At Your Own Risk

The new Sebi pronouncements have reshaped the Indian markets totally. In brief, the new market will have no carry-forward, no stock-lending, no circuit filters. It will have rolling settlements and single-stock option trading will be introduced on a revamped derivative platform.

The changes lead to a different set of risks and lower rewards for the non-speculator. The lack of CF ensures that volumes stay low. Lack of circuit filters induce higher daily volatility.

The combination of no circuits and low volumes make it easier to move the market with a lower capital outlay. The brave day trader benefits from this combination of factors. The rewards rise along with the risks for those who stay glued to their terminals through every minute of every session. The greater volatility can be exploited if one handles the greater risks involved.

The investor loses because of the same factors of additional volatility and the loss of liquidity. As stocks become less liquid, bid-ask spreads increase, and what is called impact cost, rises.

Impact cost is defined as the effect of a large trade on the price of a stock. In a stock with an average daily volume of one lakh shares, a single trade of say, 1,000 shares will not move the price even one per cent since it barely alters the supply-demand position.

So the impact cost can be assessed at around one per cent by a conservative operator in these circumstances. However a trade of 50,000 shares in the same conditions could swing the price as much as 50 per cent as it skews the supply-demand pattern. As average volumes drop, impact costs rise.

A big long-term investor is hobbled by high impact costs. If a stock could swing 50 per cent up when he buys, and 50 per cent down when he books profits, even the most long-term of players will be worried about the effect on returns.

It doesn