Understanding India VIX for your Trading Strategy

Understanding India VIX for your Trading Strategy

The Volatility Index (VIX) has been part off stock market analysis for the last decade. You must have noticed that the Nifty goes up when the VIX is low (below 15) and it tends to go down sharply when the Nifty is above 22. While there is no sanctity to these numbers, the VIX broadly represents the fear in the market and that is why it is also called the Fear Index. When expected volatility is high, the fear factor is high and equity markets react negatively to fear. That explains why you see Nifty and VIX moving in opposite directions.

How exactly is the VIX calculated?

To understand the VIX calculation, you need to briefly go back to the Black & Scholes Model for options pricing. In the model, you input factors like spot price, strike price, volatility, time to expiry and interest rates to arrive at the option value. In VIX calculation you work backward. You assume that the option market price is the correct value and instead you calculate the volatility as the unknown. This is the implied volatility and it is used to calculate the VIX. But that raises another question; which Nifty option strikes to use?

VIX Calculation involves both the current month and next month Out of the Money (OTM) options. In the Money (ITM) and At the Money (ATM) options are excluded from VIX calculation. These bid and ask prices of OTM options are considered for calls and puts. The output you get is the VIX. So, what exactly does the VIX represent?

VIX is about expected volatility and not about actual volatility

Before we get to the interpretation of VIX in the Indian context, remember that VIX is about future volatility expected in the market. The VIX assumes that the price of OTM options fairly reflect the market volatility. If VIX index is currently at 15.3 it can be interpreted as a probable annual variation of 15.3% in the next 30 days. But that is the annualized variation and the monthly variation will be the twelfth root which is roughly 1.19%. So if the Nifty is currently at 11,000, its expected range is 131 points either ways. That means; Nifty could be in the range of 10,869 to 11,131 in the next 1 month assuming volatility does not change. The Sensex may also react and swing and accordingly.

How to interpret the rise and fall in VIX

VIX is an estimate of volatility for the next one month expressed in annualized terms. VIX is also called the Fear Index because it shows the quantum of fear that exists in the market at that point of time. Higher VIX means higher fear, which raises the expectation of future volatility. Let us also see how the VIX interacts with the Nifty?

Over the last 10 years since the inception of VIX, the VIX has gone down and the Nifty has almost doubled. But that is not really important. What matters is how Nifty and the VIX interface during times of sharp spikes and sharp falls in volatility. You will find that any sharp spike in volatility tends to coincide with a fall in the Nifty and vice versa. So how can investors leverage on the VIX?

How traders and investors and traders can use the India VIX data?

Since the VIX is a barometer of expected volatility, it can be used by investors and traders alike. Here are some key takeaways.

  • Long term investors can tweak their sector exposure and hedges based on shifts in VIX. For example, if VIX is moving up sharply, then investors can shift to defensive sectors or increase their hedge ratio.

  • VIX adds a lot of value for traders. It is possible to trade VIX futures on the NSE. For example, if you expect volatility in the market to go up, then the VIX would go up. In such a case you can buy VIX futures. Here the trader is only taking a view on volatility; not the market direction. These types of trades are very useful in times of key events or key announcements and policies.

  • If you look at the long term chart of the VIX, it has been normally ranging between 13 and 17. It has gone as low as 9.5 and as high as 60, but these are exceptions. You can use the median range chart of VIX to trade on mean reversion.

  • Lastly, VIX gives you the short term range to trade. The Nifty spot range is defined by the VIX and one can go long or short at the appropriate levels.

VIX is a smart way to interpret the markets and trade on volatility. It provides a non-directional approach to markets. 

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5 Factors to Look at While Selecting a Stockbroker

5 Factors to Look at While Selecting a Stockbroker
01/10/2019

Today, there is an abundance of stockbrokers offering their premium services to individuals wanting to accumulate wealth through the financial markets. As such, it is vital to choose a good stockbroker who understands the investor’s financial goals and guides him/her towards substantial returns.

Investors of today have two choices when it comes to stockbrokers: the traditional stockbroker and the discount brokerages. Traditional brokers charge a certain percentage as a fee, which differs with the type and size of the transaction. These brokers also send out trading tips and research bytes to the clients.

Discount brokerages, on the other hand, offer the standard services but at a fixed (flat) cost, i.e. regardless of the type and size of the transaction. They, however, do not offer any trading expertise, i.e. they do not give out trading or stock tips nor do they provide any insights into a trade. As such, they are suitable for those who prefer to self-educate themselves and take independent decisions.

Considering these, an investor has to carefully think about his/her requirements as well as exercise caution when choosing a stockbroker.

Here are five factors that would help a new investor in selecting a stockbroker who understands the financial goals of the investor.

  1. Credibility

    It is vital to perform a thorough background check on the stockbroker before entrusting them with your life savings. Finding out how many years the stockbroker has been in business, how it has performed in the past, what do the clients say about the firm, and any other relevant questions. This will help the individual to know more about the broker.

  2. Minimum Balance

    Investors need to maintain a minimum balance in their stockbroking account, and hence, it is vital to inquire about the same. This amount varies from broker to broker, hence, investors should choose a broker who not only provides the best services, but also has a low minimum amount threshold so that it does not tax their monthly budget. Other than the minimum amount, there should also be ease of access when it comes to depositing and withdrawing funds. Typically, brokerage houses have tie-ups with local banks which lets investors access their funds at any time. Withdrawals normally take three days to reach the client’s account.

  3. Technological Expertise

    Brokers who constantly update their platforms with the latest technology are able to give a unique advantage to the investor. There are also able to match the evolving needs of the investors and educate them on new features and solutions. Choosing a broker who consistently provides a stable and steady platform to their clients is a must.

  4. Availability

    A broker should be available during stock market hours to execute orders without any lag or delay or to address any issues that may arise on their electronic platforms. An investor should also check the speed and the stability of the website/mobile applications, especially during peak hours, to ensure that the pages load quickly and easily as even a split second can lead to the investor losing out on a profitable trade.

  5. Transparency and Capability

Transparency and capability are also important parameters when looking for the perfect stockbroker. There are many ways in which brokers charge their clients. Hence, the client has to ensure that all charges involved are mentioned in a lucid and transparent manner while opening an account. This will help you avoid any hidden costs that brokers might impose later. Apart from this, a broker should also have strong business policies that maintain the quality of the business.

When it comes to the capability of the brokers, investors should make sure that the stockbroker and his team have a strong background and passion for trading in order to have a hassle-free experience. When the team is able, it largely influences the business practices and delivers a profitable outcome to its investors.

Choosing the right stockbroker is vital to trading as the investor is entrusting their life savings into the former’s care. If a stockbroker or his brokerage satisfies the above-mentioned criteria as well as provides real-time customer support, add-on financial services and, as a bonus, is interested in enhancing the client’s knowledge of the markets, then engaging with them is a wise decision.

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How to Buy Stocks Online: A Step-By-Step Guide?

How to Buy Stocks Online: A Step-By-Step Guide?
by 5paisa Research Team 04/10/2019

Online trading has picked up in a big way in the Indian markets. To buy stocks online, the following steps are essential to understand how to go about the process.

1. Choose your online broker carefully

The first step to buy stocks online is to select your online broker. You have a choice of discount brokers and full service brokers and you can select one based on whether you want pure execution or are you looking for research and stock tips as well. Also check the follow-up services provided by the broker and the back-up order placing facility like call-n-trade, before making your choice.

2. Opening your trading and demat account

If you want to trade in equities, trading account and Demat account is a must. While online trading account is for executing transactions, the demat account is for holding shares when you take delivery. The process of account opening is quite simple and you need to provide basic documentation like proof of identity, address proof, cancelled cheque and PAN card. Once your account is activated and you reset your password you are ready to trade online.

Know: Difference between Demat Account and Trading Account

3. Next step is to fund your account

Whether you want to buy stocks online for short term or long term delivery or intraday; you need to fund your trading account. You can either fund the account through NEFT or IMPS or UPI. The online broker will permit you to place orders only after your account is adequately funded.

3. Screen stocks you want to buy before placing the order

One advantage of online stock buying is that you can read research reports, screen stocks on parameters like profitability, ROCE, ROE, among others and execute orders seamlessly. Many brokers also offer you the “call to action” facility. You can read the report or stock tips and directly execute the order from that place with a few clicks.

4. Select the price and select the right type of order

Once you are ready to place the order, you can take the help of online technical charts to identify the best level to enter the stock and also put stop losses accordingly. Try to get the best price possible. Take care of how you place the order. For example, if the market is volatile, try to place a limit order so that you can get the price of your choice or better. Alternatively, if you are buying in a falling market, use a market order to get the best possible price.

5. Once the order is placed, do the follow up work

Once the order is placed, your job does not end. Check with the order book if the order is reflecting properly. To check the status of execution, you must refer to the trade book. Only executed orders are shown in the trade book whereas the open orders are shown in the order book. Before the order is executed, if you are unhappy with the price, you can always cancel the order or even modify the order price and quantity. The discretion is entirely yours. Once the trade is completed, cross check with the contract notes in the evening and also do a weekly reconciliation with the demat account and the ledger account.

6. Finally, take care of security of your online trades

There are quite a few critical things to take care here. Firstly, ensure that your password is safe and as complicated as possible. Avoid writing down your password anywhere. Secondly, use dual authentication for your trading account and make it a point to log out of your trading account when not in use. Thirdly, you cannot let your hardware be compromised. Avoid downloading software and games from unknown sources. Update the anti-virus and anti malware regularly. Lastly, avoid using your online trading account at cyber café or via public wi-fi. They are not secured and can endanger your personal data and wealth.

These basic steps to buy stock online can go a long way in enhancing and enriching your online trading experience.

Check the latest guide on: How to invest in stock market for beginners

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How to Invest in Mutual Funds in Indian Markets?

How to Invest in Mutual Funds in Indian Markets?
07/10/2019

When you get down to investing in mutual funds, there is a problem of plenty. With more than 40 AMCs, over 2000 schemes and with each scheme having a growth or dividend option along with a Regular Plan and a Direct Plan, you can imagine how complex it gets. Your screeners on the website can help you up to a point but you still need to narrow down to the scheme that best suits your needs. That is where this process will come in handy. Before you make your choice of fund, go through the following process.

Narrow down to funds based on AUM

A small fund with a corpus of Rs.100 crore may be the best performer but the fund business may be hard to sustain for them. Such funds are best avoided if you have a long term perspective. You must ideally stick to larger funds that have been around for over 15-20 years in the business. Such funds and fund managers have gone through cycles in business. Also, a higher AUM reduces your expense ratio as it gets spread over a large corpus.

In equity funds, prefer diversified funds over thematic funds

The whole idea of investing in mutual funds is to get the benefit of diversification. Don’t let go of this benefit by selecting thematic funds. The last thing you want is the fund manager to introduce concentration risk into your portfolio. This rule applies to equity funds and to debt funds also. While equity funds must diversify across sectors, business models and quality; debt funds must diversify across quality, tenor, duration etc.

Select funds that are consistent as they are more predictable

Two funds may have given the same CAGR returns over 5 years but you must look at the consistency. A fund that has given annual returns around the CAGR is better than the fund that has given super returns in 2 years and negative returns in 2 years. When you buy an inconsistent fund, timing becomes too critical. If you get in one of their super years, you may be disappointed at the end of 5 years. That is why consistent funds are a lot more predictable and reliable.

Is it the fund manager skill that is rewarding you?

An equity fund manager has to be better than an index fund manager. At the same time you cannot have a fund manager with the risk appetite of a seafarer. But how do you verifiably measure this? A simple method is the out performance of the fund returns over benchmark index. But that tells you only one side of the story. If the fund manager has outperformed by taking on too much risk then the fund manager is not working hard enough. Sharpe ratio and Treynor ratio can calculate risk-adjusted returns. You can also use the Fama coefficient to measure whether the fund manager is generating returns out of his stock selection skill or through pure luck.

Check our SIP calculator and Lumpsum calculator before planning your mutual fund investment

Cost efficiency is the next thing to look at

Expense ratios on equity funds range from 2.50% to 2.75%. If you can save on these costs it can make a substantial difference to your returns in the long run. When you calculate the cost of the fund, include all relevant costs and that includes the TER as well as the exit load. Some funds may charge a lower TER but have a higher exit load. Such funds can become very expensive when you exit before the 1 year period.

Mutual fund must fit into your financial plan

In fact, your activity must begin with a financial plan and these mutual fund investments must fit into the plan. The question you need to ask yourself is, “Is this fund good enough for me”? Look at every fund from the perspective of your own goals; your return requirements, your risk capacity, tax status and liquidity needs. It is only when you apply this litmus test that the effort of navigating through a plethora of mutual funds actually becomes meaningful for you.

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Do’s and Don’ts of Stock Market Investing for Beginners

Do's and Don'ts for beginners

With a trading account and demat account you are ready to trade. But if you are a beginner in the stock markets, then that is not all. You also need to keep a tab on some major do’s and don’ts before you venture into investing in the stock markets. Let us look at 10 such key dos and don’ts for investors.

10 important do’s and don’ts for investment beginners

Do’s are about doing the right things in the market when you are starting off on your investing journey while the don’ts are the ones to avoid. Here are ten such important dos and don’ts for investing beginners.

  1. Do your research before investing? Remember, research of a stock is not a rocket science and it is all about getting your research process right. Get comfortable reading the balance sheets and income statements of a company. Also read the Management Discussion and Analysis (MDA) of the stock you are planning to invest in.

  2. Start with your goals in mind. You must be clear about how much risk you are willing to take and how much risk you can afford to take. Your equity portfolio should be within the limits defined by your allocation. Always start with a plan.

  3. Don’t put all your eggs in one basket. That is age old wisdom and applies to investing as well. In technical parlance it is called diversification where you effectively spread your equity investments across sectors and themes so that your investment performance is not dependent on any one stock or sector.

  4. Take a long term view and cultivate that habit in the very beginning. It is futile to time the market. Not only that it is hard to consistently get the tops and bottoms of the market right but it hardly makes any difference to your eventual returns.

  5. Try to invest consistently and regularly instead of putting a large corpus in a stock of your choice. The advantage of being regular is that it instils discipline in your investment and also gives the added benefit of rupee cost averaging. That means; over time your average cost of investing comes down.

  6. Even through equity is about the long term, try to get bargains. Even if you are convinced about the long term prospects of Infosys, it makes a lot of business sense to buy at Rs.650 than at Rs.750. Quite often, a market correction creates salivating bargains. Use such corrections to add quality stocks at low prices.

  7. Divide your equity portfolio between core holdings and satellite holdings. Your core holdings are your long term investment portfolio and you don’t sell these stocks at every correction. On the other hand, the satellite portfolios are more of a trading portfolio where you look out for short to medium term opportunities in the market. Have a separate approach to both these types of stocks.

  8. Don’t ignore trading costs. Even if you are a long term investor, take at a close look at your costs. Your cost is not just about brokerage costs but there are a number of other costs too. There are statutory costs, exchange charges, demat AMC, DIS charges, demat and remat charges etc. All these need to be added to calculate your effective cost. Nowadays, it makes a lot of sense to opt for low-cost discount brokers who can give the same execution at a much lower cost.

  9. As a beginner, remember that quality always wins in the end. When we talk about quality we are talking about quality at a number of levels. Look at quality of earnings; more of the earnings must be coming from the core business. Look at profitability; the company must be earning more margins than the peer group. Take stock of asset turnover; it tells you how efficiently the business is using assets. At a qualitative level, prefer companies that have high standard of disclosure and transparency. Large caps or mid caps, this quality approach always works in your favour.

  10. Make effective use of technology and if you are a beginner then you better get used to it early. Ideally use the online trading platform; it gives you a lot more control over your trades. Also, if possible you can download the app on your smart phone which allows you to trade on the run. Get used to reading electronic contract notes and ledgers; they are a lot more convenient and environment friendly than printed stuff.

In an effort to chase stocks, investors tend to forget that investment success is a lot more about discipline than about skills or flair. It is in your hands to make your investments work in a systematic manner.

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5 Tips for Investing in Initial Public Offerings (IPO)

5 Tips for Investing in Initial Public Offerings (IPO)
06/11/2019

Between 2015 and 2018, IPOs became a principal source of raising funds and also an interesting avenue for investors to park their funds. IPOs like Alkem, Avenue Supermarts and Shankara Building Products, among others, did extremely well post listing. However, the IPO market also had its share of disappointments. How to separate the good IPOs from the mediocre IPOs, remains the million dollar question. Here are five tips to help you invest in IPO offerings.

Don’t invest in IPOs without checking the background of the promoters

This may look intangible but pedigree of promoters matters a lot. If the promoters have a past record of destroying stock market wealth or of corporate governance issues, such issues are best avoided. Irrespective of the attractiveness of the business, a bad management can do a lot of damage. Look at Satyam versus Infosys in the same industry. Quality of promoters has a direct bearing on the valuations of a company and the performance of an IPO. More often than not, it is the promoters who make the difference between a bad company and a good company.

Valuations matter because you cannot pay too much for IPO hype

When we talk of valuations, it is not just about P/E ratio but more about P/E ratios with reference to the growth of the company. For example, Avenue Supermarts was richly valued even at the time of the IPO. Despite that, the company gave more than 200% returns post listing. Be cautious when promoters and anchor investors try to use the IPO to exit their holdings in the company at rich valuations. You don’t have to play ball in such cases.

Utilization of funds tells you a lot about the quality of the IPO

In the IPO prospectus, the utilization of funds is clearly laid out. It is always good to focus on IPOs that utilize a bigger share of the IPO resources in enhancing their core business. For example, if a manufacturing company is using the IPO funds to expand its scale or to make strategic diversifications then it is a good idea. This will enhance the long term prospects of the company. You must be doubly cautious about investing in IPOs where the bulk of the IPO proceeds are going into meeting working capital needs, investing in real estate properties, investing in group companies etc. Some companies also use IPO proceeds to repay high cost loans. While that is acceptable, investors must remember that equity has a higher cost compared to debt.

Be wary of IPOs where promoter is substantially diluting stake

Quite often you come across IPOs that also have an OFS (offer for sale) component. Here the promoter or the anchor investor looks to monetize part of their stake as part of the IPO. This is true for companies promoted by large institutions as well as entrepreneurs. This is perfectly understandable. However, you must be wary of companies where promoters have been trying to consistently dilute their stake in the company. This is not a good sign at all. Promoter stake in the company post IPO is a signal of their continued commitment to the company and its business. Remember that promoters can also pledge shares and that can also result in forced reduction of promoter holdings. All these are red flags to look out. You invest in the promoters as much as in the business so you need promoters committed to the business in the long term.

Be wary of too much debt or too much equity

In the last 11 years since the financial crisis, the worst performing IPOs are the ones that got into too much debt. Companies with high debt levels will always have a solvency problem and that puts a limit to the wealth that they can create. This is more so in industries that are cyclical in nature as in the case of metals and infrastructure. There is financial risk in debt and that is where most mid-cap and even large cap companies falter. Just as too much debt is bad, too much equity also makes the company languid.

The next time you invest in an IPO, watch out for these five things. It is a good starting point!