Trading Mechanism of Indian Stock Market

Trading Mechanism

Trading at both the exchanges takes place through an open electronic limit order book, in which order matching is done by the trading computer. There are no market makers or specialists and the entire process is order-driven, which means that market orders placed by investors are automatically matched with the best limit orders. As a result, buyers and sellers remain anonymous. The advantage of an order driven market is that it brings more transparency, by displaying all buy and sell orders in the trading system. However, in the absence of market makers, there is no guarantee that orders will be executed.

All orders in the trading system need to be placed through brokers, many of which provide online trading facility to retail customers. Institutional investors can also take advantage of the direct market access (DMA) option, in which they use trading terminals provided by brokers for placing orders directly into the stock market trading system. (For more, read Brokers And Online Trading: Accounts And Orders.)

Trading Procedure on a Stock Exchange:

The Trading procedure involves the following steps:

1. Selection of a broker: The buying and selling of securities can only be done through SEBI registered brokers who are members of the Stock Exchange. The broker can be an individual, partnership firms or corporate bodies. So the first step is to select a broker who will buy/sell securities on behalf of the investor or speculator.

2. Opening Demat Account with Depository: Demat (Dematerialized) account refer to an account which an Indian citizen must open with the depository participant (banks or stock brokers) to trade in listed securities in electronic form. Second step in trading procedure is to open a Demat account.

The securities are held in the electronic form by a depository. Depository is an institution or an organization which holds securities (e.g. Shares, Debentures, Bonds, Mutual (Funds, etc.) At present in India there are two depositories: NSDL (National Securities Depository Ltd.) and CDSL (Central Depository Services Ltd.) There is no direct contact between depository and investor. Depository interacts with investors through depository participants only.

Depository participant will maintain securities account balances of investor and intimate investor about the status of their holdings from time to time.

3. Placing the Order: After opening the Demat Account, the investor can place the order. The order can be placed to the broker either (DP) personally or through phone, email, etc.

Investor must place the order very clearly specifying the range of price at which securities can be bought or sold. e.g. “Buy 100 equity shares of Reliance for not more than Rs 500 per share.”

Order types and conditions

The system allows the trading members to enter orders with various conditions attached to them as per their requirements. These conditions are broadly divided into the following three categories:

Time conditions

Day order: A day order, as the name suggests is an order which is valid for the day on which it is entered. If the order is not executed during the day, the system cancels the order automatically at the end of the day.

Immediate or Cancel (IOC): An IOC order allows the user to buy or sell a contract as soon as the order is released into the system, failing which the order is cancelled from the system. Partial match is possible for the order, and the unmatched portion of the order is cancelled immediately.

Price condition

Stop–loss: This facility allows the user to release an order into the system, after the market price (Last Traded Price) of the security reaches or crosses a threshold price e.g. if for stop–loss buy order, the trigger is 1027.00, the limit price is 1030.00 and the market (last traded) price is 1023.00, then this order is released into the system once the market price reaches or exceeds 1027.00. This order is added to the regular lot book with time of triggering as the time stamp, as a limit order of 1030.00. For the stop–loss sell order, the trigger price has to be greater than the limit price.

Other conditions

Market price: Market orders are orders for which no price is specified at the time the order is entered (i.e. price is market price). For such orders, the system determines the price.

Limit price: Price of the order after triggering from Stop Loss Book.
Pro: Pro means that the orders are entered on the trading member’s own account.
Cli: Cli means that the trading member enters the orders on behalf of a client.
Trigger Price: Price at which an order gets triggered from Stop-loss book.
Several combinations of the above are allowed thereby providing enormous flexibility to the users.

4. Executing the Order: As per the Instructions of the investor, the broker executes the order i.e. he buys or sells the securities. Broker prepares a contract note for the order executed. The contract note contains the name and the price of securities, name of parties and brokerage (commission) charged by him. Contract note is signed by the broker.

5. Settlement: This means actual transfer of securities. This is the last stage in the trading of securities done by the broker on behalf of their clients. There can be two types of settlement.

(a) On the spot settlement: It means settlement is done immediately and on spot settlement follows. T + 2 rolling settlement. This means any trade taking place on Monday gets settled by Wednesday.

 (b) Forward settlement: It means settlement will take place on some future date. It can be T + 5 or T + 7, etc. All trading in stock exchanges takes place between 9.55 am and 3.30 pm. Monday to Friday.

Settlement Cycle and Trading Hours

Equity spot markets follow a T+2 rolling settlement. This means that any trade taking place on Monday, gets settled by Wednesday. All trading on stock exchanges takes place between 9:55 am and 3:30 pm, Indian Standard Time (+ 5.5 hours GMT), Monday through Friday. Delivery of shares must be made in dematerialized form, and each exchange has its own clearing house, which assumes all settlement risk, by serving as a central counterparty

The important settlement types are as follows:

Normal segment (N)

Trade for trade Surveillance (W)

Retail Debt Market (D)

Limited Physical market (O)

Non cleared TT deals (Z)

Auction normal (A)

Trades in the settlement type N, W, D and A are settled in dematerialized mode. Trades under settlement type O are settled in physical form. Trades under settlement type Z are settled directly between the members and may be settled either in physical or dematerialized mode.

Details of the two modes of settlement are as under:

Dematerialised settlement

NSCCL follows a T+2 rolling settlement cycle. For all trades executed on the T day, NSCCL determines the cumulative obligations of each member on the T+1 day and electronically transfers the data to Clearing Members (CMs). All trades concluded during a particular trading date are settled on a designated settlement day i.e. T+2 day. In case of short deliveries on the T+2 day in the normal segment, NSCCL conducts a buy –in auction on the T+2 day itself and the settlement for the same is completed on the T+3 day, whereas in case of W segment there is a direct close out. For arriving at the settlement day all intervening holidays, which include bank holidays, NSE holidays, Saturdays and Sundays are excluded. The settlement schedule for all the settlement types in the manner explained above is communicated to the market participants vide circular issued during the previous month.

Rolling Settlement

	Activity	Day
Trading	Rolling Settlement Trading	T
Clearing	Custodial Confirmation	T+1 working days
	Delivery Generation	T+1 working days
Settlement	Securities and Funds pay in	T+2 working days
	Securities and Funds pay out	T+2 working days
	Valuation Debit	T+2 working days
Post Settlement	Auction	T+2 working days
	Auction settlement	T+3 working days
	Bad Delivery Reporting	T+4 working days
	Rectified bad delivery pay-in and pay-out	T+6 working days
	Re-bad delivery reporting and pickup	T+8 working days
	Close out of re-bad delivery and funds pay-in & pay-out	T+9 working days

In a rolling settlement, for all trades executed on trading day .i.e.T day the obligations are determined on the T+1 day and settlement on T+2 basis i.e. on the 2nd working day. For arriving at the settlement day all intervening holidays, which include bank holidays, NSE holidays, Saturdays and Sundays are excluded. A tabular representation of the settlement cycle for rolling settlement is given below:

Settlement Cycle

Physical settlement

Limited physical Market : To provide an exit route for small investors holding physical shares in securities the Exchange has provided a facility for such trading in physical shares not exceeding 500 shares in the 'Limited Physical Market' (small window).

Salient features of Limited Physical Market

Delivery of shares in street name and market delivery (clients holding physical shares purchased from the secondary market) is treated as bad delivery. The shares standing in the name of individuals/HUF only would constitute good delivery. The selling/delivering member must necessarily be the introducing member.

Any delivery of shares which bears the last transfer date on or after the introduction of the security for trading in the LP market is construed as bad delivery.

Any delivery in excess of 500 shares is marked as short and such deliveries are compulsorily closed-out.

Shortages, if any, are compulsorily closed-out at 20% over the actual traded price. Non rectification/replacement for bad delivery are closed out at at 10% over the actual trade price. Non rectification/replacement for objection cases are closed out at at 20% above the official closing price in regular Market on the auction day.

The buyer must compulsorily send the securities for transfer and dematerialisation, latest within 3 months from the date of pay-out.

Company objections arising out of such trading and settlement in this market are reported in the same manner as is currently being done for normal market segment. However securities would be accepted as valid company objection, only if the securities are lodged for transfer within 3 months from the date of pay-out.
 

Settlement Cycle

Bad Deliveries (in case of physical settlement)

Bad deliveries (deliveries which are prima facie defective) are required to be reported to the clearing house within two days from the receipt of documents. The delivering member is required to rectify these within two days. Un-rectified bad deliveries are assigned to auction on the next day

Company Objections (in case of physical settlement

The CM on whom company objection is lodged has an opportunity to withdraw the objection if the objection is not valid or the documents are incomplete (i.e. not as required under guideline No.100 or 109 of SEBI Good/Bad delivery guidelines), within 7 days of lodgement against him. If the CM is unable to rectify/replace defective documents on or before 21 days, NSCCL conducts a buying-in auction for the non-rectified part of defective document on the next auction day through the trading system of NSE. All objections, which are not bought-in, are deemed closed out on the auction day at the closing price on the auction day plus 20%. This amount is credited to the receiving member's account on the auction pay-out day.

Market watch window

The following windows are displayed on the trader workstation screen.
• Title bar
• Ticker window of futures and options market
• Ticker window of underlying(capital) market
• Tool bar
• Market watch window
• Inquiry window
• Snap quote
• Order/trade window
• System message window

The purpose of market watch is to allow continuous monitoring of contracts or securities that are of specific interest to the user. It displays trading information for contracts selected by the user. The user also gets a broadcast of all the cash market securities on the screen. This function also will be available if the user selects the relevant securities for display on the market watch screen. Display of trading information related to cash market securities will be on “Read only” format i.e. the dealer can only view the information on cash market but, cannot trade in them through the system. This is the main window from the dealer’s perspective.

Inquiry window

The inquiry window enables the user to view information such as Market by Price (MBP), Previous Trades (PT), Outstanding Orders (OO), Activity log (AL), Snap Quote (SQ), Order Status (OS), Market Movement (MM), Market Inquiry (MI), Net Position, On line backup, Multiple index inquiry, Most active security and so on.

Important Entities of the Clearing Process (Stock Exchange of India)

The transactions in secondary market are processed through three distinct phases, viz. trading, clearing and settlement. While the stock exchange provides the platform for trading to its trading members, the clearing corporation determines the funds and securities obligations of the trading members and ensures that trading members meet their obligations.

The clearing banks and depositories provide the necessary interface between the custodians/clearing members (who clear for the trading members or their own transactions) for settlement of funds and securities obligations of trading members.

Stock Exchange

The clearing process involves determination of what counter-parties owe, and what counter-parties are due to receive on the settlement date. It is essentially the process of determination of obligations, after which the obligations are discharged by settlement. To illustrate, the clearing and settlement process for transactions in securities on NSE is presented.

Several entities, like clearing corporation, clearing members, custodians, clearing banks, depositories, are involved in the process of clearing. The roles of each of these entities are explained below:

i) Clearing Corporation: The clearing corporation is responsible for post-trade activities of a stock exchange. Clearing and settlement of trades and risk management are the central functions for a clearing corporation.

ii) Clearing Members: Clearing members can be of two types: (i) those who are trading as well as clearing members; these members trade as well as take the responsibility to settle their trades, and (ii) those who act only as clearing members; these members do not trade but take on the responsibility to settle the trades of other trading members. They are responsible for settling their obligations as determined by the clearing corporation. They have to make available funds and/or securities in the clearing account or pool account, as the case may be, to meet their obligations on the settlement day.

iii) Custodians: Custodians are clearing members but not trading members. They settle trades on behalf of other trading members. A trading member may assign a particular trade to a custodian for settlement. The custodian is required to confirm whether he is going to settle that trade or not. If it confirms to settle that trade, then clearing corporation assigns that particular obligation to that custodian and the custodian is required to settle it on the settlement day.

iv) Clearing Banks: Clearing banks are a key link between the clearing members and clearing corporation for funds settlement. Every clearing member is required to open a dedicated clearing account with one of the clearing banks. Based on the clearing member’s obligation as determined through clearing, the clearing member makes funds available in the clearing account for the pay-in and receives funds in case of a pay-out.

v) Depositories: Depository helps in the settlement of the dematerialised securities. It holds dematerialised securities of the investors in the beneficiary accounts. Each clearing member is required to maintain a clearing pool account with all the depositories Separate accounts are required to be opened for the settlement of trades on different stock exchanges.

The clearing members are required to provide the securities as per their obligations in the clearing pool account on settlement day. At a pre-determined time, the depository sends the information about the availability of securities in the clearing pool accounts of the clearing member to the clearing corporation.

Who Can Invest In India?

India started permitting outside investments only in the 1990s. Foreign investments are classified into two categories: foreign direct investment (FDI) and foreign portfolio investment (FPI). All investments in which an investor takes part in the day-to-day management and operations of the company, are treated as FDI, whereas investments in shares without any control over management and operations, are treated as FPI.

For making portfolio investment in India, one should be registered either as a foreign institutional investor (FII) or as one of the sub-accounts of one of the registered FIIs. Both registrations are granted by the market regulator, SEBI. Foreign institutional investors mainly consist of mutual funds, pension funds, endowments, sovereign wealth funds, insurance companies, banks, asset management companies etc. At present, India does not allow foreign individuals to invest directly into its stock market. However, high-net-worth individuals (those with a net worth of at least $US50 million) can be registered as sub-accounts of an FII.

Foreign institutional investors and their sub accounts can invest directly into any of the stocks listed on any of the stock exchanges. Most portfolio investments consist of investment in securities in the primary and secondary markets, including shares, debentures and warrants of companies listed or to be listed on a recognized stock exchange in India. FIIs can also invest in unlisted securities outside stock exchanges, subject to approval of the price by the Reserve Bank of India. Finally, they can invest in units of mutual funds and derivatives traded on any stock exchange.

An FII registered as a debt-only FII can invest 100% of its investment into debt instruments. Other FIIs must invest a minimum of 70% of their investments in equity. The balance of 30% can be invested in debt. FIIs must use special non-resident rupee bank accounts, in order to move money in and out of India. The balances held in such an account can be fully repatriated. (For related reading, see Re-evaluating Emerging Markets. )

Restrictions/Investment Ceilings

The government of India prescribes the FDI limit and different ceilings have been prescribed for different sectors. Over a period of time, the government has been progressively increasing the ceilings. FDI ceilings mostly fall in the range of 26-100%.

By default, the maximum limit for portfolio investment in a particular listed firm, is decided by the FDI limit prescribed for the sector to which the firm belongs. However, there are two additional restrictions on portfolio investment. First, the aggregate limit of investment by all FIIs, inclusive of their sub-accounts in any particular firm, has been fixed at 24% of the paid-up capital. However, the same can be raised up to the sector cap, with the approval of the company's boards and shareholders.

Secondly, investment by any single FII in any particular firm should not exceed 10% of the paid-up capital of the company. Regulations permit a separate 10% ceiling on investment for each of the sub-accounts of an FII, in any particular firm. However, in case of foreign corporations or individuals investing as a sub-account, the same ceiling is only 5%. Regulations also impose limits for investment in equity-based derivatives trading on stock exchanges. (For current restrictions and investment ceilings go to https://rbi.org.in/​)

Investment Opportunities for Retail Foreign Investors

Foreign entities and individuals can gain exposure to Indian stocks through institutional investors. Many India-focused mutual funds are becoming popular among retail investors. Investments could also be made through some of the offshore instruments, like participatory notes (PNs) and depositary receipts, such as American depositary receipts (ADRs), global depositary receipts (GDRs), and exchange traded funds (ETFs) and exchange-traded notes (ETNs). (To learn about these investments, see 20 Investments You Should Know.)

As per Indian regulations, participatory notes representing underlying Indian stocks can be issued offshore by FIIs, only to regulated entities. However, even small investors can invest in American depositary receipts representing the underlying stocks of some of the well-known Indian firms, listed on the New York Stock Exchange and Nasdaq. ADRs are denominated in dollars and subject to the regulations of the U.S. Securities and Exchange Commission (SEC). Likewise, global depositary receipts are listed on European stock exchanges. However, many promising Indian firms are not yet using ADRs or GDRs to access offshore investors.

Retail investors also have the option of investing in ETFs and ETNs, based on Indian stocks. India ETFs mostly make investments in indexes made up of Indian stocks. Most of the stocks included in the index are the ones already listed on NYSE and Nasdaq. As of 2009, the two most prominent ETFs based on Indian stocks are the Wisdom-Tree India Earnings Fund (NYSE: EPI) and the PowerShares India Portfolio Fund (NYSE:PIN). The most prominent ETN is the MSCI India Index Exchange Traded Note (NYSE:INP). Both ETFs and ETNs provide good investment opportunity for outside investors.