I have been in stock market since1977. I really feel badla was banned because FIIs could not understand its logic and they forced Indian regulators to destroy the system.It should have been monitored, but not banned.
]
Reliance Industries's freak fall and the revenge of the badla
Shankar Sharma / DNA
Thursday, June 17, 2010 2:10
The 22% fall in the price of the Reliance Industries (RIL) stock on June 1 has been explained away by the Bombay Stock Exchange (BSE) as one that had no malintent behind it.
According to the BSE, it was merely a block of 160,000 shares being sold at "market", which caused the price to plummet since the sell order hoovered up all the buy orders in the orderbook, and still didn't find quite enough buyers to sell to at or around the market price. And hence, the crash of 22% in India's largest market-cap company.
The explanation seems reasonable and there is no reason to suspect any foulplay.
But that is precisely what should be worrying.
It puts to question the entire purported robustness of India's stock market infrastructure: How could a genuine trade this small (and mind you, most importantly, there was no punching error wherein a dealer can, by mistake, put in a price away from the market) destabilise the largest stock in India? Has India's stockmarket infrastructure truly evolved since the days of 2001? Or is it that our markets are like a well-done crème brûlée — firm and crusty on top, and nothing but quivering custard below?
Before we answer this question, let's see what explanations have been offered by various people for this "freak" trade: Indian markets lack depth because Indians don't invest in equities; Indian household wealth needs to be channelled into equities to lend markets greater depth and liquidity, etc, etc.
I find little logic in these explanations. The real answer, in my view, lies in the products available for trading. And to understand this, let's go back in history and see what trading products existed in India, prior to the introduction of futures & options (F&O) in 2001.
Prior to the introduction of F&O products, there existed a
homegrown product called badla. Badla was an ingenious product, since it was a hybrid cash and futures product, rolled into one. It had survived and thrived as a product for many decades on the BSE, till it was outlawed by the Securities and Exchange Board of India sometime in the first half of 2001, in the market fall that happened post the tech meltdown.
The way badla worked was this: a typical settlement cycle on the BSE (we will restrict our analysis only to the BSE, since badla was a core BSE offering) ran from Monday to Friday. The list of stocks on which badla was offered was called the 'A Group' (like the F&O list of today). On Monday morning, an investor/trader wanting to buy 1 million shares of say, RIL, would buy it, and then, till Friday 3.25 pm (five minutes before market closes), had all three options open to him: he could take delivery of the million shares by paying cash to his broker, he could choose to square up his position and settle the difference at close with his broker, or, he could choose to carry forward (roll over) his position into the next settlement by paying an interest cost, or badla, which was dynamically decided in badla trading on Saturday.
Now focus on this: when you decided to go long on a million RIL shares on Monday, you could have had any of the three motives that a legitimate participant has: take delivery, square up or roll it over. And you could keep your options open till the very end of the settlement cycle. And even if you always wanted to take delivery when you entered the trade, you could always change your mind.
Or, even more pertinently, in the entire pool of RIL buyers, there would be a mix of investors, long-term traders and short-term scalpers, but — and here is the key to the jigsaw — all categories of participants had to, by necessity, enter the same trading pool.
There was no RIL cash stock, and no separate RIL futures. It was one huge pool of aggregated liquidity in which all participants, regardless of their vastly differing proclivities and objectives, had to enter.
What this did was coalesce liquidity into one stream.
All buyers and sellers of RIL, whether they were doing the trade for a minute, a day, a week or a year had to drink from the same pool. They all had a single, unified way to enter the game, but could decide to exit on Friday in any of the three ways outlined above. Perfect.
And then, we threw this pool in 2001 and introduced a twin-track system wherein people who wanted to buy the RIL share as investors would have to do so in the cash segment, while those who were traders in the stock will have to trade in the futures segment.
In other words, the single pool of liquidity was split into two — cash and futures.
This is the core reason why a minuscule trade of 160,000 shares crashed the market.
The moment the pool of liquidity was divided, problems began. It is commonsensical, anyway: multiple streams of liquidity can never be as good as a single stream. Further, the number of buyers and sellers in the cash segment will always be a fraction of those who want to speculate on a stock without taking delivery.
When regulators split the stream, they separated the investor from the trader, though many wear both hats. Liquidity streams became pre-determined, inflexible and incapable of co-mingling as in the badla system.
View it this way: In the old days of badla, a seller of the RIL share, wanting to tender delivery went straight to that single pool. There he would find investors willing to buy the stock for the next ten years, and hence happy to take delivery. He would also run into a larger number of buyers who were day-traders or position traders, who were wanting buy RIL because they saw anything from a 1-minute gain to 90-day gain (badla positions could be rolled over for a maximum period of 90 days).
The seller was indifferent to the motivations of the buyers on the screen. All that mattered to him was, since participants were in the same stream, liquidity for his million shares would always be plentiful. And that he could transact with minimal price impact. And that's the way it used to work.
The situation is completely different now. A seller of a million RIL shares has to, by necessity, find buyers for a million shares (or parts thereof) — for cash, on delivery. That is the key. The delivery-seller has to find a delivery-buyer. It will be of no help at all if in the futures segment, there are strong buyers. They can't take the million shares delivery, so, can't come to the rescue of the RIL cash-segment seller. The RIL seller, thus, has a far more restricted audience to appeal to, and this is what causes 'freak' trades and sharp falls that have beset our markets since 2001.
The bifurcation has reduced liquidity in both segments, and more potently in the cash segment, which is where most of the institutional investors play. Under badla, the cash segment buyer or seller benefited from vastly higher demand and supply emanating from the speculator. View it like the 'interlinking of rivers' project, where the idea is to aggregate liquidity of another kind on a national basis.
Now the cash player has only other cash players to rely upon. To find a cash player willing to step up and take a million share sale off the table is not always possible in real-time, even for large stocks like RIL. Hence, the sweeping-off of the orderbook, as it happened on June 1. Shares get sold almost into a vacuum of cash buyers.
Data also are pretty unambiguous: let's compare some parameters. For starters, let's look at the number of times the Indian market has fallen 10% intra-day.
In the post-badla, 9-year period (2001 onwards), this has happened 6 times. In the pre-badla era (1978-2001), just twice!
Even more shocking, the market fell between 4-7% intraday on 60 occasions in the 23 years of badla till 2001, but has fallen that much on 58 occasions in the 9 years after!
Now, think about it: in an era when there were a just a handful of institutional players, the market was dominated by traders, small investors and speculators.
The market never exhibited the kind of gut-wrenching moves it has since 2001, something that becomes even more damning when examined in the light of far greater institutional participation, increased sophistication of players and an overall far-larger marketplace by way of capitalisation and listings.
The difference in the daily trading volumes of major stocks in that era versus now is telling. The volume bars for the badla period look like the Manhattan skyline, while the post-badla period looks like Dharavi slums. RIL used to trade, on the BSE and the National Stock Exchange (NSE) combined, an average 2.5 crore shares a day during 1998-2001. Now it does around 30-35 lakh shares. For Infosys, the comparables are 30-40 lakh shares then versus 5-7 lakh shares now. For L&T, 90-100 lakh shares versus 10-12 lakh now. And so on.
In most cases, our blue chips now trade 90% lower volumes now than what they traded 10 years back. The decline simply can't be adjusted against greater volumes in the futures segment because of bifurcated liquidity. A cash buyer is a cash buyer and a futures buyer is almost never also a buyer in the cash segment.
In badla, since it was one co-mingled trading stream, a speculator who had only a 10% margin to fork out would have bought off the RIL stock far before it went down 22%.
The cash seller didn't have to look for a cash buyer. A speculator would do just as nicely.
Just to underline the point a tad better, the same 160,000 shares' trade in RIL would only have been 0.6% of RIL daily traded volume back in the badla days. Now, it's about 5%.
I rest my case.
Ergo, on depth and liquidity, we haven't come a long way, baby; we have actually regressed.
The conclusion is in sharp relief: our markets were far less volatile, far more liquid, and had far better price discovery under the badla system, even though we were a far smaller marketplace back then.
Till date, I have never heard any cogent argument (except that advanced countries don't use badla!) as to why badla had to be replaced. Sure, some brokers misused it. But then any system can be misused. Across the world, we have seen derivatives blow up as well. Of course, the real reason was to end the broker-dominated BSE's rule. To that extent, it worked.
But what it ended up really doing was hollow-out the arena, make it highly susceptible to huge price swings even on small trades. I hold no brief for either the BSE or the NSE, but have no hesitation in saying that the splitting of the cash and futures segment has failed.
The hallmark of a well-developed market is depth, continuity, overall liquidity, and availability of a large number of trading products.
Markets are ultimately about democratic choices. Ideally, given the vast benefits they bestow and their superior features, one would like to see a hybrid, aggregated cash-cum-futures single product in India (call it some better name than badla, though), and then let the market decide whether it wants the disaggregated system.
What is required is for policymakers to sit with a clean piece of paper, unencumbered by history and stock exchange politics, and then examine whether what we have now can be improved upon.
If a truly fair and merit-driven thought-process exists— I doubt it does! — the results may well surprise everybody.
Shankar Sharma is the chief global strategist of First Global Stock Broking
--
For Anything related with Stock market be Online at
http://www.niftyviews.com/
Get free updates on your mobile phone. SMS- JOIN SRESEARCHERS to 567678for our market updates
You received this message because you are subscribed to Google Group "STOCKRESEARCHER" group.
To post to this group, send an email to STOCKRESEARCHER@googlegroups.com
To unsubscribe email
Stockresearcher-unsubscribe@googlegroups.com
for more info visit
http://groups.google.com/group/STOCKRESEARCHER?hl=en-GB
.
This is Not a Spam Mail.
Disclaimer :-
"The opinions expressed by the members on this board are based on
their individual experience and perceptions and to share information
with other members with the best of intentions to help fellow members
in investment decisions as equity investment is a risky venture."
--
John Kurian
For Anything related with Stock market be Online at
http://www.niftyviews.com/
Get free updates on your mobile phone. SMS- JOIN SRESEARCHERS to 567678for our market updates
You received this message because you are subscribed to Google Group "STOCKRESEARCHER" group.
To post to this group, send an email to STOCKRESEARCHER@googlegroups.com
To unsubscribe email
Stockresearcher-unsubscribe@googlegroups.com
for more info visit
http://groups.google.com/group/STOCKRESEARCHER?hl=en-GB
.
This is Not a Spam Mail.
Disclaimer :-
"The opinions expressed by the members on this board are based on
their individual experience and perceptions and to share information
with other members with the best of intentions to help fellow members
in investment decisions as equity investment is a risky venture."
Posts
0 comments:
Post a Comment