Trading of Securities on a Stock Exchange

1. Trading Process on a Stock Exchange

Stock exchanges, such as the BSE (Bombay Stock Exchange) and NSE (National Stock Exchange), provide a regulated platform for buying and selling securities, including stocks, bonds, and derivatives. Investors cannot trade directly on these exchanges; instead, they must engage the services of a SEBI-registered broker.

The trading process generally follows these steps:

Step 1: Selection of a Broker:

• Requirement for a Broker: Investors must trade through SEBI-registered brokers, who act as intermediaries between the investor and the exchange.
• Types of Brokers:
  • Full-Service Brokers: Offer a wide range of services, including research reports, investment advisory, and personalized trading assistance. (e.g., HDFC Securities, ICICI Direct)
  • Discount Brokers: Provide basic trading services at lower brokerage fees, typically through online platforms, and may offer limited research or advisory services. (e.g., Zerodha, Groww)
• Broker as Intermediary: Brokers facilitate order placement, trade execution, and settlement on behalf of their clients.

Step 2: Opening a Demat & Trading Account:

• Demat Account: A Dematerialized Account (Demat Account) holds securities in electronic form, eliminating the need for physical share certificates.
• Trading Account: A Trading Account is used to place buy and sell orders for securities on the stock exchange.
• Account Linkage: Both the Demat Account and Trading Account are linked to the investor's bank account, allowing for seamless fund transfers for trading activities.
• KYC Compliance: Opening these accounts requires completion of Know Your Customer (KYC) procedures, including providing identification and address proof.

Step 3: Placing an Order:

• Order Placement: Investors place buy or sell orders through their broker's trading platform, specifying the security, quantity, and price.
• Types of Orders:
  • Market Order: An order to buy or sell a security at the best available price in the current market. Market orders are typically executed quickly but may not guarantee a specific price.
  • Limit Order: An order to buy or sell a security at a specific price or better. The order will only be executed if the market price reaches the specified limit price.
  • Stop Loss Order: An order to automatically sell a security when its price reaches a certain level (the "stop loss price"), designed to limit potential losses.

Step 4: Order Matching & Execution:

• Electronic Matching: The stock exchange's electronic trading system matches buy and sell orders based on price and time priority.
• Trade Execution: Once a matching buy and sell order is found, the trade is executed, and the transaction details are recorded.

Step 5: Trade Settlement (T+1 Cycle):

• T+1 Settlement: In India, stock trades follow a T+1 settlement cycle, meaning that the settlement process is completed within one business day from the date of the trade (T+1).
• Settlement Day: On the settlement day:
  • The buyer receives the shares in their Demat account.
  • The seller receives the funds from the sale in their bank account.

2. Selection of Broker: Factors to Consider

Choosing the right broker is crucial for a successful trading experience. Investors should consider the following factors when selecting a broker:

• SEBI Registration: Ensure that the broker is registered with SEBI, indicating that they are authorized to operate in the Indian stock market and subject to regulatory oversight.
• Brokerage Fees: Compare transaction charges, account maintenance fees, and other costs associated with using the broker's services.
• Trading Platform: Look for a user-friendly trading platform with fast execution speeds, real-time market data, and analytical tools.
• Research & Advisory: If you are a beginner or require investment guidance, choose a broker that offers comprehensive research reports and advisory services.
• Margin Facility: If you plan to engage in leveraged trading, check the availability of margin facilities and the associated interest rates.

3. Capital & Margin Requirements of a Broker

A. Capital Requirement for Brokers

• Minimum Capital: Stockbrokers are required to maintain minimum capital levels as prescribed by SEBI and the stock exchanges.
• Financial Stability: These capital requirements are designed to ensure that brokers have sufficient financial resources to handle potential risks and meet their obligations to clients.
• Categories of Brokers Based on Capital:
  • Trading Members: Typically require a lower deposit as they only trade on behalf of clients.
  • Clearing Members: Need to maintain higher capital levels as they are responsible for clearing and settling trades, assuming greater financial responsibilities.

B. Margin Requirements for Trading

• Margin Definition: Margin is the amount of money or securities that a trader must deposit with their broker to enter into leveraged trading positions (e.g., futures and options contracts).
• Exchange-Set Requirements: The stock exchanges set margin requirements to mitigate risk and ensure that traders can meet their financial obligations.
• Types of Margins:
  • Initial Margin: The minimum amount of capital required to open a trading position.
  • Maintenance Margin: The minimum amount of equity that a trader must maintain in their account to keep the position open. If the account balance falls below the maintenance margin, the trader will receive a margin call and be required to deposit additional funds.
  • Mark-to-Market (MTM) Margin: A daily adjustment to the margin account to reflect the profit or loss on the trading position. If the position is profitable, the margin account is credited; if it is losing money, the margin account is debited.
  • Exposure Margin: Additional margin that may be required to cover potential losses due to extreme market volatility or other unforeseen events.

Conclusion:

Trading securities on a stock exchange involves several key steps, from selecting a broker and opening trading accounts to placing orders and settling trades. Brokers play a critical role in facilitating trading, and capital and margin requirements are in place to ensure financial stability and protect investors. Understanding this process is essential for anyone participating in the stock market.