Shares & Stock Markets
Let’s catch up with ‘Bulls’ and ‘bears’. The two most commonly used terms in stock markets.
A common story is that the terms ‘Bull market’ and ‘Bear market’ are derived from the way those animals attack. Bulls are supposed to be aggressive and attacking while bears would wait for the prey to come down.
Another story is that long back, bear trappers would first trade in the market and fix a price for bear skins, which they actually din’t own. Once the price is fixed , they would go hunting for bear skins. So eventually even if the prices go down, they will still be able to sell if for a high price. This term eventually was used to describe short sellers and speculators who sell what they do not own and buy it when the price comes down and makes money in the process.
However, it was Thomas Mortimer,in his book called ‘Every Man His Own Broker’ (1775) who first officially used the terms Bulls and bears to describe investors according to their behavior.
When can you say it’s a bull market? When the prices of stocks moves up rapidly cracking previous highs , you may assume that it’s a bull market.If there are many bullish days in a row you can consider that as a ‘bull market run’. Technically a bull market is a rise in value of the market by at least 20%.
A bear market is the opposite of a bull market. When the prices of stocks moves crashes rapidly cracking previous lows , you may assume that it’s a bear market. Generally markets must fall by more than 20% to confirm that it’ a bear market.
This is another category of market participant. The stags are not interested in a bull run or a bear run. Their aim is to buy and sell the shares in very short intervals and make a profit from the fluctuation. It’s a daily tussle for stags in the stock market.
The basic idea behind stock market investment is simple- Buy low, sell high and make money. So to make money, you buy stocks in a bear market when stock prices are low and sell stocks in a bull market when stock prices are high.
However, knowing the exact time when a bear market would start or when a bull market run would come is not possible. Just when you thought the markets would go up, it may surprise you by trading low. Your strategy should be to pick up shares in the bear market and sell it when there’s a bull market run.
HERE’S THE CRUX..
- Technically a bull market is a rise in value of the market by at least 20%.Anything less than 20% would be considered as a minor rally.
- A market launches into a bull phase when sentiment turns buoyant, which is usually because of a series of positive developments that beat expectations
- Reverse is also true. A 20% or more fall in value is considered as a bear market. Anything less than 20% would be considered as a ‘correction’.
- Bear markets occur when news flow tends to be worse than expectations, causing investors to sharply punish stocks or sectors. This has happened in the US where more bad news on the sub-prime front and US economy data has stifled even the briefest of market recoveries.
- To confirm a bear market, this weakness should persist for at least two months. In bear markets, liquidity is extremely tight, volumes tend to be low and market breadth tends to be poor
- Some experts believe that for emerging markets such as India, which tend to be more volatile, the correction needs to be steeper at 30-35 per cent.
- In every bear market, there tends to be bear market rallies or a bear market pullback, where the market rises 10-15 per cent only to decline yet again. The bounce-back usually occurs when some stocks or sectors are ‘oversold’, to borrow a term used by technical analysts.
- Worst bear market conditions are followed by great bounce backs.
That covers Bulls, bears and stags.
There is an old saying which would further give authenticity to our bear story-
“Never sell a bear skin unless you have one.”
Have a nice day!
Stock market indices, as we have explained earlier, gives you a snapshot of how the economy is going forward.It’s just a snapshot.
If you look at the total number of companies listed in the BSE, it is above 6500. The Sensex however, tracks only 30 of the most liquid stocks based on their selection criteria. That’s approximately 0.45% of the total companies listed. Similarly NIFTY tracks only 50 of the most liquid stocks based on NSE’s stock selection criteria. So, the market index represents only a very small section of the stocks and these 30 or 50 companies unfortunately may not be a correct representation of the market. There are many niche sectors that are not represented in the index.
The first eight companies in the Sensex have a weightage of more than 50% in the index. If these eight companies move in one direction, the index would be in green, even if all others don’t perform. So if the index rises, it is not necessary that your investment would also rise.
However, if you are holding shares in the exact ratio of an index (that is, if you have mimicked the index with a smaller amount) following the index may make sense.
Hence, stock indices are unimportant to an ordinary investor. What’s important is to pick stocks that are fundamentally good. Fundamentally good stocks perform well in any situations. There are many stocks which steadily rise, unnoticed by many, when the market index is going no where.
If you need a barometer to check the pulse of the market, there are some broader indices such as BSE 200 and BSE 500, which represents 200 and 500 companies respectively. These indices should be better than the Sensex and the nifty since, a lot companies from many wide sectors are included.
If you want to track a particular sector, like banking or technology, Sectoral indices are available from the BSE and NSE. This too, works well.
USES OF AN INDEX.
Indexes are however, used a proxy for investor confidence in equity markets.
Investors, who are not good in analysing fundamentals, but wants to put their money in the best companies around can track changes in the indices and take decisions.
Those who feel that they cannot beat the index can invest in Index based mutual funds, which actually track the performance of the index and allocates money in the same ratio as the index. It is a good option for those who wants keep their money growing exactly like the index.
Indices can be used to measure and compare the performance of individual stock portfolios.
Last but not least, they can be used to check how the market reacted to specific events like terrorist attacks or earth quakes and that will help you to forecast how the market would behave , should such a disaster happen again.
In the last post, we discussed what Sensex is and how it is calculated.
Just like the Sensex which was introduced by the Bombay stock exchange, Nifty is a major stock index in India introduced by the National stock exchange.
NIFTY was coined fro the two words ‘National’ and ‘FIFTY’. The word fifty is used because; the index consists of 50 actively traded stocks from various sectors.
So the nifty index is a bit broader than the Sensex which is constructed using 30 actively traded stocks in the BSE.
The methodology for calculating the Sensex was given in our earlier post. Nifty is calculated using the same methodology adopted by the BSE in calculating the Sensex – but with three differences. They are:
- The base year is taken as 1995
- The base value is set to 1000
- Nifty is calculated on 50 stocks actively traded in the NSE
- 50 top stocks are selected from 24 sectors.
The selection criteria for the 50 stocks are also similar to the methodology adopted by the Bombay stock exchange.
LATEST LIST OF NIFTY STOCKS
If you want the list of 50 stocks that have been included in the nifty, here’s the direct link.
The SENSEX-(or SENSitve indEX) was introduced by the Bombay stock exchange on January 1 1986. It is one of the prominent stock market indexes in India. The Sensex is designed to reflect the overall market sentiments. It comprises of 30 stocks. These are large, well-established and financially sound companies from main sectors.
METHOD ADOPTED FOR SENSEX CACULATION
The method adopted for calculating Sensex is the market capitalisation weighted method in which weights are assigned according to the size of the company. Larger the size, higher the weightage.
The base year of Sensex is 1978-79 and the base index value is set to 100 for that period.
WHY IS THE BASE VALUE SET TO 100 POINTS?
The total value of shares in the market at the time of index construction is assumed to be ’100′ in terms of ‘points’. This is for the purpose of ease of calculation and to logically represent the change in terms of percentage. So, next day, if the market capitalization moves up 10%, the index also moves 10% to 110.
HOW ARE THE STOCKS SELECTED?
The stocks are selected based on a lot of qualitative and quantitative criterias. You can view the listing criteria here.
HOW IS THE INDEX CONSTRUCTED?
The construction technique of index is quite easy to understand if we assume that there is only one stock in the market. In that case, the base value is set to 100 and let’s assume that the stock is currently trading at 200. Tomorrow the price hits 260 (30% increase in price) so, the index will move from 100 to 130 to indicate that 30% growth. Now let’s assume that on day 3, the stock finishes at 208. That’s a 20% fall from 260. So, to indicate that fall, the Sensex will be corrected from 130 to 104(20%fall).
As our second step to understand the index calculation, let us try to extend the same logic to two stocks – A and B. A is trading at 200 and let’s assume that the second stock ‘B’ is trading at 150. Since the Sensex follows the market capitalization weighted method, we have to find the market capitalization (or size of the company- in terms of price) of the two companies and proportionate weightage will have to be given in the calculation.
How do we compute size of the company- in terms of price?
- That’s simple. Just multiply the total number of shares of the company by the market price. This figure is technically called ‘market capitalization’.
Back to our example-
We assume that company A has 100,000 shares outstanding and B has 200,000 shares outstanding. Hence, the total market capitalization is (200 x 100000 + 150 x 200000) Rs 500 lakhs. This will be equivalent to 100 points.
Lets assume that tomorrow, the price of A hits 260 (30% increase in price) and the price of B hits 135. (10% drop in price). The market capitalization will have to be reworked. It would be – 260 x 100,000 + 135 x 200,000 = 530 lakhs. That means, due to the changes in price, the market capitalization has moved from 500 lakhs to 530 indicating a 6% increase. Hence, the index would move from 100 to 106 to indicate the net effect.
This logic is extended to many selected stocks and this calculation process is done every minute and that’s how the index moves!
CALCULATION OF SENSEX.
What we said was the general method to construct indices. Since, the Sensex consists of 30 large companies and since it’s shares may be held by the government or promoters etc, for the purpose of calculating market capitalization only the free float market value is considered, instead of the total number of shares.
What is free float?
- That’s the total number of shares available for the public to trade in the market. It excludes shares held by promoters, governments or trusts, FDIs etc..
- To find the free float market value, the total value of the company (total shares x market price) is further multiplied by a free float market value factor, which is nothing but the percentage of free float shares of a particular company.
- So logically, the company which has more public holding will have the highest free float factor in the Sensex. This equalizes everything.
- Example- let’s assume that the market value of a company is Rs 100,000 Crore and it has 100 Crore shares having a value of Rs 1,000 each but only 20% of it are available to the public for trade. The free float factor would be 20/100 or 0.20 and the free float market value would be .20 x 100,000 = 20,000 Crores.
- You need not calculate the free float market capitalization since its available straight on the BSE website – Click this link to get it.
NOW, LET’S SE HOW THE SENSEX MOVES.
- Sensex value = Current free-float market value of constituents stocks/Index Divisor
So, the numerator is available straight from the BSE site. It’s the total of free float factors of 30 stocks x market capitalization.
NOW, THE DENOMINATOR.
The index divisor nothing but the present level of index.
So, now, we have all the figures.
Lets assume that the free-float market capitalisation is Rs 10,00,000 Crore. At that point, the Sensex is at 12500. What would be the value of Sensex if the free-float market capitalization is Rs 11,50,000 Crore?
(Those who can’t find the answer may go back to the ratios and proportions chapter elsewhere in school text book)
……..The answer is 14,375.
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- Financial Discipline for all.
- Investing Basics
- Shares & Stock Markets
- Introduction to Financial Statements
- Financial ratios.
- Stock investing strategies
- Technical Analysis I
- Technical analysis II
- Before Picking up stocks..
- Choosing a Broker and opening Demat Accounts
- Make your debut !!
- More ... from stock markets.
- Valuation of shares
- Futures and Options - The basics.
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