Monday, November 8, 2010

In India, trading in shares began in 1840s

When did share trading start in India? 

Trading in shares started in India with the arrival of the first incorporated companies back in the 1840s. Shares at that time were sold at princely prices (Rs 500-2,000) and were typically held either by Englishmen or extremely wealthy Indians. Trades were facilitated by unregistered brokers who were also proficient speculators. 

Lack of regulation and headless speculation resulted in India's first stock market boom, which started in 1861 when civil war broke out in the US and crash in 1865 after the surrender of General Lee. The boom was created because of the cut off in cotton supplies to Lancashire mills, making India the only ray of hope for the British cotton industry. The crash, however, made people understand the need for a share trading institution rather than depending on individual brokers and the Bombay Stock Exchange was established in 1875. 

Although the exchange has been operational for more than a hundred years, until 1986 there was no method to measure whether the average prices of shares are going up or coming down and by how much. The BSE-sensex or sensitive share index was born in 1986. 

How is the sensex calculated? 

The changes in value of the index basically reflect movement in the market value of the companies that are represented in it. This is measured by their market capitalization, which is simply the price of each share multiplied by the total number of shares in the company. If the sensex doubles over a period of time, that essentially means the market capitalization has doubled. 

Does it include the market cap of all companies listed in the BSE? 

No. Only 30 scrips are selected based on certain criteria - the list should be a balanced representation of the listed companies in BSE, the company should have an acceptable track record, it should have a listing history of at least three months at BSE, the scrip should have been traded on each and every trading day in the last three months and so on. Typically, the sensex includes the 30 largest and most actively traded stocks listed in the BSE. 

Non-performing scrips get replaced by active ones. 

Does every share of a listed company get traded in the market? 

Not necessarily because most have a dominant shareholder which can be the government or some promoting group and hence a particular fraction of its shares are rarely traded in the market. Taking this into account, the sensex which was initially based on the full market capitalization of its 30 scrips, shifted to a free float market capitalization based index in September 2003, in line with the practice in most developed markets. Now a company with large market capitalization but few publicly traded shares can not influence the index movement much. 

To calculate the free float market cap, the full market cap of each scrip is multiplied by the free-float adjustment factor. This factor varies from 0 to 1 for each scrip. If it is 1 that means about 95 to 100% of the shares of that particular company are publicly tradable. On the other hand if the factor is 0.35, it means that only 30-35% of that company's shares are available for public trading.