiates and closes the position during the day.

For example – He would buy 100 shares of TCS at 2212 at 9:15AM and sell it at 2220 at 3:20 PM making a profit of Rs.800/- in this trade. 

b.Scalper –He usually trades very large quantities of shares and holds the stock for very less time with an intention to make a small but quick profit. For example – He would buy 10,000 shares of TCS as 2212 at 9:15 and sell it 2212.1 at 9.16. He ends up making 1000/- profit in this trade. 

c.Swing Trader – A swing trader holds on to his trade for slightly longer time duration, the duration can run into anywhere between few days to weeks.

For example – He would buy 100 shares of TCS at 2212 on 12th June 2014 and sell it 2214 on 19th June 2014.


There are two popular types of investors..

a.Growth Investors – The objective here is to identify companies which are expected to grow significantly because of emerging industry and macro trends.

 Hindustan Unilever, Infosys, Gillette India

b.Value Investors – The objective here is to identify good companies irrespective of whether they are in growth phase or mature phase but beaten down significantly due to the short term market sentiment thereby making a great value buy. An example of this in recent times is L&T. Due to short term negative sentiment.


Key takeaways from this chapter

1.A stock market is a place where a trader or an investor can transact (buy, sell) in shares

2.A stock market is a place where the buyer and seller meet electronically

3.Different opinions makes a market

4.The stock exchange electronically facilitate the meeting of buyers, and sellers

5.News and events moves the stock prices on a daily basis

6.Demand supply mismatch also makes the stock prices move

7.When you own a stock you get corporate privileges like bonus, dividends, rights etc

8.Holding period is defined as the period during which you hold your shares

9.Use absolute returns when the holding period is 1 year or less. Use CAGR to identify the growth rate over multiple years

10.Traders, and investors differ on two counts – risk taking ability and the holding period.


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