1.1 Meaning of Trading Mechanism
The trading mechanism in the stock exchange is based on a transaction between a buyer, seller, and a trading specialist who actually executes transactions in a stock exchange. In general, the trading mechanism is similar to a simple auction, with investors biddng on a particular stock or security. If the bid is accepted by the owner of the security, the trading specialist executes the sale. Most major stock exchanges trade a collection of stocks, bonds, and other domestic and foreign investments.
The trading mechanism exists because of the constant need to channel money from investors into business entities. Investors range from wealthy individuals and investment funds to small-scale investors saving for retirement. Entities that raise money in the stock market include corporations, governments, and government agencies. The combination of investors and borrowers creates the market for securities. The trading mechanism refines the market by matching buyers and sellers with the prices they are willing to pay or take.
2. Trading Mechanism at National Stock Exchange
The trading on stock exchanges in India used to take place through open outcry without use of information technology for immediate matching or recording of trades. This was time consuming and inefficient. This imposed limits on trading volumes and efficiency. In order to provide efficiency, liquidity and transparency, NSE introduced a nation-wide on-line fully automated screen based trading system (SBTS) where a member can punch into the computer quantities of securities and the prices at which he likes to transact and the transaction is executed as soon as it finds a matching sale
or buy order from a counter party. The screen based trading system offers various advantages such as: • Removes time, cost and risk of error and thereby improves operational efficiency • Faster incorporation of price sensitive information • Improves the depth and liquidity of the market • Provides full anonymity by accepting orders, big or small, from members without revealing their identity • Offers perfect audit trail which helps to resolve disputes by logging in the trade execution process in entirety •
Later, NSE carried the trading platform further to the PCs at the residence of investors through the Internet and to handheld devices through Wireless Application Protocol (WAP) for convenience of mobile investors.
2.1 Trading Network- National Exchange for Trading (NEAT)
NSE has main computer which is connected through Very Small Aperture Terminal (VSAT) installed at its office. The main computer runs on a fault tolerant STRATUS mainframe computer at the Exchange. Brokers have terminals installed at their premises which are connected through VSATs/leased lines/modems. An investor informs a broker to place an order on his behalf. The broker enters the order through his PC, which runs under Windows NT and sends signal to the Satellite via VSAT/leased line/modem. The signal is directed to mainframe computer at NSE via VSAT at NSE’s office. A message relating to the order activity is broadcast to the respective member. The order confirmation message is immediately displayed on the PC of the broker. This order matches with the existing passive order(s) otherwise it waits for the active orders to enter the system. On order matching, a message is broadcast to the respective member.
2.2 Corporate Hierarchy
The trading member has the facility of defining a hierarchy amongst its users of the NEAT system. This hierarchy comprises:
Corporate Manager: The corporate manager is a term assigned to a user placed at the highest level in a trading firm. Such a user receives the end-of-day reports for all branches of the trading member.
Branch Manager: The branch manager receives end-of-day reports for all the dealers under that branch. He can set user order value limit for each of his branch.
Dealer: A dealer can view and perform order and trade related activities only for himself and do not have access to information on other dealers under either the same branch or other branches.
2.3 Market Phases
The trading system is normally made available for trading on all days except Saturdays, Sundays and other holidays. Holidays are declared by the Exchange from time to time. A trading day typically consists of a number of discrete stages as below:
(i) Opening: The trading member can carry out the following activities after login to the NEAT system and before the market opens for trading: (a) Set up Market Watch (the securities which the user would like to view on the screen)
(b) View Inquiry screens
At the point of time when the market is opening for trading, the trading member cannot login to the system. A message ‘Market status is changing. Cannot logon for sometime’ is displayed. If the member is already logged in, he cannot perform trading activities till market is opened.
(ii) Pre-open: The pre-open session is for duration of 15 minutes i.e. from 9:00 am to 9:15 am. The pre-open session is comprised of order collection period and order matching period. The order collection period of 8* minutes is provided for order entry, modification and cancellation. Order matching period starts immediately after completion of order collection period. Orders are matched at a single (equilibrium) price which will be open price. The order matching happens in the following sequence: • Eligible limit orders are matched with eligible limit orders • Residual eligible limit orders are matched with market orders • Market orders are matched with market orders
(iii) Normal Market Open Phase: The open period indicates the commencement of trading activity. To signify the start of trading, a message is sent to all the trader workstations. The market open time for different markets is notified by the Exchange to all the trading members. Order entry is allowed when all the securities have been opened. During this phase, orders are matched on a continuous basis.
(iv) Market Close: When the market closes, trading in all instruments for that market comes to an end. A message to this effect is sent to all trading members. No further orders are accepted, but the user is permitted to perform activities like inquiries and trade cancellation.
(v) Post-Close Market: This closing session is available only in Normal Market Segment. Its timings are from 3.50 PM to 4.00 PM. Only market price orders are allowed.
(vi) Surcon: Surveillance and Control (SURCON) is that period after market close during which, the users have inquiry access only. After the end of SURCON period, the system processes the data for making the system available for the next trading day.
2.4 Basket Trading
A process that allows NEAT users with a facility to create offline order entry file for a selected portfolio. All the orders generated through the offline order file are priced at the available market price.
Quantity of shares of a particular security in portfolio are calculated as under:
No. of Shares of a security in portfolio = Amount * Issued Capital for the Security
Current Portfolio Capitalization
Current Portfolio Capitalisation = Summation [Last Traded Price (Previous close if not traded) * No. of Issued shares]
2.5 Reverse Basket on Traded Quantity
The Reverse Basket Trading provides the users with an offline file for reversing the trades that have taken place for a basket order. This file will contain orders for different securities of the selected basket file. The Orders are created according to the volume of trade that has taken place for that basket.
2.6 Index Trading
A trading that allows users to buy and sell indexes in terms of securities that comprises the Index. The users have to specify the amount, and other inputs that are sent to the host, and the host generates the orders.
2.7 Buy Back Trades
The purpose of Buy Back Trade functionality is to give information to the market about the buy back trades executed from the start of the buy back period till current trading date in the securities whose buyback period is currently on.
3. Order Management
Order Management consists of entering orders, order modification, order cancellation and order matching.
The trading member can enter orders in the normal market and auction market. A user can place orders in any of the above mentioned markets by invoking the respective order entry screens. • Active & Passive Orders: When any order enters the trading system, it is an active order. It tries to find a match on the other side of the books. If it finds a match, a trade is generated. If it does not find a match, the order becomes a passive order and goes and sits in the order book.
3.1 Order Modification
All orders can be modified in the system till the time they do not get fully traded and only during market hours. Once an order is modified, the branch order value limit for the branch gets adjusted automatically.
3.2 Order Cancellation
Order cancellation functionality can be performed only for orders which have not been fully or partially traded (for the untraded part of partially traded orders only) and only during market hours and in pre-open period.
3.3 Order Matching
The best sell order is the order with the lowest price and a best buy order is the order with the highest price. The unmatched orders are queued in the system by the following priority:
(a) By Price: A buy order with a higher price gets a higher priority and similarly, a sell order with a lower price gets a higher priority. E.g. consider the following buy orders: 1) 100 shares @ Rs. 35 at time 10:30 a.m.
2) 500 shares @ Rs. 35.05 at time 10:43 a.m.
The second order price is greater than the first order price and therefore is the best buy order. (b) By Time: If there is more than one order at the same price, the order entered earlier gets a higher priority. E.g. consider the following sell orders: 1) 200 shares @ Rs. 72.75 at time 10:30 a.m.
2) 300 shares @ Rs. 72.75 at time 10:35 a.m.
Both orders have the same price but they were entered in the system at different time. The first order was entered before the second order and therefore is the best sell order.
4. Internet Broking
SEBI Committee approved the use of Internet as an Order Routing System (ORS) for communicating clients’ orders to the Exchanges through brokers. ORS enables investors to place orders with his broker and have control over the information and quotes and to hit the quote on an on-line basis. Once the broker’s system receives the order, it checks the authenticity of the client electronically and then routes the order to the appropriate Exchange for execution. On execution of the order, it is confirmed on real time basis. Investor receives reports on margin requirement, payments and delivery obligations through the system. His ledger and portfolio account get updated online.
NSE was the first stock exchange in India to launch internet trading in early February 2000. It provides web-based access to investors to trade directly on the Exchange. The orders originating from the PCs of the investors are routed through the Internet to the trading terminals of the designated brokers with whom they are connected and further to the Exchange for trade execution. Soon after these orders get matched and result into trades, the investors get confirmation about them on their PCs through the same internet route.
5. Wireless Application Protocol
SEBI has also approved trading through wireless medium on WAP Platform. NSE-IT launched the Wireless Application Protocol (WAP) in November 2000. This provides access to its order book through the hand held devices, which use WAP technology. This serves primarily retail investors who are mobile and want to trade from any place when the market prices for stocks at their choice are attractive. Only SEBI registered members who have been granted permission by the Exchange for providing internet based trading services can introduce the service after obtaining permission from the Exchange.
6. Trading Rules
6.1 Insider Trading
A practice wherein an insider deals in listed securities on account of possession of unpublished price sensitive information or communicate, counsel or procure directly or indirectly any unpublished price sensitive information to any person who while in possession of such unpublished price sensitive information should not deal in securities. Price sensitive information is any information, which if published, is likely to materially affect the price of the securities of a company.
Such information may relate to the financial results of the company, intended declaration of dividends, issue of securities or buy back of securities, amalgamation, mergers, takeovers, any major policy changes, etc. Insider trading is prohibited and considered as an offence under the SEBI (Prohibition of Insider Trading) Regulations, 1992. SEBI, on the basis of any complaint or otherwise, investigates/ inspects the allegation of insider trading. On the basis of the report of the investigation, SEBI may prosecute persons found prima facie guilty of insider trading in an appropriate court or pass such orders as it may deem fit. Based on inspection, an adjudicating officer appointed by SEBI can impose monetary penalty.
6.2 Unfair Trade Practices
The SEBI (Prohibition of Fraudulent and Unfair Trade Practices in relation to the Securities Market) Regulations, 2003 enable SEBI to investigate into cases of market manipulation and fraudulent and unfair trade practices. These regulations empower SEBI to investigate into violations committed by any person, including an investor, issuer or an intermediary associated with the securities market. The regulations define frauds as acts, expression, omission or concealment committed whether in a deceitful manner or not by a person or by any other person or agent while dealing in securities in order to induce another person with his connivance or his agent to deal in securities, whether or not there is any wrongful gain or avoidance of any loss.
6.3 Buy Back
Buy back is done by the company with the purpose to improve liquidity in its shares and enhance the shareholders’ wealth. Under the SEBI (Buy Back of Securities) Regulations, 1998, a company is permitted to buy back its shares or other specified securities by any of the following methods:- • From the existing security holders on a proportionate basis through the tender offer • From the open market through (i) book building process (ii) stock exchange • From odd-lot holders
The company has to disclose the pre and post-buy back holding of the promoters. To ensure completion of the buy back process speedily, the regulations have stipulated time limit for each step. For example in the cases of purchases through tender offer an offer for buy back should not remain open for more than 30 days. The company should complete the verifications of the offers received within 15 days of the closure of the offer and shares or other specified securities. The payment for accepted securities has to be made within 7 days of the completion of verification and bought back shares have to be extinguished and physically destroyed within 7 days of the date of the payment. Further, the company making an offer for buy back will have to open an escrow account on the same lines as provided in takeover regulations.
The restructuring of companies through takeover is governed by SEBI (Substantial Acquisition of shares and Takeover) Regulations, 1997. These regulations were formulated so that the process of acquisition and takeovers is carried out in a well-defined and orderly manner following the fairness and transparency.
The trading system, known as the National Exchange for Automated Trading (NEAT) system, is an anonymous order-driven system and operates on a strict price/time priority. The system allows to trade capital market, wholesale debt market and retail debt market. It is designed to offer investors across the length and breadth of the country a safe and easy way to invest. Additionally, the exchange has a wholly owned subsidiary, National Securities Clearing Corp. Ltd. that carries out clearing and settlement of the trades executed in the capital market segment of National Stock Exchange.
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