Trading in the market
Introduction
How does one purchase or sell shares in the open market? If you wanted to buy 500 shares of Infosys, how would you acquire them? Or if you wished to sell 1000 shares of Hindustan Lever whom would you dispose off these shares to? Of course you could search around for someone who wished to sell 500 shares of Infosys and purchase them or find someone who wished to buy 1000 shares of Hindustan Lever. On a practical level this may be difficult and even if there are such people you may not be able to find them. Stock exchanges or markets came into being as a place where buyers could purchase what they wanted and sellers could sell the shares that he wished to be rid of.
The stock exchange is a market where securities are bought and sold. However unlike usual markets all sellers and all buyers do not visit it but deal through their agents who are members of the stock exchange. This makes the operations more controlled, disciplined and workable. Earlier there were brokers and jobbers. Brokers brought and sold on behalf of their clients. Jobbers were intermediaries who dealt with specific shares. Brokers approached them if they wanted to buy or sell a share. With computerisation and online trading jobbers have ceased to exist.
An individual if he wishes to invest in shares must first open an account with a depository participant. This is because all shares that are traded have been dematerialised and are held in depositories. The individual must also register himself with a broker.
A stock market is like an auction house. Buyers offer a price and if the seller is agreeable to the offer, a transaction is completed. Buyers naturally try to purchase at the lowest rate and the seller aims to sell his holdings at the highest price.
How does the procedure take place? Vijay Rao wishes to buy 500 shares of company A. He would place with his broker an order for the purchase stipulating usually the maximum price he is prepared to go upto. The broker would punch the order into the NSE system or BSE system (known as BOLT). Others who are keen on selling the share would also punch in the price they would like to sell at. As soon as prices match the deal is consummated.
The first thing a prospective buyer or seller has to do is to locate a broker. This can sometimes be difficult especially if one is new to the city and does not know anyone. In those situations one can ask his bank manager or a business colleague for an introduction. Ideally one should deal with a registered stock broker (an actual member of the stock exchange) as he is obliged to fulfill every contract that he enters into whether it be for a purchase or a sale. If he does not, the stock exchange authorities can take action against him, debar him from membership and take other measures.
However, often a large busy broker may not be interested in acting for a small investor and this is not an uncommon occurrence these days. It may be necessary then to deal with a sub-broker operating under a registered broker. There is a little danger in dealing through sub-brokers since as sub-brokers are not members of the stock exchange, disputes or disagreements between an investor and his sub-broker does not fall under the regulatory control of the exchanges.
Once having zeroed in on a broker, one must discuss the commission he proposes to take. Commissions range from between ½ percent for a large investor to about 1 percent or at times 1½ percent. The percentage will depend really on the need of the broker for your business and your trading volume. However when you buy a share, it would not be apparent as to what the commission is that the broker has taken because the price quoted is say Rs.201 net to you. If your agreement was a commission of ½ percent, the actual sale price in this instance would be Rs.200 per share and the broker’s commission would be Re.1.
Now having settled this how do you instruct your broker? You have two options.
· You could ask the broker to purchase or sell from the ‘market’. This means that you are authorizing your broker to buy from the stock market at the ruling market price. One normally places such an order when the market is going up or it is expected that the price of the share will rise.
· You can instruct the broker with limits i.e. to purchase a share at a maximum of Rs. 25 per share or to sell at not less than Rs.28 per share. You could tell him that if the shares are not currently available or cannot be sold (as applicable) at the price stipulated that he should not take any action and conversely he should get back to you. One would do this when:
1. The markets are reasonably stable and a large or dramatic rise in prices is not anticipated.
2. One is cautious and wants to control his commitments.
3. One is unprepared to give carte blanche to one’s broker.
4. One does not expect to make a large profit and therefore does not want to buy at a very high price.
· On receiving your instruction, the broker would punch in the quantity and the rate into the system. When a match takes place the deal is consummated.
Normally if a broker is unable to execute the contract during the day then it usually lapses. Orders have to be given fresh every day. This is because the market is volatile and can fluctuate enormously. And it is important that one does not give orders without any time limits because it is possible that on account of bad news, calamities and the likes the price may plunge.
Another way a person could purchase or sell a share is by online trading. One can register with companies such as Kotak Securities or Share Khan and buy or sell shares without the intervention of a broker. I do not recommend this for the beginner because it is possible to make mistakes if one is not familiar with what to do.
At times a broker may himself own the shares his client wishes to buy or he may wish to buy the shares his client wishes to sell. In these instances if the transaction one does go through it is called a trade “from principal to principal”.
The relation between clients and brokers are determined by the laws of the stock exchange where the broker is registered. The broker is personally liable to third parties for any transactions he enters into on behalf of his clients. Consequently the broker is entitled to, if the client does not honour his commitment to pay for the shares purchased, claim any loss he has incurred as a consequence from his client.
The question that would immediately arise is what protection is offered to a client if a broker defaults. A client can, after serving a written notice to the broker, settle his contracts through another broker. He can then claim any loss that he has incurred. He can also complain to the governing body of the exchange. The board is obliged to investigate the complaint and if the broker is found to be guilty to take suitable action. In extreme cases the broker would be declared as a defaulter. The defaulter committee would take into custody his books of account, papers and securities. This committee would then sell the members assets (including shares) and take custody of his money and distribute them prorata between the other member’s. As is usual in such cases, the claims of the clients would be considered last. Consequently the small investor is at a disadvantage. To protect clients and small investors an insurance fund has been created.
As a last option clients can seek redress from civil or criminal courts. This is however, time consuming and costly and should be only a last resort.
There are a few points that should be remembered and is worthy of comment:
1. In choosing a broker it is always preferable to select one who is recommended by someone who has dealt with him for sometime and is satisfied with his integrity and honesty.
2. Brokers often give advice. This in itself is good but before you act on this advice it is prudent to remember that the broker may have a vested interest in the advice that is doled out. There may be a share he is unable to sell at a particular price. It is therefore always better to check with one or two others before the order is given.
3. A common complaint that most buyers have is that the broker appears to have purchased the share at the highest price for the day and sold them for the lowest price for the day. This is not really true as soon as an individual’s order is punched in it is given a number is derived and the time of booking the order is made.
Like it on Facebook, Tweet it or share this article on other bookmarking websites.