Trading System & Stock

Exchanges
Contents
• Trading System – Introduction
• Types of orders
• Margin Trading
• Trading System - Settlement
Trading System-Intro
• Stock exchanges is the market for trading
securities.

• The investors or participants buy and sell

securities through the services of brokers.

• The brokers are members of stock exchanges.

• The stock trading takes places through a fully

automated system of networked computers.
Trading System-Intro
• Trading takes place in two phases:

▫ Phase 1:
 The brokers execute buy and sell orders on behalf of
investors

▫ Phase 2:
 The exchange of security and cash.
 This requires services of other two agencies:
 Clearing house
 Depositories
Trading System-Intro
• Earlier the trading system was floor trading.

• Under floor trading buyers and sellers used to transact face to

face.

• An investor who wants to buy stock will hand over the cash to
his broker.

• Similarly, an investor who wants to sell stock will handover

share certificate to the broker.

• The broker would match the buying and selling orders and
conduct the transaction.
Trading System-Intro
• The floor trading is now replaced by screen-based
trading.

• Under this system the trading ring is replaced by

computer screens.

• The member brokers can install terminals at any

place in the country.

• Now the buyer and seller do not meet but they can
individually make transactions through brokers.
Trading System-Type of Orders
• As a first phase of trading the investor needs to
place an order of buying or selling with the
broker.

• The investor can place following types of orders:

▫ Market order:
 The broker is instructed to buy or sell stated number
of shares at the best prevailing price.

 Here, the trade will certainly be executed but at what

price is uncertain.
Trading System-Type of Orders
• Limit Order:
▫ The investor specifies a limit price

▫ In buy order, investor would specify a maximum price at

which he is willing to buy.
▫ Thus, the order should be executed at this price or a price
lower to it.

▫ In a sell order, the investor would specify a minimum price

at which he is willing to sell.
▫ Thus, the order should be executed only if the price reaches
that level or at a higher price.
Trading System-Type of Orders
• Stop loss orders:
▫ These orders are placed to protect their
investment.

▫ The investor has to specify a stop price.

▫ The order will be executed only when the market

price will cross this stop price.
Trading System-Type of Orders
▫ Example:
 An investor purchased 100 shares at the price of 35.

 Now, the current price of the share is 75.

 Thus, a profit of 40 per share if he sells.

 This profit can be protected.

 He can set a stop price at 70.

Trading System-Type of Orders
 This means that till the price remains above 70, the
shares will not be sold.

 If the price starts falling, the shares will be sold as

the price falls to 70.

 Thus, there is surety of earning 35 profit per share

without losing the chance of earning higher profits.
Trading System-Type of Orders
• Example:
▫ Stop loss can also be used in case of short selling.

▫ Suppose the current price of a share is 250.

▫ The investor is anticipating a fall in price and

hence short sells it.

▫ But there is a risk of price increase and a loss to

investor.
Trading System-Type of Orders
▫ Here, the investor can put a stop price at 260.

▫ This means if the price rises, as soon as it reaches

260, the shares will be bought to cover the
position.

▫ This would limit his loss in case of a price rise.

Trading System-Type of Orders
• Stop Limit Orders:
▫ They are an extension to stop price orders.

▫ Here, instead of a stop price a stop limit is

specified.

▫ The investor has to give a stop price and limit

price.
Trading System-Type of Orders
▫ Suppose the current price of a share is 60, an
investor holding a share give a stop price of 55 and
limit price of 52.

▫ Means the share will be sold as soon as price falls

below 55 at any price between 55 and 52.
Trading System-Type of Orders
▫ Suppose current price is 85 and investor is short
selling, thus he places a stop price of 90 and limit
price of 93.

▫ This means the shares will be bought as soon as

price increase to 90 or above, at any price between
90 and 93.
Trading System-Type of Orders
• Day order (intra-day)
▫ Has to be closed before the end of trading session
of the day.

• Month orders
▫ Consists of futures and options.

• Open orders/ Delivery orders/Good Till Valid

orders
▫ Will stay valid till specified by the investor.
Trading System – Margin Trading
• When an investor buys stock, he can buy it
totally in cash or borrow a part of the cost from
the broker.

• This is known as margin trading or leveraging

the transaction.

• In this case the interest rate on the amount

borrowed is slightly lower than the prime
lending rate.
Trading System – Margin Trading
• Suppose an investor buys shares worth 50000 and pays
in cash 30000 and borrows remaining 20000 from the
broker.

• Whatever the investor pays in cash is considered as

margin, so over here 30000 is margin (60% of total
value)

• In other words, the equity is 30000 and debt is 20000.

• The profit or loss he would earn will be affected by the

interest to be paid on borrowed amount.
Trading System – Margin Trading
• Suppose you bought 200 shares at the price of
Rs 50, the total value being Rs. 10000.

• Suppose according to the rule, your margin is

5000.

• Means you pay 5000 in cash and borrow

remaining 5000 from the broker.

• Thus, the equity is 5000 and debt is 5000.

Trading System – Margin Trading
• Now, the price of share increases to Rs.60, the
total value of your investment increases to
12000.

• But the value of your equity is 7000(12000 -

5000).

• The return is 7000/5000 -1 = 0.40 or 40%

Trading System – Margin Trading
• Suppose the price decreases to Rs. 40, the total
value of your investment is now 8000.

• But, the value of your equity is now 3000(8000

– 5000).

• Return is 3000/5000 - 1 = -0.40 or -40%

Trading System – Margin Trading
• But these are profits or losses before payment of
interest and commission.

• Suppose there is a 6% interest on borrowed

funds (5000 × 6% = 300) and Rs 100
commission.

• The return in the first case now becomes:

▫ 12000 – 5000 – 300 – 100/5000 - 1 = 0.32 or
32%
Trading System – Margin Trading
• The return in the second case now becomes:
▫ 8000 – 5000 – 300 – 100/5000 - 1 = -0.48 or
48%

• Maintenance margin:
▫ For safety purpose of the broker, at times margin
call is made.

▫ When price declines considerably, a margin call is

made to the investor to put in more cash.
Trading System – Margin Trading
▫ If the maintenance margin percentage is 25%, the
price at which margin call will be made is
determined by the following formula:

N(P) – B = M
N(P)

Where, N = number of shares bought

P = prevailing price of share
B = borrowed amount
M = maintenance margin
Trading System – Margin Trading
• Thus, in the above example,
200P – 5000 = 0.25
200P
Thus, P = 33.33

▫ Thus as soon as price reaches 33.33 or lower the

broker will give a margin call to investor to put in
additional cash.

▫ Thus in any case the proportion of equity should

remain 25 % of the total value of investment.
Trading System – Settlement
• The second phase of any trade is when securities and
cash are exchanged.

• This phase is known as settlement.

• Trade done on a particular day is settled after a

specified number of business days/working days.

• Initially, a T+5 settlement was introduced, which over

a time reduced to T + 3, now currently it is T + 2.
Trading System – Settlement
• This settlement is done through two agencies:
▫ The clearing corporation
▫ The depository

• Every stock exchange has an individual clearing

corporation.

• Depository is common for the entire nation.

• Today, all shares are held in demat form.

Trading System – Settlement
• The depository of the nation has a custody of all the
shares issued in an IPO.

• Whenever shares are traded they might increase the

depository or decrease it.

• Ideally, the stock exchange sends all the data relating

to buying and selling transactions every day to the
clearing corporation.

• The clearing house sends this data to the depository.

Trading System – Settlement
• The depository then transfers the required
stocks to the clearing house and the clearing
house sends it to the stock exchange.

• Thus, the clearing house acts as a agent between

stock exchange and depository.

• All this happens through an automated process

which requires almost 2 days.
Trading System – Settlement
• Clearing corporations in India:
▫ There are two stock exchanges in India- BSE &
NSE.

▫ The clearing corporation of BSE is managed by

BOISL(Bank of India Share Holding ltd.).

▫ BOI holds 51% stake in BOISL and BSE holds

49%.

▫ It is popularly known as clearing house.

Trading System – Settlement
• The clearing operation of NSE is NSE Clearing
(Formerly known as National Securities Clearing
corporation of India).

• Earlier it was an wholly owned subsidiary of

NSE.

• But now it is an independent body.

Trading System – Settlement
• Depositories of India:
▫ There are two major depositories of India:
 National Securities Depository Ltd (NSDL)
 Central Depositories Services Ltd. (CDSL)
Costs Involved in Stock Investment
• Brokerage
▫ (0.01% to 0.5% of transaction amount)

• STT (Securities Transaction Tax)

▫ (0.1% for delivery and 0.025% for intraday)

• Stamp Duty and GST

▫ As a percentage of brokerage charged – 9% CGST
and 9% SGST

• Transaction Charges
▫ 0.00325% - NSE and 0.00275% - BSE
• SEBI turnover Charges
▫ (0.0002% of transaction amount)

• Depository Participant

• Capital Gains Tax

▫ Short term is 15% and long term is 10% (above 1
lakh)