Historically, India's speculative facets have often been missed despite the fact that they are extremely fascinating. The spread of computing and internet has facilitated and made speculation a preferred mode for small town speculators. Small towns, often without a bank branch, have trading terminal in which small time speculators try to gamble their way to riches, often with the opposite effect.
A recent advertisement issued by the Government, ostensibly to increase 'investor awareness' is very interesting. The advertisement in The Times of India (Hyderabad Edition, 18 December 2011, p.7), suggests that the government is intent on grappling with some of these important issues that plague stock and commodity trading in India – at least publicly. Luckily, policy makers do not seem to be intent on making the same mistake as Manmohan Singh, who disastrously statement in Parliament after the Harshad Mehta Scam, that he cannot lose sleep over such problems.
A recent advertisement issued by the Government, ostensibly to increase 'investor awareness' is very interesting. The advertisement in The Times of India (Hyderabad Edition, 18 December 2011, p.7), suggests that the government is intent on grappling with some of these important issues that plague stock and commodity trading in India – at least publicly. Luckily, policy makers do not seem to be intent on making the same mistake as Manmohan Singh, who disastrously statement in Parliament after the Harshad Mehta Scam, that he cannot lose sleep over such problems.
It is interesting to note that trading on the exchanges is reflective of the tendency on the part of participants to operate in the gray areas of the law or to indulge in outright illegal activities. The social acceptability of this illegality is itself an interesting phenomenon that is reflective of a broader malaise in the business environment. India is replete with business models that seem to be blissfully unaware of various provisions of the law. The complexities of the socio-economic environment make it relatively easy for such business models to flourish, especially in the backwaters beyond the major urban centres.
The advertisement itself raises very interesting issues as a form of tutorial for investors. A brief analysis of the issues raised by the advertisement is imperative as they reveal the nature of speculation in the different parts of India. A number of insights from interactions with market participants in Andhra Pradesh are fascinating and point to actual working that is opposite of what the government hopes and intends. That, the Union Government has decided to issue this advertisement is indicative that the issues raised are essentially prevalent in different parts of the country, albeit in different degrees.
1. Illegality of Trading outside the official exchange platform:
The ironic, though an unintended consequence of India’s liberalisation has been that it has led to the proliferation of illegal trading and business practices, including the existence of illegal stock exchanges. Illegal stock exchanges are not some shady underground centres of speculation that took place in the dark alleys of small town. On the contrary these illegal exchanges numbered nearly 22 in different towns of India and were often centres of speculation and the trading members were considered to be part of the social elite (). While technological growth has obviated the need for illegal stock exchanges, stringent regulatory norms, especially the KYC norms, are a sufficient justification for a number of people to work outside the regulatory ambit. The fact that unaccounted wealth needs to be hidden from the taxman increases this need.
A sane practice is that individuals or companies open accounts after submitting the necessary documentation to the broker or their sub-brokers, etc. A simpler way that speculators in the commodity markets prefer is to pool in their margin money with a broker in the form of cash and the broker opens an account in the name of a third party. The account holder may not even know that an account exists in his/her name and instead simply ‘lends’ his/her name: a classic old fashioned benami account! The broker serves as a literal intermediary and provides a business ‘opportunity’ to people who in normal circumstances may not even know each other. The broker trades in that account and speculators replenish the account with the required margin money. That solves the problems, at least for a short-span of time. The broker generates scarce trading volumes and hence revenues. A problem usually arises when the speculators start losing money, especially by trading on the advice of the broker.
2. Verifying broker credentials:
A well intended advice but, one that is rarely followed in India. Traders are keen on negotiating trading commissions rather than service and related issues – a classic case of penny-wise, pound foolish. The commissions charged are often a fraction of the profits/losses that occur. Since commodity trading is restricted to futures contracts, it means outsized, often leveraged bets. Small time speculators, who often trade blind and base their actions on the duration of the red/blue colours on the screen, will invariably tend to lose most of their capital. The more money they lose, the more they are convinced that larger bets and lower commissions would help forcing them to leverage ever greater sums until they finally go bankrupt.
3. Promises of Assured Returns:
The advertisement seems naive when it underscores the need for own research before investment decisions. In AP there are few long-term investors: there are mostly very short-term speculators and short-term speculators. Long-term is often a week. Making a quick buck is the primary objective of the entrepreneurial populace. What else who explain the ability pyramid schemes peddled as high return savings products? The long period of buoyancy has meant that those with excess capital believe that the era of perpetual buoyancy and high returns has just dawned.
A rather simplistic notion is that money is invested not only because people have an unnatural expectation of the returns possible, but also because they think that anybody can deliver 24% annualised returns. Interestingly, 24% returns per annum are often considered the justified rate of return – for a lender, the concept of dharmavaddi. Even a casual enquiry about expectations of returns among those people with investible cash quickly, draws attention to these high expectations. A frequently asked question for portfolio advisors is how much assured returns are they willing to ‘guarantee’. A visit to small town brokers suggests that they often ‘guarantee’ 24% or more. Interestingly, some of these assurances are based on written agreements. How the person with investible surplus hopes to enforce these agreements seems to be unknown even to those who invest the money. Brokers happily speculate on behalf of these clients and end up losing money – often through benami accounts. Once the investor loses money, there is little they can do as most this is undeclared money. This largely explains small towns in the coastal regions of Andhra Pradesh generating hundreds of crores of commodity volumes on a daily basis. The spread of broadband internet connectivity has only helped.
4. Keeping Verified records of all market transactions
That is clearly well intended but clearly a dangerous advice for speculators, especially those who deploy unaccounted money and trade on lending provided by a trading terminal operator. This leads to a peculiar feature of present day speculation: traders do not speculate with even a pie of their own money. Little wonder that we have the stampeding hordes.
5. I always pay by cheque from the designated account
This is probably one of the few rules that the regulators have been able to enforce, though there may be issues related to the exact entity or person who operates the account on a practical basis.
6. I trade within my investment and risk taking capacity
This is a rarity in India. There is a tendency among participants to leverage their futures trading bets. It is imperative to note that futures trading are inherently leveraged in nature. An example best illustrates the nature of trading. A speculator with about Rupees One Hundred Thousand in trading capital has the potential to purchase Rupees One Million worth of contracts in various commodity contracts. But, since mark-to-market requirement necessitates additional cash to be posted in case of price declines, trader is safe (provided they take the right directional call) only if their margin of safety is at about 30%. It is common for participants in India to purchase contracts to the maximum possible extent permissible: in the case of the above cited hypothetical participant, they would be eligible buy Rs.8 lakhs if not the full Rs.10 lakhs value of the contract. Hence, a 3-4% change in price is likely to trigger either sales or the need to post fresh collateral, forcing them to cough up money or liquidate their positions. The probability of a 3-4% move in the lifetime of a futures contract in the commodity market: Nearly 100%. A dominant trading strategy is to trade on ‘tips’ (rumours).
Thus, the probabilities are always stacked against India’s small town speculators. One must confess that Ignorance is, after all, bliss.
The advertisement itself raises very interesting issues as a form of tutorial for investors. A brief analysis of the issues raised by the advertisement is imperative as they reveal the nature of speculation in the different parts of India. A number of insights from interactions with market participants in Andhra Pradesh are fascinating and point to actual working that is opposite of what the government hopes and intends. That, the Union Government has decided to issue this advertisement is indicative that the issues raised are essentially prevalent in different parts of the country, albeit in different degrees.
1. Illegality of Trading outside the official exchange platform:
The ironic, though an unintended consequence of India’s liberalisation has been that it has led to the proliferation of illegal trading and business practices, including the existence of illegal stock exchanges. Illegal stock exchanges are not some shady underground centres of speculation that took place in the dark alleys of small town. On the contrary these illegal exchanges numbered nearly 22 in different towns of India and were often centres of speculation and the trading members were considered to be part of the social elite (). While technological growth has obviated the need for illegal stock exchanges, stringent regulatory norms, especially the KYC norms, are a sufficient justification for a number of people to work outside the regulatory ambit. The fact that unaccounted wealth needs to be hidden from the taxman increases this need.
A sane practice is that individuals or companies open accounts after submitting the necessary documentation to the broker or their sub-brokers, etc. A simpler way that speculators in the commodity markets prefer is to pool in their margin money with a broker in the form of cash and the broker opens an account in the name of a third party. The account holder may not even know that an account exists in his/her name and instead simply ‘lends’ his/her name: a classic old fashioned benami account! The broker serves as a literal intermediary and provides a business ‘opportunity’ to people who in normal circumstances may not even know each other. The broker trades in that account and speculators replenish the account with the required margin money. That solves the problems, at least for a short-span of time. The broker generates scarce trading volumes and hence revenues. A problem usually arises when the speculators start losing money, especially by trading on the advice of the broker.
2. Verifying broker credentials:
A well intended advice but, one that is rarely followed in India. Traders are keen on negotiating trading commissions rather than service and related issues – a classic case of penny-wise, pound foolish. The commissions charged are often a fraction of the profits/losses that occur. Since commodity trading is restricted to futures contracts, it means outsized, often leveraged bets. Small time speculators, who often trade blind and base their actions on the duration of the red/blue colours on the screen, will invariably tend to lose most of their capital. The more money they lose, the more they are convinced that larger bets and lower commissions would help forcing them to leverage ever greater sums until they finally go bankrupt.
3. Promises of Assured Returns:
The advertisement seems naive when it underscores the need for own research before investment decisions. In AP there are few long-term investors: there are mostly very short-term speculators and short-term speculators. Long-term is often a week. Making a quick buck is the primary objective of the entrepreneurial populace. What else who explain the ability pyramid schemes peddled as high return savings products? The long period of buoyancy has meant that those with excess capital believe that the era of perpetual buoyancy and high returns has just dawned.
A rather simplistic notion is that money is invested not only because people have an unnatural expectation of the returns possible, but also because they think that anybody can deliver 24% annualised returns. Interestingly, 24% returns per annum are often considered the justified rate of return – for a lender, the concept of dharmavaddi. Even a casual enquiry about expectations of returns among those people with investible cash quickly, draws attention to these high expectations. A frequently asked question for portfolio advisors is how much assured returns are they willing to ‘guarantee’. A visit to small town brokers suggests that they often ‘guarantee’ 24% or more. Interestingly, some of these assurances are based on written agreements. How the person with investible surplus hopes to enforce these agreements seems to be unknown even to those who invest the money. Brokers happily speculate on behalf of these clients and end up losing money – often through benami accounts. Once the investor loses money, there is little they can do as most this is undeclared money. This largely explains small towns in the coastal regions of Andhra Pradesh generating hundreds of crores of commodity volumes on a daily basis. The spread of broadband internet connectivity has only helped.
4. Keeping Verified records of all market transactions
That is clearly well intended but clearly a dangerous advice for speculators, especially those who deploy unaccounted money and trade on lending provided by a trading terminal operator. This leads to a peculiar feature of present day speculation: traders do not speculate with even a pie of their own money. Little wonder that we have the stampeding hordes.
5. I always pay by cheque from the designated account
This is probably one of the few rules that the regulators have been able to enforce, though there may be issues related to the exact entity or person who operates the account on a practical basis.
6. I trade within my investment and risk taking capacity
This is a rarity in India. There is a tendency among participants to leverage their futures trading bets. It is imperative to note that futures trading are inherently leveraged in nature. An example best illustrates the nature of trading. A speculator with about Rupees One Hundred Thousand in trading capital has the potential to purchase Rupees One Million worth of contracts in various commodity contracts. But, since mark-to-market requirement necessitates additional cash to be posted in case of price declines, trader is safe (provided they take the right directional call) only if their margin of safety is at about 30%. It is common for participants in India to purchase contracts to the maximum possible extent permissible: in the case of the above cited hypothetical participant, they would be eligible buy Rs.8 lakhs if not the full Rs.10 lakhs value of the contract. Hence, a 3-4% change in price is likely to trigger either sales or the need to post fresh collateral, forcing them to cough up money or liquidate their positions. The probability of a 3-4% move in the lifetime of a futures contract in the commodity market: Nearly 100%. A dominant trading strategy is to trade on ‘tips’ (rumours).
Thus, the probabilities are always stacked against India’s small town speculators. One must confess that Ignorance is, after all, bliss.
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