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Refers to any of the measures used by stock exchanges during large sell-offs to avert panic selling. Sometimes called a "collar."
tock prices of companies listed on the stock exchanges are influenced by several factors - company financials, investor's perception of the company's growth, industry trends, government regulations, market speculation, to name a few. Some factors are predictable and can be studied and analysed using statistical tools like graphs and techniques like ratio analysis, trend analysis, theory of probability etc.
Certain other factors and their influence on prices of a particular stock or the market in general and the degree of their impact are completely unpredictable. Since market sentiments cannot be predicted accurately and their impact on stock prices is difficult to judge, sometimes the movement of stock prices can beat all logic and move tremendously in any direction. Circuit Breaker is a system to sustain sanity of the stock market in such situations. For example, the BSE Sensex moved up by 2110.79 points on May 18, 2009 after the Parliament election results were announced. The trading had to be halted since the market became extremely volatile and moved beyond reasoning. What is a circuit? Circuits are of two types - circuit for an index and for a stock. So, if an index or the price of a stock increases or declines beyond a specified threshold it is said to have entered into a circuit. Securities and Exchange Board of India specifies this threshold as a percentage of the prior day's closing figures. What is a circuit breaker? Factors like market speculations force stock prices or indices to enter in a circuit. Such a condition is beyond the control of regulatory authorities. Hence they use the circuit breaker to curb such market situations. Circuit breaker, simply put, is a set of rules formed and issued
by SEBI in order to bring back normalcy in the stock markets in the event an index or stock enters a circuit. SEBI has different circuit breakers for indices and for stocks. Circuit breaker for an Index Circuit breakers are applied only on equity and equity derivative markets. Whenever the major stock indices like BSE Sensex and Nifty cross the threshold level, SEBI rules require that the trading at the stock exchange be stopped for a certain period of time beginning from half an hour to even an entire day. The time frame for which trading is stopped depends upon the time and amount of movement in the indices. The idea is to allow the market to cool down and resume trading at normal levels. The thresholds are implemented stage wise. Movement in Indices 10 per cent Time Before 1.00 pm 1.00 pm to 2.30 pm After 2.30 pm 15 per cent Before 1.00 pm 1.00 pm to 2.30 pm After 2.30 pm 20 per cent Any time Close period 1 hour hour Does not close 2 hour 1 hour Close for the rest of the day Close for the rest of the day
Circuit Breaker for a stock A price band specifies the span or price range for a stock to move without any interference from regulatory authorities. Only when the stock prices move beyond the range, it is considered as entering into a circuit and circuit breakers are applied. Daily price bands of 2 per cent, 5 per cent and 10 per cent are applicable to different equity stocks. Price bands of 20 per cent are applicable to all remaining scrip like preference shares or debentures. For example, for a stock with a price band of 5 per cent that closes at Rs100 on the previous day, the price band will be between Rs 105 and Rs 95. What are an Upper circuit and Lower circuit? Stock prices can either move up or down and hence circuit breakers are required for movements in both directions. An upward movement over the threshold will cause a stock to enter an upper circuit. Similarly a downward movement in stock price beyond the threshold will cause a stock to enter a lower circuit. The objective of circuit breakers is to control the stock markets at times when they move beyond reasonable limits. When a stock enters an upper circuit, it puts an investor who has already invested in the stock at an advantage. On the contrary a stock movement into a lower circuit places the investor at a disadvantage because it is now difficult to sell off these shares as they have lost a lot of mone
A circuit breaker is a concept whereby trading is halted for a few hours, or in extreme cases, the days trade is suspended for a stock if its price increases beyond or decreases below a predetermined value that is calculated based on the previous days closing price
Any stock exchange can moderate trade only during its specified trading hours. The trading hours of worlds largest stock exchange NYSE is between 9:30 and 16:00 and that of Indias largest (by means of market capitalization), BSE is between 9:15 and 15:30. There are occasions when the market is too turbulent so that the index may climb steeply or fall sharply.
During these occasions, prices of certain shares may spike or plunge in a single day, neither of which is healthy for trade. While sharp falls in prices leads to panic selling, high gains can exhaust liquidity and lead to excessive speculations. A circuit breaker is a concept whereby trading is halted for a few hours, or in extreme cases, the days trade is suspended for a stock if its price increases beyond or decreases below a predetermined value that is calculated based on the previous days closing price. Circuit breakers are specific to stock exchanges in that the percentage change in value after which it gets activated varies with stock exchange while some stock exchanges may not even have this concept. For example, BSE has an upper circuit breaker of 20% and a lower circuit breaker of 10%. If a stock closes at Rs.100 on a day and if the stock reaches Rs.120 on the next day, then the circuit breaker becomes active and trading of that stock is halted. Similarly, if the stock falls to Rs.90, again trading is halted. NSE has more complicated circuit breaker rules, rules that are similar to that of New York Stock Exchange (NYSE). It has three circuit breaker limits: 10%, 20% and 30% of the previous days closing stock price. Trade halt duration also depends on the time of the day when the breach occurs. For a 10% decline in price before 14:00, the halt will be for an hour and for the same decline between 14:00 and 14:30, the halt will be for half an hour and no halt for 10% decline if it occurs after 14:30. For a 20% decline, halt in trading will be for two hours if it happens before 13:00, for an hour if it occurs between 13:00 and 14:00 and if it occurs after 14:00, market will be suspended for the day. In case of a 30% decline, trading will be suspended for the day, whenever the breach may occur. NYSE first brought out and implemented the concept of circuit breaker after its disastrous experience on October 19, 1987, a day widely known as the black Monday. On that day, the Dow Jones Industrial Average faced a historic drop in index with index falling by almost 22%. There was panic selling everywhere and this event became the trigger for a worldwide stock market crash. The peculiar thing about the incident was that there were no important announcements or news released during the weekend preceding the day, nothing that can be attributed to have caused the crash. Following this incident, NYSE wanted to keep a check on panic selling and have more control over the market and it subsequently devised the circuit breaker. Its usage and success enticed other stock exchanges worldwide and was later widely adopted. The main purpose of circuit breakers is to curb panic selling. Halting operations for a while gives traders time to think over their options and to reconsider their decision. As a result of circuit breakers, especially to avoid them, traders trade at or slightly above the lower circuit limit and at slightly below the upper circuit limit. Hence it helps in regulating the prices of shares. For example, on January 15th 2009, around 190 stocks in BSE were trading at their lower circuit at as early as 12:00 noon as selling frenzy drove mad the entire market. Had the circuit breaker not been in place, share values wouldve been hit much more. Moreover as share markets are rapidly changing day by day, circuit breaker categories and levels too change. This is to cope up with the changing trader sentiments and better regulation. Separate circuit breaker levels are set for individual stocks and the overall key index of the stock exchange. For example, apart from day to day fixing of limits for individual stocks, NYSE also sets limits on its key index Dow Jones Industrial Average for a particular quarter based on its value during the month preceding the start of that quarter.
Indices Market Analysis - Price
SENSEX 19748.19
Gainers and Losers New High/Low
Change -56.57
% Change -0.29
Value Toppers
Lifetime High/Low
High/Low
Exchange Turnover
Report :
Pricew ise
Group :
GO
26-Jul-13 16:00 Hrs IST Volume in (000's) 102.76 1690.58 3.63 582.32 440.74 62.43 Value (Rs. Lakhs) 0.13 3.97 0.03 123.23 47.88 4.32 Prev || Next
Circuit breakers
by J Victor on December 17th, 2011
Hi there.. As you would have observed , stock prices can move up or down due to a number of reasons. For example earnings results, government policies, trends in the industry etc. Such prices movements are reasonable and logical. But in some cases, stock prices may move up or down drastically, accelerated mostly due to fear or greed by speculators and manipulators. Such movements are harmful for the stock markets. In order to control such heavy price fluctuations, stock exchanges have a system called circuit breakers, something that works similar to the electricity circuit breakers that we have at home. Circuit breakers were first introduced in the trading system of Indian stock exchanges back in 1992 at the BSE. There are separate circuit breakers for the indices and individual stocks. These control systems ensure sanity of the stock market and protects investors. These are also called circuit limits or price bands. HOW DOES IT WORK? When the volatility of a stock breaks a certain limit as decided by the exchange, trading in that stock is stopped for some time. The limit is fixed as a percentage of the stocks price by the stock exchange. The rules for circuit breaking are decided by the Securities exchange Board. For example if the regulators decide that the circuit limit for a stock is 15%, then, trading in that stock will be halted for the day, if the stock price moves up or down 15% in one day. CIRCUIT LIMITS FOR SENSEX AND NIFTY There are 3 circuit limits for indices 10%, 15% and 20%.Circuit filter is applied to Sensex or Nifty whichever is breached first. The trigger of circuit limits also depends on the time at which it occurs. 10% movement in either direction If the movement is before 1 pm 1 hour halt If the movement is after 1 but before 2:30 pm half an hour halt If the movement is after 2.30 pm no halt 15% movement in either direction After the above mentioned halts, trading starts again. If the market hits 10% again, there will not be any halts, but if it breaches 15%, circuit limits comes to play again. If the movement is before 1 pm 2 hours halt If the movement is after 1 pm but before 2 pm- 1 hour halt I the movement is after 2 pm no further halt. 20% movement in either direction On resumption, if the market hits 20%, trading will be halted for the day. The above percentage is calculated on the closing value of the Sensex or the Nifty on the last day of the immediate preceding quarter. So, for deciding the circuit limit for the Jan-march 2011 period, the closing value of the bellwether indices on December 31, 2010 would be used. WHAT HAPPENS TO ORDERS DURING CIRCUIT LIMITS?
If the market hits the upper or lower circuits, trading is halted and you cannot place orders until the market reopens If you have pending orders with the broker at the time of circuit break, such orders can be modified or cancelled only once the trading re-opens. CIRCUIT LIMITS FOR INDIVIDUAL STOCKS. Stock specific circuit filters are applied in both BSE and NSE index; the percentage for circuit filter limit is 2%, 5%, 10%, 20%. Not all stocks fall in the circuit limit category. There are stocks to which circuit limits are not applicable. For newly listed companies, there is a circuit limit of 20% from the issue price.
Circuit breaker: Stock exchange is marked by changes in the stock value frequently. There are steps taken by people to take action against the falling value of the assets. They try to stop trading for a short period on a temporarily basis when they find that the market value has been depreciated. This is mainly targeted at preventing the fall in market value by allowing the selling and buying of orders thereby maintaining a balance. The stock exchanges generally wish to reduce the damages caused due to the falling of a price of assets. They then plan to regulate the stock exchange by defensive methods. A falling of price can lead to a dangerous situation where the panic selling can rise up. Circuit breaking will permit them to stop trading in the market for that period. This allows them to limit things from going beyond their scope. Thus circuit breaking is initiated by stock market when they expect something catastrophic to happen in the stock market. A lot of investors can plan to dump their securities because of a fear of depression in the stock market. This situation can be handled only through a circuit breaking mechanism. Circuit breaking can be handled with care. The halting of trade need to be done by lowering down the price. With the help of this, the commodity exchanges can happen thereby creating a healthier situation and thus preventing things from going out of control. This strategy of stopping trade is a newer approach. Different steps were taken and these were agreed upon by the stock markets all over the world. The steps are taken by lowering the market activities. The action taken by companies might be for falls of ten or twenty or thirty based on a firm. The average of lowering is monitored by evaluating the status of Dow Jones International average. Circuit breaker has proved to be an effective step in taking actions in preventing heavy fall in market. A critical situation is handled in an effective manner. The steps need to be taken by efficiently monitoring the status of the market value. Carry forward: Carry forward are usually related to the firms that have cyclic working such as transportation. This is often referred to as tax loss. This is the operating loss in a business. This can be claimed after a fixed number of years in a future period. A loss in the current year will be carry forward to a later period in a future year and this can be used to offset profit.
There are no limits set on the capital loss that can be used to offset profit in a year for carry forward. The losses that are in excess of gains only will be used to offset income. This is also referred to as carry over. Carry forward is a term used to apply to personal pensions. This takes into consideration the tax rules. This means that the individual can make contributions apart from the taxes of the current tax year. Before applying the carry forward, the contributions for the current year has to be paid in full. If an account has a year end balance and that is positive, the amount will be automatically carry forwarded to the nest fiscal year. The budget will be appropriated before the calculations for the next fiscal year is made. Carry forward has several rules that need to be documented and is dependent on the place where it is going to be executed. The rules need to be followed in connection to the carry forward of surplus or deficit in a budget. The carry forward needs to be executed in connection to the department where it is applicable. There are university rules concerning the carry forward in specific departments in carry forward. There can be special rules as to how the budget needs to be carry forwarded to the next fiscal year. The balance can be adjusted to be used for the next fiscal year and this requires that the rules are strictly followed. This has to be properly documented and submitted to the concerned authority to make the rule analysis proper. Carry forward is yet another jargon used in stock market. That in connection to the working of carry forward has to understand the term properly. This is because; the calculation might be simple but users will have to understand each aspect of the term in order to make the gains cross the loss.
Understand Stock Exchange Circuit Breakers June 06 , 2012
Free markets work on the ideal of price discovery. Share prices reflect not only a company's performance but also investors' views and expectations about it. While performance is measurable and can be forecasted with reasonable accuracy, people's sentiments is hard to predict and at times cannot be justified by reason. Therefore market regulator SEBI has put in place a mechanism to ensure that in a trading session prices don't move beyond what can be said to be supported by logical reason. What are circuit breakers? Circuit breaker is a measure enforced by stock exchanges to restrict trades of a share or index when there is tremendously large price movement in a single trading day. Circuit breakers work at index level and individual share level. Trigger price levels and trade halt time are prescribed by SEBI and are followed on the NSE and BSE. In India a tremendous fall or even rise in price can trigger circuit breakers. In many countries only a fall activates circuit filter. Circuit breakers are in place for all securities. Circuit breaker that gets triggered when price has risen is called an upper circuit and circuit breaker that gets triggered when price has fallen is called a lower circuit. How do circuit breakers work? Like circuit breakers in some electronic devices that block unwanted frequencies, circuit breakers stop prices from moving very steeply in any direction in a short span of time. When price of a share or index leaps and touches a prescribed level, circuit breaker is automatically triggered. This halts trading of the share or all shares on the index for a set time. 1. Index level circuit breaker On the index level circuit breakers are applicable to both cash trades and derivative trades of equity shares. Since some shares are common on both Sensex and Nifty there is a market wide circuit breaker which gets triggered in whichever index crosses the price level first. There are three levels of prices at which circuit breaker would get activated. The prices are calculated with index value as on last trading session of the previous quarter as base. Level 1 circuit breaker- 10% movement in either index
If breached before 1 pm there would be a trading halt of 1 hour. If breached between 1 pm and 2.30 pm there would be a trading break of half an hour. If breached after 2.30 pm there would be no trading halt.
Level 2 circuit breaker- 15% movement in either index If breached before 1 pm there would be a trading halt of 2 hours. If breached between 1 pm and 2.30 pm there would be a trading halt of 1 hour. If breached after 2.30 pm trading would be halted for the rest of the day.
Level 3 circuit breaker- 20% movement in either index If any of the indices cross 20% of the price as on previous quarter's last trading day at any time trading will be stopped on that index for the rest of the day.
2. Individual security level price filter Price filter does not apply for stocks on which derivatives are available or those stocks on indices like sensex and nifty which have derivative products. On all other securities a 20% filter is applicable. In addition stocks exchanges may have filters at 2%, 5% and 10% level. Circuit breakers for individual securities are displayed on BSE and NSE website. Why are circuit breakers in place? When prices rise or fall freakily it could be as a reaction to some sensitive news or incorrect punching by a broking staff or even a technical glitch on the exchange's network. Extreme volatility is most damaging to retail investors than other big investors. So whenever there is abnormal rise or fall in prices investors need to be given time to recollect and evaluate what is causing the steep price movement and react with sanity. Otherwise fear and panic can cause slaughter on the markets. From past instances where markets were halted it has been observed trading resumed to normal when markets resumed from the halt. Some might recall the recent freak trade by a staff at Emkay Global in October 2012 who placed erroneous orders that saw Nifty fall by 15.5% and triggered the market wide circuit breaker. As soon as markets resumed after the halt trades became normal. In the absence of such measures retail investors could be big victims.
Buying and selling shares is an easy process with fast online terminals. There are different types of Buy & sell orders you can place in the market. Although its an easy process, carelessness in exe cuting can result in financial loss. Heres a brief explanation of each type of order and its benefits. TYPES OF ORDERS LIMIT ORDERS Type of orders where you specify the price while entering the order into the system. You have to select the appropriate option to notify whether you are placing the order at Market or at Limit. If you select the Limit order option then you have to enter a price that is in multiple of regular tick size (multiples of 0.05). MARKET ORDERS when you place an order without a limit price with an intention to get it executed at the best price obtainable at the time of entering the order, its called a Market order. STOP LOSS ORDERS when you place an order with a trigger price its called a stop loss order.. Till the trigger price spe cified in the order is reached or surpassed such orders are kept dormant. The intention for placing a Stop Loss order is to restrict the maximum loss in a particular position to a predetermined amount. Stop Loss orders are always placed in pairs. The first order has to be a normal order either limit order or market order. The second order will be a stop loss order that will ensure that maximum loss is restricted. The benefit of stop loss orders: If you place a buy order at Rs100 and do not wish to take a loss of more than Rs2 then you will want to sell at Rs98, when the market starts sliding contrary to your expectations. You can obviously keep a watch on the market and sell when it slides and exit your position at Rs98. But this may not always be possible. By entering a Stop Loss order you achieve the same objective without a need to keep a watch on the market.If you place a sell order when the price is above Rs98, your order will get immediately executed. If you place a stop loss order for Rs98 then this order will remain dormant till market prices breach the trigger price.
In the current example you will place a Stop Loss order for Rs98 with a trigger price of Rs98.10. You can also place a Stop loss order at Market with a trigger price of Rs98.10. In this case when stop loss is triggered the shares will be sold at market rate. Most users make a mistake of placing a stop loss order without the original order. Users typically mistake the limit price to be the main order and trigger price to be stop loss order. Thus in the above example many users intending to limit the loss to Rs2 will place only one order at a limit price of Rs100 and a trigger price of Rs98. You should have a clear understanding of how stop loss orders are to be placed before placing such orders. IOC ORDERS Here you place an order with an IOC instruction i.e. with an intention to get it executed immediately, failing which the order is cancelled. It is possible that the order gets partially traded, and in such cases the remaining portion of the order is cancelled immediately. Stop loss orders cannot be placed as IOC orders. You can place a normal order (at limit or market) as an IOC order. Take Note You must fill the Quantity text box correctly before placing the order. Quantity has to be in multiple of lot size. In cash market most of the shares have a lot size of 1. In Derivatives lot sizes vary from scrip to scrip. In most of the trading platforms, Quantity field cannot be directly entered in the Derivatives OE window. You have to click on the up/down control next to the Quantity text box and the quantity will increment/ decrement by lot size. Disclosed Quantity You can leave the Disclosed Quantity (DQ) text box blank. In case you fill it, it has to be at least 10% of the order quantity. An order with a DQ condition allows you to disclose only a part of the order quantity to the market. For example, an order of 1000 with a DQ condition of 200 will mean that 200 is displayed to the market at a time. After this is traded, another 200 is automatically released and so on till the order is executed fully. PLACING ORDERS TO BUY AND SELL Once you are sure you entered all the information correctly (quantity and the type of order) you can click on the Place button. This will create an Order packet and display it to you. You have to confirm that the packet is generated correctly by clicking on the Confirm button. After your confirmation, the order will be sent into the market. Each order packet that is created at your end is uniquely numbered (Local Order ID) and timestamped before being sent to the broker. As soon as the order is received at the brokers server an acknowledgment is sent back. It is then given a unique Broker Order ID, time-stamped and sent for checking the limits. Once the broker confirms that the order is within your financial limits, it is put in queue for sending to Exchange and you will be notified of the same. When the order is sent to Exchange, another notification will be sent to you. When orders are received by Exchange they are numbered (Exchange Order ID) and time-stamped again. Exchange may either accept the order or may reject it due to errors in the order or due to price out of days price range or any other reason. It may also freeze your order and may release the freeze later. Whether the order is accepted, rejected or frozen by the Exchange will be notified to you. MODIFYING A BUY/SELL ORDER You can modify an online order to buy or sell a share once your original order it is accepted by the Exchange. You cannot modify or cancel an order after it has got executed. Obviously the application has in built safeguards and will not allow you to modify or cancel an order unless it can be done. However, there is a gap between the time when you picked an order to be modified/ cancelled and the time when it was received at the Exchange, and it is quite possible that the order changes status during that time. A pending order might get executed during that gap. You may therefore get a message saying Order does not exist. This means t hat the order that you tried to modify or cancel was not found by the Exchange in its Order Book at that time.
CONFIRMATION OF A TRADE Confirmation messages for Order and Trade related actions will be displayed in the Messages Panel instantly. Generally, you will get confirmation messages for Orders sent to the broker Orders received by the broker Orders accepted or rejected by the broker Orders put in queue to Exchange Orders sent to Exchange Orders accepted, rejected or frozen by the Exchange Trade confirmations sent by the Exchange All these messages will display the time and associated order IDs Local Order ID, Broker Order ID and Exchange Order ID.
Margin buying
Margin buying refers to the buying of securities with cash borrowed from a broker, using other securities as collateral. This has the effect of magnifying any profit or loss made on the securities. The securities serve as collateral for the loan. The net valuethe difference between the value of the securities and the loanis initially equal to the amount of one's own cash used. This difference has to stay above a minimum margin requirement, the purpose of which is to protect the broker against a fall in the value of the securities to the point that the investor can no longer cover the loan. In the 1920s, margin requirements were loose. In other words, brokers required investors to put in very little of their own money. Whereas today, the Federal Reserve's margin requirement (under Regulation T) limits debt to 50 percent, during the 1920s leverage rates of up to 90 percent debt were not uncommon. When the stock market started to contract, many individuals received margin calls. They had to deliver more money to their brokers or their shares would be sold. Since many individuals did not have the equity to cover their margin positions, their shares were sold, causing further market declines and further margin calls. This was one of the major contributing factors which led to the Stock Market Crash of 1929, which in turn contributed to the Great Depression. However, as reported in Peter Rappoport and Eugene N. White's 1994 paper published in The American Economic Review, "Was the Crash of 1929 Expected", all sources indicate that beginning in either late 1928 or early 1929, "margin requirements began to rise to historic new levels. The typical peak rates on brokers' loans were 4050 percent. Brokerage houses followed suit and demanded higher margin from investors".
Examples
Jane buys a share in a company for $100, using $20 of her own money, and $80 borrowed from her broker. The net value (share - loan) is $20. The broker wants a minimum margin requirement of $10. Suppose the share goes down to $85. The net value is now only $5 (net value ($20) - share loss of ($15)), and Jane will either have to sell the share or repay part of the loan (so that the net value of her position is again above $10).
SMA and portfolio margins offer alternative rules for U.S. and NYSE regulatory margin requirements.
[clarification needed]
Enhanced leverage is a strategy offered by some brokers that provides 4:1 or 6:1+ leverage. This requires maintaining two sets of accounts, long and short. Example 1 An investor sells a call option, where the buyer has the right to buy 100 shares in Universal Widgets S.A. at 90. He receives an option premium of 14. The value of the option is 14, so this is the premium margin. The exchange has calculated, using historical prices, that the option value will not exceed 17 the next day, with 99% certainty. Therefore, the additional margin requirement is set at 3, and the investor has to post at least 14 + 3 = 17 in his margin account as collateral. Example 2 Futures contracts on sweet crude oil closed the day at $65. The exchange sets the additional margin requirement at $2, which the holder of a long position pays as collateral in her margin account. A day later, the futures close at $66. The exchange now pays the profit of $1 in the mark-to-market to the holder. The margin account still holds only the $2. Example 3 An investor is long 50 shares in Universal Widgets Ltd, trading at 120 pence (1.20) each. The broker sets an additional margin requirement of 20 pence per share, so 10 for the total position. The current liquidating margin is currently 60 "in favour of the investor". The minimum margin requirement is now -60 + 10 = -50. In other words, the investor can run a deficit of 50 in his margin account and still fulfil his margin obligations. This is the same as saying he can borrow up to 50 from the broker.
Margin call
When the margin posted in the margin account is below the minimum margin requirement, the broker or exchange issues a margin call. The investors now either have to increase the margin that they have deposited or close out their position. They can do this by selling the securities, options or futures if they are long and by buying them back if they are short. But if they do none of these, then the broker can sell their securities to meet the margin call. If a margin call occurs unexpectedly, it can cause a domino effect of selling which will lead to other margin calls and so forth, effectively crashing an asset class or group of asset classes. This situation most frequently happens as a result of an adverse change in the market value of the leveraged asset or contract. It could also happen when the margin requirement is raised, either due to increased volatility or due to legislation. In extreme cases, certain securities may cease to qualify for margin trading; in such a case, the brokerage will require the trader to either [3] fully fund their position, or to liquidate it.
So the maintenance margin requirement uses the variables above to form a ratio that investors have to abide by in order to keep the account active. The point is, let's say the maintenance margin requirement is 25%. That means the customer has to maintain Net Value equal to 25% of the total stock equity. That means they have to maintain net equity of $50,000 * 0.25 = $12,500. So at what price would the investor be getting a margin call? Let P be the price, so 1000P in our case is the Stock Equity. (Current Market Value - Amount Borrowed) / Current Market Value = 25% (1000P - 20000)/1000P = 0.25 (1000P - 20000)= 250P 750P = $20,000 P = $20,000/750 = $26.66 / share
So if the stock price drops from $50 to $26.66, investors will be called to add additional funds to the account to make up for the loss in stock equity. An alternative formula for calculating P is P=P_0((1-initial margin requirement)/(1-maintenance margin requirement)) where P_0 is the initial price of the stock. Let's use the same information to demonstrate this: P=$50*((1-.6)/(1-.25)) P=$26.66
Reduced margins
Margin requirements are reduced for positions that offset each other. For instance spread traders who have offsetting futures contracts do not have to deposit collateral both for their short position and their long position. The exchange calculates the loss in a worst case scenario of the total position. Similarly an investor who creates a collar has reduced risk since any loss on the call is offset by a gain in the stock, and a large loss in the stock is offset by a gain on the put; in general, covered calls have less strict requirements than naked call writing.
Margin-equity ratio
The margin-equity ratio is a term used by speculators, representing the amount of their trading capital that is being held as margin at any particular time. Traders would rarely (and unadvisedly) hold 100% of their capital as margin. The probability of losing their entire capital at some point would be high. By contrast, if the margin-equity ratio is so low as to make the trader's capital equal to the value of the futures contract itself, then they would not profit from the inherent leverage implicit in futures trading. A conservative trader might hold a marginequity ratio of 15%, while a more aggressive trader might hold 40%.
Return on margin
Return on margin (ROM) is often used to judge performance because it represents the net gain or net loss compared to the exchange's perceived risk as reflected in required margin. ROM may be calculated (realized return) / (initial margin). The annualized ROM is equal to (ROM + 1)(1/trade duration in years) - 1 For example if a trader earns 10% on margin in two months, that would be about 77% annualized Annualized ROM = (ROM +1)1/(2/12) - 1 that is, Annualized ROM = 1.16 - 1 = 77% Sometimes, return on margin will also take into account peripheral charges such as brokerage fees and interest paid on the sum borrowed. The margin interest rate is usually based on the broker's call.
Have you ever been absolutely sure that a stock was going to decline and wanted to profit from its regrettable demise? Have you ever wished that you could see your portfolio increase in value during abear market? Both scenarios are possible. Many investors make money on a decline in an individual stock or during a bear market, thanks to an investing technique called short selling. (For related reading, see When To Short A Stock.) Short selling is not complex, but it's a concept that many investors have trouble understanding. In general, people think of investing as buying an asset, holding it while it appreciates in value, and then eventually selling to make a profit. Shorting is the opposite: an investor makes money only when a shorted security falls in value. Short selling involves many unique risks and pitfalls to be wary of. The mechanics of a short sale are relatively complicated compared to a normal transaction. As always, the investor faces high risks for potentially high returns. It's essential that you understand how the whole process works before you get involved.
directly from the company. Brokers are most commonly used. They serve as an intermediary between the investor and the seller and often charge a fee for their services. {C}When using a broker, you will need to set up an account. The account that's set up is either a cash account or a margin account. A cash account requires that you pay for your stock when you make the purchase, but with a margin account the broker lends you a portion of the funds at the time of purchase and the security acts as collateral. When an investor goes long on an investment, it means that he or she has bought a stock believing its price will rise in the future. Conversely, when an investor goes short, he or she is anticipating a decrease in share price. Short selling is the selling of a stock that the seller doesn't own. More specifically, a short sale is the sale of a security that isn't owned by the seller, but that is promised to be delivered. That may sound confusing, but it's actually a simple concept. (To learn more, read Benefit From Borrowed Securities.) Still with us? Here's the skinny: when you short sell a stock, your broker will lend it to you. The stock will come from the brokerage's own inventory, from another one of the firm's customers, or from another brokerage firm. The shares are sold and the proceeds are credited to your account. Sooner or later, you must "close" the short by buying back the same number of shares (called covering) and returning them to your broker. If the price drops, you can buy back the stock at the lower price and make a profit on the difference. If the price of the stock rises, you have to buy it back at the higher price, and you lose money. Most of the time, you can hold a short for as long as you want, although interest is charged on margin accounts, so keeping a short sale open for a long time will cost more However, you can be forced to cover if the lender wants the stock you borrowed back. Brokerages can't sell what they don't have, so yours will either have to come up with new shares to borrow, or you'll have to cover. This is known as being called away. It doesn't happen often, but is possible if many investors are short selling a particular security. Because you don't own the stock you're short selling (you borrowed and then sold it), you must pay the lender of the stock any dividends or rights declared during the course of the loan. If the stocksplits during the course of your short, you'll owe twice the number of shares at half the price. (To learn more about stock splits, read Understanding Stock Splits.)
a high-risk investment. Speculation has been perceived negatively because it has been likened to gambling. However, speculation involves a calculated assessment of the markets and taking risks where the odds appear to be in your favor. Speculating differs from hedging because speculators deliberately assume risk, whereas hedgers seek to mitigate or reduce it. (For more insight, see What is the difference between hedging and speculation?) Speculators can assume a high loss if they use the wrong strategies at the wrong time, but they can also see high rewards. Probably the most famous example of this was when George Soros "broke the Bank of England" in 1992. He risked $10 billion that the British pound would fall and he was right. The following night, Soros made $1 billion from the trade. His profit eventually reached almost $2 billion.(For more on this trade, see The Greatest Currency Trades Ever Made.) Speculators can benefit the market because they increase trading volume, assume risk and add market liquidity. However, high amounts of speculative purchases can contribute to an economic bubble and/or a stock market crash. Hedge For reasons we'll discuss later, very few sophisticated money managers short as an active investing strategy (unlike Soros). The majority of investors use shorts to hedge. This means they are protecting other long positions with offsetting short positions. Hedging can be a benefit because you're insuring your stock against risk, but it can also be expensive and a basis risk can occur. (To learn more about hedging, read A Beginner's Guide To Hedging.) Restrictions Many restrictions have been placed on the size, price and types of stocks traders are able to short sell. For example, penny stocks cannot be sold short, and most short sales need to be done in round lots. The Securities Exchange Commission (SEC) has these restrictions in place to prevent the manipulation of stock prices.
As of January 2005, short sellers were also required to comply with the rules set in place by "Regulation SHO", which modernized the rules overseeing short selling and aimed to provide safeguards against "naked short selling." For instance, sellers had needed to show that they could locate and get the securities they intended to short. The regulation also created a list of securities showing a high level of persistent sales to deliver. In July of 2007, the SEC eliminated the uptick, or zero plus tick, rule. This rule required that every short sale transaction be entered at a higher price than that of the previous trade and kept short sellers from adding to the downward momentum of an asset when it was already experiencing sharp declines. The rule has been around since the creation of the SEC in 1934. One of the reasons it was put in place was to slow rapid and sudden declines in share prices that can occur as a result of short selling.
In July of 2008, the SEC used its emergency powers to put an end to market manipulations, such as spreading negative rumors about a company's performance and sharp price declines. The markets had been volatile as a result of the of mortgage and credit crisis, and the SEC wanted to establish a renewed confidence. For a month, it didn't allow naked short selling on the stocks of 19 major investment and commercial banks, which included the mortgage finance companies Fannie Mae and Freddie Mac. (To learn more, read The Uptick Rule: Does It Keep Bear Markets Ticking?) The SEC took further measures in September of 2008, once again using its emergency authority to issue six orders to minimize abuses. This included a move to halt short selling in shares of 799 companies in cooperation with the United Kingdom's Financial Service Authority. 170 companies were later included in the ban, which ended after the passage of the $700 billion U.S. bailout plan in October 2008. Another order required short sellers get a sale and immediately close it by making sure the shares were delivered. It later became a rule. Who Shorts? Some insiders indicate that it takes a certain type of person to short stocks. Many short sellers have been depicted as pessimists who are rooting for a company's failure, but they've also been described as disciplined and confident in their judgment. (To learn more, read Questioning The Virtue Of A Short Sale.) Sellers are typically: wealthy sophisticated investors hedge funds large institutions day traders
Short selling isn't for everyone. It involves a great amount of time and dedication. Short sellers need to be informed, skilled and experienced investors in order to succeed. They must know: how securities markets work trading techniques and strategies market trends the firm's business operations
By Brigitte Yuille Suppose that, after hours of painstaking research and analysis, you decide that company XYZ is dead in the water. The stock is currently trading at $65, but you predict it will trade much lower in the coming months. In order to capitalize on the decline, you decide to short sell shares of XYZ stock. Let's take a look at how this transaction would unfold. Step 1: Set up a margin account. Remember, this account allows you to borrow money from the brokerage firm using your investment as collateral. Step 2: Place your order by calling up the broker or entering the trade online. Most online brokerages will have a check box that says "short sale" and "buy to cover." In this case, you decide to put in your order to short 100 shares. Step 3: The broker, depending on availability, borrows the shares. According to the SEC, the shares the firm borrows can come from: the brokerage firm's own inventory the margin account of one of the firm's clients another brokerage firm
You should also be mindful of the margin rules and know that fees and charges can apply. For instance, if the stock has a dividend, you need to pay the person or firm making that loan. (To learn more, read the Margin Trading tutorial.) Step 4: The broker sells the shares in the open market. The profits of the sale are then put into your margin account. One of two things can happen in the coming months:
The Stock Price Sinks (stock goes to $40) Borrowed 100 shares of XYZ at $65 Bought Back 100 shares of XYZ at $40 Your Profit $6,500 -$4,000 $2,500
The Stock Price Rises (stock goes to $90) Borrowed 100 shares of XYZ at $65 $6,500
-$9,000 -$2,500
Clearly, short selling can be profitable. But then, there's no guarantee that the price of a stock will go the way you expect it to (just as with buying long). Shorter sellers use an endless number of metrics and ratios to find shortable candidates. Some use a similar stock picking methodology to the longs, but just short the stocks that come out worst. Others look for insider trading, changes in accounting policy, or bubbles waiting to pop. One indicator specific to shorts that is worth mentioning is short interest. Short interest is the total number of stocks, securities or commodity shares in an account or in the markets that have been sold short, but haven't been repurchased in order to close the short position. It serves as a barometer for a bearish or bullish market. For instance, the higher the short interest, the more people will anticipate a downturn. (For more insight, read Short Interest: What It Tells Us .)
3. Shorting stocks involves using borrowed money. This is known as margin trading. When short selling, you open a margin account, which allows you to borrow money from the brokerage firm using your investment as collateral. Just as when you go long on margin, it's easy for losses to get out of hand because you must meet the minimum maintenance requirement of 25%. If your account slips below this, you'll be subject to a margin call, and you'll be forced to put in more cash or liquidate your position. (We won't cover margin in detail here, but you can read more in our Margin Trading tutorial.) 4. Short squeezes can wring the profit out of your investment. When stock prices go up short seller losses get higher, as sellers rush to buy the stock to cover their positions. This rush creates a high demand for the stock quickly driving up the price even further. This phenomenon is known as a short squeeze. Usually, news in the market will trigger a short squeeze, but sometimes traders who notice a large number of shorts in a stock will attempt to induce one. This is why it's not a good idea to short a stock with high short interest. A short squeeze is a great way to lose a lot of money extremely fast. (To learn more, see Short Squeeze The Last Drop Of Profit From Market Moves .) 5. Even if you're right, it could be at the wrong time. The final and largest complication is being right too soon. Even though a company is overvalued, it could conceivably take a while to come back down. In the meantime, you are vulnerable to interest, margin calls and being called away. Academics and traders alike have tried for years to come up with explanations as to why a stock's market price varies from its intrinsic value. They have yet to come up with a model that works all the time, and probably never will. Take the dotcom bubble, for example. Sure, you could have made a killing if you shorted at the market top in the beginning of 2000, but many believed that stocks were grossly overvalued even a year earlier. You'd be in the poorhouse now if you had shorted the Nasdaq in 1999!That's when the Nasdaq was up 86%, although two-thirds of the stocks declined. This is contrary to the popular belief that pre1999 valuations more accurately reflected the Nasdaq. However, it wasn't until three years later, in 2002, that the Nasdaq returned to 1999 levels.
Momentum is a funny thing. Whether in physics or the stock market, it's something you don't want to stand in front of. All it takes is one big shorting mistake to kill you. Just as you wouldn't jump in front of a pack of stampeding bulls, don't fight against the trend of a hot stock.
troubled companies. Some critics even believe that short sales are a major cause of market downturns, such as the crash in 1987. There isn't a whole lot of evidence to support this, as other factors such as derivatives andprogram trading also played a massive role, but two years after the crash, the U.S. government held the 1989 House subcommittee hearing on short selling. Lawmakers wanted to look at the effects short sellers had on small companies and examined the need for regulation after allegations of widespread manipulation by short sellers of over-the-counter stocks. SEC officials reassured the public that manipulations hadn't been uncovered and more rules would be put in place. (To learn more, read Questioning The Virtue Of A Short Sale and The Uptick Rule: Does It Keep Bear Markets Ticking?) But despite its critics, it's tough to deny that short selling makes an important contribution to the market by: Adding liquidity to share transactions. The additional buying and selling reduces the difference between the price at which shares can be bought and sold. Driving down overpriced securities by lowering the cost to execute a trade Increasing the overall efficiency of the markets by quickening price adjustments Acting as the first line of defense against financial fraud. For instance, in 2001, famed short seller James Chanos identified fraudulent accounting practices that occurred with the Enron Corporation, an energy-trading and utilities company. The company's activity became known as the Enron scandal when the company was found to have inflated its revenues. It filed Chapter 11 bankruptcy at the end of 2001. (To learn more about this scandal, see The Biggest Stock Scams Of All Time.)
While the conflicts of interest from investment banking keep some analysts from giving completely unbiased research, work from short sellers is often regarded as being some of the most detailed and highest quality research in the market. It's been said that short sellers actually prevent crashes because they provide a voice of reason during raging bull markets. However, short selling also has a dark side, courtesy of a small number of traders who are not above using unethical tactics to make a profit. Sometimes referred to as the "short and distort," this technique takes place when traders manipulate stock prices in a bear market by taking short positions and then using a smear campaign to drive down the target stocks. This is the mirror version of thepump and dump, where crooks buy stock (take a long position) and issue false information that causes the target stock's price to increase. Short selling abuse like this has grown along with internet trading and the growing trend of small investors and online trading. (For more insight, read The Short And Distort: Stock Manipulation In A Bear Market.)
By Brigitte Yuille
Short selling is another technique you can add to your trading toolbox. That is, if it fits with your risk tolerance and investing style. Short selling provides a sizable opportunity with a hefty dose of risk. We hope this tutorial has enabled you to understand whether it's something you would like to pursue. Let's recap: In a short sale, an investor borrows shares, sells them and must eventually return the same shares (cover). Profit (or loss) is made on the difference between the price at which the shares are borrowed compared to when they are returned. An investor makes money only when a shorted security falls in value. Short selling is done on margin, and so is subject to the rules of margin trading. The shorter must pay the lender any dividends or rights declared during the course of the loan. The two reasons for shorting are to speculate and to hedge. There are restrictions as to what stocks can be shorted and when a short can be carried out (uptick rule). Short interest tells us the number of shares that have already been sold short in a security. Short selling is very risky. You can lose more money than you invest but are limited to 100% profit on the upside. A short squeeze is when a large number of short sellers try to cover their positions at the same time, driving up the price of a stock. Even though a company is overvalued, it may take a long time for it to come back down. Fighting the trend almost always leads to trouble. Critics of short selling see it as unethical and bad for the market. Short selling contributes to the market by providing liquidity, efficiency and acting as a voice of reason in bull markets. Some unethical traders spread false information in an attempt to drive the price of a stock down and make a profit by selling short.
Insider trading
Insider trading is the trading of a public company's stock or other securities (such as bonds or stock options) by individuals with access to non-public information about the company. In various countries insider trading based on inside information is illegal. This is because it is seen as being unfair to other investors who don't have access to the information. The authors of one study claim that illegal insider trading raises the cost of capital for securities issuers, thus decreasing overall economic growth.[1] However, some economists have argued that insider trading should be allowed and could, in fact, benefit markets.[2] The trading by specific insiders such as employees may be permitted as long as it does not rely on material information that is not in the public domain, however most jurisdiction will require the reporting of such trading so that these can be monitored. In the United States and several other jurisdictions, trading conducted by corporate officers, key employees, directors, or significant shareholders must be reported to the regulator or publicly disclosed, usually within a few business days of the trade. The rules around insider trading are complex and vary significantly from country to country and enforcement is mixed. The definition of insider can be very wide and may not only cover insiders themselves but also any person related to them such as brokers, associates and even family members. Any person who becomes aware of non-public information and trades on that basis may be guilty.
Odd Lot
An odd lot is an order for anything less than 100 shares. This is the opposite of a "round lot," which are orders in multiples of 100 shares. However, thinly traded stocks sometimes trade in 10-share increments. How It Works/Example: Investors, particularly individuals, are frequently unable or unwilling to bear the expense of tradingshares in even round lots. Nearly all brokers accept odd-lot trades, but some may charge a highercommission for doing so. However, the advent of electronic and online trading platforms has reduced, and in some cases eliminated, these odd-lot premiums. Why It Matters: Odd-lot orders tend to be placed by small personal investors rather than institutional traders. Thus, the ratio of odd-lot buying to odd-lot selling is often used to evaluate small-investor sentiment. Trends in odd-lot short sales may also be indicative of negative sentiment by small investors. The controversial odd-lot theory states that odd-lot traders are poor market timers and that profits can therefore be made by trading contrary to odd-lot trading patterns.
considered to be anything less than the standard 100 shares for stocks. Trading commissions for odd lots are generally higher on a percentage basis than those for standard lots, since most brokerage firms have a fixed minimum commission level for undertaking such transactions.
Who is a broker?
A broker is a member of a recognized stock exchange, who is permitted to do trades on the screen-based trading system of different stock exchanges. He is enrolled as a member with the concerned exchange and is registered with SEBI.
Who are the major participants in bulk & block deals? Major participants in this segment are institutional players. Mostly, mutual funds, financial institutions, insurance companies, banks, venture capitalists and foreign institutional investors go for such deals. The window is also used by many of the promoters to sort out the issues related to cross holdings. How should an investor go about it? Many a time, block & bulk deals give trading cues to investors. But, such deals don't mean that the stock price of the specific stock will go up. To get a fair direction, one must check the details of the buyer and the seller. A continuous bulk deal in any share with high volume and high pending shares, indicates price appreciation in future. However, one must be cautious, as many of these shares are operator driven.
What is arbitrage?
Arbitrage is basically buying in one market and simultaneously selling in another, profiting from a temporary difference. This is considered riskless profit for the investor/trader. Here is an example of an arbitrage opportunity. Let's say you are able to buy a toy doll for $15 in Tallahassee, Florida, but in Seattle, Washington, the doll is selling for $25. If you are able to buy the doll in Florida and sell it in the Seattle market, you can profit from the difference without any risk because the higher price of the doll in Seattle is guaranteed. In the context of the stock market, traders often try to exploit arbitrage opportunities. For example, a trader may buy a stock on a foreign exchange where the price has not yet adjusted for the constantly fluctuating exchange rate. The price of the stock on the foreign exchange is therefore undervalued compared to the price on the local exchange, and the trader makes a profit from this difference. If all markets were perfectly efficient, there would never be any arbitrage opportunities - but markets seldom remain perfect. It is important to note that even when markets have a discrepancy in pricing between two equal goods, there is not always an arbitrage opportunity. Transaction costs can turn a possible arbitrage situation into one that has no benefit to the potential arbitrager. Consider the scenario with the toy dolls above. It would cost you a certain amount per doll to get the dolls from Florida to Seattle. If it costs $11 per doll, the arbitrage opportunity has been erased.
What Is Arbitrage?
[Q:] What
[A:] Terrific question! Let's start from the definition. The Economics Glossary defines arbitrage opportunity as "the opportunity to buy an asset at a low price then immediately selling it on a different market for a higher price." If I can buy an asset for $5, turn around and sell it for $20 and make $15 for my trouble, that is arbitrage. The $15 I gain represents an arbitrage profit. Arbitrage profits can occur in a number of different ways. We'll look at a few examples: One Type of Arbitrage - One Good, Two Markets Suppose Walmart is selling the DVD of Shaft in Africafor $10. However, I know that on eBay the last 20 copies of Shaft in Africa on DVD have sold for between $25 and $30. Then I could go to Walmart, buy copies of the movie and turn around and sell them on eBay for a profit of $15 to $20 a DVD. It is unlikely that I will be able to make a profit in this manner for too long, as one of three things should happen: 1. Walmart runs out of copies of Shaft in Africa on DVD 2. Walmart raises the price on remaining copies as they've seen an increased demand for the movie 3. The supply of Shaft in Africa DVDs skyrockets on eBay, which causes the price to fall.
This kind of arbitrage is actually quite common on eBay. Many eBay sellers will go to flea markets and yard sales looking for collectibles that the seller does not know the true value of and has priced much too low. They will buy the rare collection of Colecovision games from the yard sale for $10 then turn around and sell them on eBay for $100. There are costs to this however. First of all, you don't find rare Colecovision games just lying around, you have to spend time and energy looking for them. Secondly, you have to spend time learning what is valuable and what is not valuable so you don't find out later what you thought was worth $100 is only worth $5. Lastly, just because something has sold for $100 in the past does not mean it will sell for $100 again in the future. So given both the financial costs and theopportunity costs involved, we would expect arbitrageurs on this market to make as much money as they would doing other productive activities that require the same set of skills. One Good, Two Markets Arbitrage in Sports Gambling Arbitrage of the "One good, Two markets" variety is quite common in the world of sports gambling. Arbitrage on the sports market exists because different betting agencies often post different odds on the outcome of a game. Suppose the White Sox are playing the Red Sox. Bookmaker Billy is giving even money on the game, so a $100 bet placed on either team will earn you $100 if the team you picked wins. Sportsman Steve has the White Sox at +200, which means if you place a $100 bet with Steve on the White Sox to win, you will get $200 if they win, and $100 if they lose. You can guarantee yourself a profit if you make the following bets: 1. Place a $300 bet on the Red Sox with Billy at even odds. 2. Place a $200 bet on the White Sox with Steve at +200. In baseball there are no ties. So either the Red Sox will win, or the White Sox will win. Profit if the Red Sox Win If the Red Sox win, Billy pays you $300. However since the White Sox lost, you lost your bet with Steve and must pay him $200. Your profit is $100, as that's the difference between what Billy pays you and what you must pay Steve. Profit if the White Sox Win Since the bet you made with Steve on the White Sox was at +200, Steve pays you $400 for your $200 bet. Since the Red Sox lost, you must pay Billy $300. Again your profit is $100, represented by the difference of what Steve pays you and what you must pay Billy. There are a number of gamblers who try to exploit differences in odds from bookmaker to bookmaker. It's not quite as profitable as it seems, as the odds do not generally differ as much as they do in this example, plus you have to pay the bookmaker in order to place the bet as that's how they make their money.