The Secondary Market
Chapter Objectives
To understand the functions of stock exchanges To explain the process of buying and selling of shares To know the types of orders To comprehend the settlement procedures To understand the process of online trading
Concept of Secondary Market
Outstanding securities are traded in the secondary market. It is commonly known as stock market or stock exchange. Equity shares, bonds, debentures and derivative products are traded on the stock exchanges. Well regulated and active stock market promotes capital formation. Growth of the primary market depends on the secondary market.
Functions of Stock Exchange
Functions of the Stock exchange are:
Maintenance of active trading
Fixation of prices through supply and demand forces
Ensuring safe and fair dealing
Aiding in financing the industry Dissemination of information Inducing the company to perform well
Regulatory Framework
Means framing regulations in order to govern the activities of the stock exchanges and the members. It is provided by the Securities Contract Regulation Act, 1956 and the Securities and Exchange Board of India Act, 1992. The regulatory structure consists of:
Ministry of Finance Securities and Exchange Board of India The Governing Board
Members of Stock Exchange
The Securities Contract Regulation Act, 1956 provides certain regulations for the admission of an individual in the stock exchange. Following are the qualifications an individual must possess in order to become a member of the stock exchange:
S/he must be 21 years of age. S/he should be a citizen of India. S/he should not be insolvent. S/he should not be convicted for malpractices. S/he should satisfy the capital adequacy norm.
Trading in secondary market
It happens through placing of orders by the investors and their matching with a counter order in the trading system. Orders refer to instructions provided by a customer to a brokerage firm, for buying or selling a security with specific conditions. These conditions may be related to the price of the security (limit order or market order or stop loss orders) or related to time (a day order or immediate or cancel order).
Types of Orders
Limit Price/Order:
In these orders, the price for the order has to be specified while entering the order into the system. The order gets executed only at the quoted price or at a better price (a price lower than the limit price in case of a purchase order and a price higher than the limit price in case of a sale order).
Types of Orders
Market Price/Order Here the constraint is the time of execution and not the price. It gets executed at the best price obtainable at the time of entering the order. The system immediately executes the order, if there is a pending order of the opposite type against which the order can match.
Types of Orders
The matching is done automatically at the best available price (which is called as the market price). If it is a sale order, the order is matched against the best bid (buy) price and if it is a purchase order, the order is matched against the best ask (sell) price. The best bid price is the order with the highest buy price and the best ask price is the order with the lowest sell price.
Types of Orders
Stop Loss (SL) Price/Order Stop-loss orders which are entered into the trading system, get activated only when the market price of the relevant security reaches a threshold price. When the market reaches the threshold or pre-determined price, the stop loss order is triggered and enters into the system as a market/limit order and is executed at the market price / limit order price or better price. Until the threshold price is reached in the market the stop loss order does not enter the market and continues to remain in the order book.
Stop-loss orders
A sell order in the stop loss book gets triggered when the last traded price in the normal market reaches or falls below the trigger price of the order. A buy order in the stop loss book gets triggered when the last traded price in the normal market reaches or exceeds the trigger price of the order. The trigger price should be less than the limit price in case of a purchase order and vice versa.
Time Related Conditions
Day Order (Day): A Day order is valid for the day on which it is entered. The order, if not matched, gets cancelled automatically at the end of the trading day. At the National Stock Exchange (NSE) all orders are Day orders. That is the orders are matched during the day and all unmatched orders are flushed out of the system at the end of the trading day.
Time Related Conditions
Immediate or Cancel order (IOC): An IOC order allows the investor to buy or sell a security as soon as the order is released into the market, failing which the order is removed from the system. Partial match is possible for the order and the unmatched portion of the order is cancelled immediately.
Matching of orders
Orders lying unmatched in the trading system are passive orders and orders that come in to match the existing orders are called active orders. Orders are always matched at the passive order price. Given their nature, market orders are instantly executed, as compared to limit orders, which remain in the trading system until their market prices are reached.
Buying and Selling of Shares
An investor, in order to buy or sell shares, must first locate a registered broker. The investor after locating the broker must place an order specifying the number of shares he intends to buy or sell. The broker executes the order in his computer terminal and matches the most appropriate order. The broker, after finding an appropriate order, delivers a contract note to the investor. A contract note specifies the name of the company, number of shares bought/sold, price, brokerage and date of delivery of shares.
Share Groups
The shares of a company are divided into the following categories in Bombay Stock Exchange (BSE)
Group A shares: Also referred to as specified shares selected on the basis of: Track record Market capitalisation Liquidity B1 and B2 groups represent equity segment F group Debt segment C group Odd lot segment
Rolling Settlement System
Under rolling settlement, all trades executed on a trading day are settled X days later. This is called T+X rolling settlement, where T is the trade date and X is the number of business days after trade date on which settlement takes place. The rolling settlement has started on T+2 basis in India, implying that the outstanding positions at the end of the day T are compulsorily settled 2 days after the trade date.
T + 5 settlement was introduced on 2nd July 2001
T + 3 settlement was introduced on 1st April 2002
T + 2 settlement was introduced on 1st April 2003
Online Trading
The Internet is used as a medium for the trading of shares online. In online trading, the orders of shares are placed with the stock exchange through a website. The Securities and Exchange Board of India (SEBI) has developed an Order Routing System (ORS) In ORS, the requirements for the shares are entered by the investor. On execution of the order, the investor receives the confirmation of the order.
Chapter Summary
By now, you should have:
Understood the functions of stock exchanges
Learnt the process of buying and selling of shares
Comprehended the settlement procedures
Understood the process of online trading