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Beginners Guide to Trading in India

May 14, 2018

Imagine Mohan is running a toy manufacturing company. The total revenue of his company is ₹ 20 lakh. He wants to expand his business since they are getting more orders from his customers Now, you may say that he can approach a leading bank in that case. But bank generally issues loans as per the valuation of his assets, which may not meet his requirement of raising ₹ 40 lakhs. So, he decides to go through the IPO process. After taking necessary approvals from the authority, he launches IPO of his company. Now, he decides to issue 4 lakh shares with face value of ₹ 10 and in this way he raised ₹ 40 lakhs, hence he was able to expand his business and meet the increasing demands of his customers and also earn more profits.

But how can you earn money from this system? Say, you have bought 1000 shares of ₹ 10 each, in this way you have invested ₹ 10,000. Now, for example, when the company makes profit, its market value becomes ₹ 11. Your profit becomes ₹ (11-10) *1000 = ₹ 1000!

Now let us study the ABCs of stock market!

Financial Market in India

Financial market is dived into two types – money market and capital market.

Money Market

Money market in India is regulated by RBI (Reserve Bank of India). Banks and other financial institutions meet their short term requirement by trading in this market. In this case, short term refers to less than one year. Trading is done by issuing Certificate of Deposit, Commercial Paper and Repurchase Agreements. Return is lesser than investment in capital market and the risk involved is also less.

Capital Market

Capital Market in India is regulated by SEBI (Securities and Exchange Board of India). Government and various companies fulfill their long term capital requirement by trading in this market. In this case, long term refers to more than one year. Trading is done by issuing bonds and shares. While the returns are higher than the money market, risks are also higher. It is further divided into primary market and secondary market.

Primary Market

The primary market plays a significant role in the securities market by forming a link between the savings and investments. It is through primary market that the borrower’s viz., the Government and the corporates issue securities in which the investors deploy their savings. The primary market comprises the public issues and the private placement market. A public issue consists of a company entering the market to raise funds from all types of investors; its debut is known as the initial public offer (IPO). While in case of private placement, there are only a few select subscribers to the issue. The securities can be issued at a face value, or at a discount or premium. They can take a variety of forms like equity, debt or some hybrid instrument. Apart from raising funds in domestic markets, resources are mobilized in international markets through the issuance of American Depository Receipts (ADRs)/Global Depository Receipts (GDRs) and External Commercial Borrowing (ECB) route.

Secondary Market

In this market, trading of securities is done. Secondary market consists of both equity as well as debt markets.

Securities issued by a company for the first time are offered to the public in the primary market. Once the IPO is completed and the stock is listed, they are traded in the secondary market. The main difference between them is that in the primary market, an investor gets securities directly from the company through IPOs, while in the secondary market, one purchase securities from other investors willing to sell the same.

Equity shares, preference shares, bonds, treasury bills, debentures, etc. are some of the key products available in a secondary market.   

IPO

An initial public offering (IPO) is the first time that the stock of a private company is offered to the public. It is underwritten by one or more investment banks, who also arrange for the shares to be listed on one or more stock exchanges. A privately held company is transformed into a public company through IPOs. An IPO allows a company to increase the number of potential investors to provide itself with capital for future growth, repayment of debt, or working capital.

Brokers

Brokers help you to trade in the market. As per the regulations of SEBI, physical holding of shares is not allowed. So, you need to have a demat account. Demat account is now provided by several leading banks and other institutions like zerodha, indiabulls etc. Discount brokerage is gaining the momentum now.

Trading hours

Equity and Derivatives Trading:

The duration of Pre-opening session is between 9:00 AM to 9:15 AM. This is further divided in three sub-sessions.

However, most people do not use the pre-opening session and only use the normal session for trading. That’s why there is still huge volatility even in the normal session after the pre-opening session.

Stock Exchanges in India

There are three prominent stock exchanges in India. They are:

National Stock Exchange (NSE)

Bombay Stock Exchange (BSE)

Multi Commodity Exchange (MCX)

SEBI

Imagine a banking system without the presence of regulatory body (like RBI). Would you deposit money in banks? Definitely no! Rather you would like to keep the money in your house. RBI has eliminated this uncertainty and takes care of your hard earned money by acting as a watchdog for banks. Similarly, in securities market, SEBI acts as a watchdog for the market, frames rules and regulations. Moreover, it also promotes the stock trading industry.

Taxations

If you have made capital gains on any financial transactions e.g. on shares, property, you may have to pay tax on these gains. Long-term capital gains (LTCG) and short-term capital gains (STCG) are taxed at different rates as per the income tax laws. Further, there are specified cases where these gains are taxed at special rates.

Capital gains tax (CGT) is charged on the gains in the financial year in which the capital asset is transferred, but the tax is only payable in the financial year in which the money from transfer/sale proceeds are actually received by the assesse.

LTCG: It is taxed at 20% (plus education cess @ 3% for FY 2017-18/AY 2018-19 and 4% for FY2018-19/AY 2019-20). You cannot avail any deductions under Chapter VI-A (such as deductions under Section 80C, 80D, etc.) from these gains. If you have invested or contributed any amount in tax-saving instruments, then you must claim that amount from your gross income excluding LTCG. Further, in case your taxable income after availing all the deductions is less than the maximum exempt limit as per slab rates for individuals (which is ₹ 2,50,000 for AY 2018-19), then the difference between ₹ 2,50,000 and your taxable income (excluding these gains) will be allowed as deduction and you will be charged tax @ 20% of the remaining amount.   

STCG: Similarly, STCG from the sale of equity shares or equity oriented mutual funds on which STT is charged on sale transaction are taxed at 15% (plus education cess) instead of your normal slab rates. So if you are an individual who comes in the 10% tax bracket, then you would have to pay more on these gains, but if you fall in the 20% or 30% tax bracket, then this special rate of 15% is beneficial for you.

Here also, cess has been increased from 3% (for FY 2017-18) to 4% (for FY 2018-19). 

Also, you cannot avail any deductions under Chapter VI-A (like deduction under Section 80C, 80D, etc.) from these gains. Further, the relaxation of reducing your capital gains amount in case your total taxable income is less than the minimum exemption limit of ₹ 2,50,000 is also available in this in the same manner as explained above (in case of general rates - LTCG).

Here one must remember that, NRIs do not have the option to adjust their capital gains either long-term or short term against the basic exemption limit of ₹ 2.5 lakh.  

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