Rules For Traders - Simple Reminder

1. Buying a weak stock is like betting on a slow horse. It is retarded.

2. Stocks are only cheap if they are going higher after you buy them.

3. Never trust a person more than the market. People lie, the market does not.

4. Controlling losers is a must; let your winners run out of control.

5. Simplicity in trading demonstrates wisdom. Complexity is the sign of inexperience.

6. Have loyalty to your family, your dog, your team. Have no loyalty to your stocks.

7. Emotional traders want to give the disciplined their money.

8. Trends have counter trends to shake the weak hands out of the market.

9. The market is usually efficient and can not be beat. Exploit inefficiencies.

10. To beat the market, you must have an edge.

11. Being wrong is a necessary part of trading profitably. Admit when you are wrong.

12. If you do what everyone is doing you will be average, so goes the definition.

13. Information is only valuable if no one knows about it.

14. Lower your risk till you sleep like a baby.

15. There is always a reason why stocks go up or down, we usually only learn the reason when it is too late.

16. Trades that make a lot of intellectual sense are likely to be losers.

17. You do not have to be right more than you are wrong to make money in the market.

18. Don't worry about the trades that you miss, there will always be another.

19. Fear is more powerful than greed and so down trends are sharper than up trends.

20. Analyse the people, not the stock.

21. Trading is a dictators game; you can not trade by committee.

22. The best traders are the ones who do not care about the money.

23. Do not think you are smarter than the market, you are not.

24. For most traders, profits are short term loans from the market.

25. The stock market can not be predicted, we can only play the probabilities.

26. The farther price is from a linear trend, the more likely it is to correct.

27. Learn from your losses, you paid for them.

28. The market is cruel, it gives the test first and the lesson afterward.

29. Trading is simple but it is not easy.

30. The easiest time to make money is when there is a trend.

Daily circuit limit on Sensex, Nifty from October 1

Market regulator Sebi asked stock exchanges to calculate circuit limits -- the maximum permissible movement allowed to Sensex or Nifty in a trading session -- on a daily basis as against the current practice of doing the same on a quarterly basis.

Currently the stock exchanges calculate the circuit filters on the basis of the level attained by Sensex and Nifty at the end of every quarter and the same limits are applicable for every day of trade for the next three months.

The new calculation would apply for 10 per cent, 15 per cent and 20 per cent circuit limits in Sensex and Nifty, the two benchmark indices of Indian stock market, with effect from October 1, 2013. While 10 per cent and 15 per cent limits result into temporary trading halts, a 20 per cent movement triggers into trading getting halted for the entire day.

The move assumes significance in the wake of rising volatility in stock markets. For example, the 10 per cent circuit limit for Sensex in the current quarter is fixed at 1,950 points, while 15 per cent limit is at 2,900 points and 20 per cent limit is 3,875 points.

These limits were fixed as per the closing value of Sensex at the end of previous quarter, April-June 2013.

However, the circuit limits would be much lower if they are calculated on the basis of previous day closing levels.

For example, the Sensex today closed at 18,235 points and therefore the 10 per cent circuit filter would stand at 1,823 points for tomorrow's trade.

Announcing the new guidelines, Sebi said: "The stock exchange on a daily basis shall translate the 10 per cent, 15 per cent and 20 per cent circuit breaker limits of market-wide index variation based on the previous day's closing level of the index".

Sebi further said that the stock exchange should resume trading in stocks with a 15-minute pre-open call auction session, after any trading halt.

In order to accommodate such pre-open call auction session, the extant duration of the market halt would be suitably reduced by 15 minutes, Sebi said.

Under the circuit breaker system, a rise or fall of 10 per cent in Sensex triggers into the trading being halted across the market for one hour, if such a movement takes place before 1 pm, while halt is of 30 minutes is a 10 per cent movement happens between 1 pm and 2.30 pm. pm. In case the movement takes place at or after 2.30 pm, there is no trading halt at the 10 per cent level.

In case of a 15 per cent movement of either index, there is a two-hour market halt if the movement takes place before 1 pm. If the 15 per cent trigger is reached between 1-2 pm, there is a one hour halt, while trading is halted for rest of the day if a 15 per cent trigger is reached on or after 2 pm.

In case of a 20 per cent movement of the index, the trading is halted for the remainder of the day.

Source: ET

DIVERSIFICATION: Don't put ALL your EGGS in one BASKET

For starters, allow me to provide a quick definition:

Diversification - (1) the process of making diverse; giving variety to (2): to divide funds with the expectation that the positive performance of some will offset negative performance of others (as in investing).

Diversification can be compared to a kitchen sink casserole; it takes time, requires a handful of ingredients and if not executed well, it can result in an experience that is hard to stomach.   Just as I believe in making use of food that may spoil, I also believe in diversification.  However, there are a few issues that investors should consider when developing a diversification strategy.

Most investors have been told to diversify their portfolio. They think if they buy companies that are in different industries that they will be covered if there is some adversity in the markets. The problem is that they do not fully understand the risks in the markets and how to offset those risks. To trade properly, you need to understand the degree of risk you are taking on by involving yourself in the markets.

There are several risks that any trader or investor will face.  Depending on the type of investment or trading vehicle you select, you will be exposed to one or many of these types of risk.  The levels of risk are listed in order along with the securities that are involved at those levels.

Systemic Risk – These are shocks to the entire financial system where there are few to no safe havens left. Everyone experienced this during the 2008 collapse in the global markets.

Asset Class Risk – Stocks, bonds, commodities, and currency markets all go through cycles where they are bullish or bearish.  You face the risk of entering at the wrong part of the cycle for any of these asset classes.

Country Specific Risk – Countries grow at different paces and can offer distinct opportunities and risks based on economic projections, political stability, and other factors.

Sector Risk – Companies fall into sectors: consumer discretionary, technology, basic materials, industrials, energy, consumer staples, services, utilities, and financials. The sectors also undergo bullish and bearish cycles, falling in and out of favor with investors.

Industry Risk – Within these sectors, there are many industry labels that inform investors about the nature of a company's products or services.  Companies also fall into cycles.  

Company Risk – Individual stocks have risks tied to the company's operations. Lackluster earnings, accounting irregularities, and corporate member changes are all issues you face.

If you trade or invest in individual stocks, you are exposed to the highest levels of risk.  Even if you try to reduce risk by buying many stocks in different industries or sectors, you still have the asset class and company risk. When it comes to minimising your risk, you want to balance risk and reward.  When you increase your risk, you also increase your potential for profit.  You will usually see larger price movements with stocks than you will see with exchange traded funds, or ETFs, but most ETFs hold up much better than individual stocks if a company encounters an issue. 

To really be diversified, you should invest or trade in multiple asset classes, such as futures or forex, to spread your exposure out over different asset classes.  Even if you own a tech stock and a financial company, you will lose when the stock market collapses.  Know your risks and manage them when trading. Success comes from protecting your capital as much as it comes from making winning trades.

Finance Myths

The most important factor that prevents to be financially secure is the trust in the age old beliefs and deceptive thoughts about money. The advice and guidance financial experts give may work well for many people, but at the same time may not fit in your personal situation. Tips about money sometimes can be life saving and sometimes life destroying. Before deciding on any plan about money spending or saving, you must keep in mind few very common myths about money.

1. You can save money by budgeting

A budget can no doubt help you save money, but it should be given a space as an item in your budget. It's important to set apart some money as savings.

While budgeting you are likely to set apart a fixed amount for an item. For eg., you might set apart 8000 for a refrigerator, chances are you're going to buy the product just by checking the money and not the item. You might get what you need at a much lesser price.

2. You are becoming wealthy as you are earning more

Generally, as you start earning more, you tend to shop a lot. You tend to buy things that you've always dreamt of. You actually ignore to think about savings imagining you've a lot of money. This is one of the reasons lottery winners declare bankruptcy soon. It's important to ensure that higher earnings equals to higher savings too.

3. Money can't buy happiness

The relationship between people, money and joy is not clearly captured in the phrase "Money doesn't buy happiness". The reality is money can buy happiness, specially for lower and middle class people. You can buy things that you actually need, this will of course give you contentment and happiness. If you want to spend quality time with your family, you need to go on vacation. A vacation is only possible if you have money to earn it. Quality time with family gives you happiness, which is the result of vacation that you buy from money.

4. The neediest is the first one to get the financial aid

There are many government aided programs that provide financial aid to people who are actually needy. However, most student based programs are merit based rather than need based. Even high income families can qualify for financial aid programs. This kind of programs makes rich people richer and needy people more needy.

5. Owning a home is better than renting

Keeping in mind today's financial scenario, it's better to keep your lifestyle flexible. Change in job or city isn't a rare thing. In a condition like this, buying a home can give extra mental pressure. You need to sell the house before flipping jobs or city. In a rented house, you have no hassle of managing anything. Also, you never know the estate prices might just go down when you need to sell the house. You might suffer loss also.

6. Red cars are expensive to insure

The truth is the insurance companies are color blind. It doesn't bother them if your car is blue, black, striped or red. The insurance rate for a particular model, make and age of the vehicle will be the same irrespective of the color.

7. Closing old unused credit cards is good for your credit

Your credit rating largely depends on your credit history wherein your borrowing history and balances on your credit card are shown. It's a good idea to keep unused credit cards also open. Credit card companies keep a track of old accounts, especially those with good credit history.

8. Saving for an emergency is more important than paying off your credit card bills

The ideal decision should be saving money while paying off your debts. Instead, when you keep saving money without paying debt, you are actually stocking up more debt. The high interest rates are racking up in your account. Your credit ratings are also getting affected.

9. Expenses will cut down after you retire

Nothing like this is actually going to happen. Retirement, generally, means old age and aging people cost more than babies. People theses days don't have their house completely paid off and prices of all products are getting higher not lower. Hence, retirement doesn't by any chance means lower spendings.

10. You don't have enough money to save

There is no guarantee that your income is going to increase or the time when it's going to happen. It's important to save some percentage of money with whatever you earn. You must start saving with small amounts.

A thought may be age old but it's not necessary that it'll work for you. So, whenever you hear something about finances, analyze your situation then take any action.

Rules Of Investing, Market Truisms and Axioms

If you are going to insist on investing your money into the financial markets then it is imperative that before you take on the additional risk you take some safety precautions. If you don't follow the basic rules – you will lose and lose big. 

P. Arthur Huprich published a terrific list of rules that you should consider as a starting guide.

Commandment #1: "Thou Shall Not Trade Against the Trend." If the market is going up then it is okay to have money exposed to the market – if it isn't, don't.

 

• Portfolios heavy with underperforming stocks rarely outperform the stock market!

 

• There is nothing new on Street. There can't be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again, mostly due to human nature.

 

• Sell when you can, not when you have to.

 

• Bulls make money, bears make money, and "pigs" get slaughtered.

 

• We can't control the stock market. The very best we can do is to try to understand what the stock market is trying to tell us.

 

• Understanding mass psychology is just as important as understanding fundamentals and economics.

 

• Learn to take losses quickly, don't expect to be right all the time, and learn from your mistakes.

 

• Don't think you can consistently buy at the bottom or sell at the top. This can rarely be consistently done.

 

• When trading, remain objective. Don't have a preconceived idea or prejudice. Said another way, "the great names in Trading all have the same trait: An ability to shift on a dime when the shifting time comes."

 

• Any dead fish can go with the flow. Yet, it takes a strong fish to swim against the flow. In other words, what seems "hard" at the time is usually, over time, right.

 

• Even the best looking chart can fall apart for no apparent reason. Thus, never fall in love with a position but instead remain vigilant in managing risk and expectations. Use volume as a confirming guidepost.

 

• When trading, if a stock doesn't perform as expected within a short time period, either close it out or tighten your stop-loss point.

 

• As long as a stock is acting right and the market is "in-gear," don't be in a hurry to take a profit on the whole positions. Scale out instead.

 

• Never let a profitable trade turn into a loss, and never let an initial trading position turn into a long-term one because it is at a loss.

 

• Don't buy a stock simply because it has had a big decline from its high and is now a "better value;" wait for the market to recognize "value" first.

 

• Don't average trading losses, meaning don't put "good" money after "bad." Adding to a losing position will lead to ruin. Ask the Nobel Laureates of Long-Term Capital Management.

 

• Human emotion is a big enemy of the average investor and trader. Be patient and unemotional. There are periods where traders don't need to trade.

 

• Wishful thinking can be detrimental to your financial wealth.

 

• Don't make investment or trading decisions based on tips. Tips are something you leave for good service.

 

• Where there is smoke, there is fire, or there is never just one cockroach: In other words, bad news is usually not a one-time event, more usually follows.

 

• Realize that a loss in the stock market is part of the investment process. The key is not letting it turn into a big one as this could devastate a portfolio.

 

• Said another way, "It's not the ones that you sell that keep going up that matter. It's the one that you don't sell that keeps going down that does."

 

The table below depicts the percentage gain necessary to get back even, after a certain percentage loss.

• Your odds of success improve when you buy stocks when the technical pattern confirms the fundamental opinion.

 

• You can lose money even in the "best companies" if your timing is wrong. Yet, if the technical pattern dictates, you can make money on a short-term basis even in stocks that have a "mixed" fundamental opinion.

 

• To the best of your ability, try to keep your priorities in line. Don't let the "greed factor" that Street can generate outweigh other just as important areas of your life. Balance the physical, mental, spiritual, relational, and financial needs of life.

 

• Technical analysis is a windsock, not a crystal ball. It is a skill that improves with experience and study.

 

Always be a student, there is always someone smarter than you!

 

I hope this helps clarify the some of the issues that you wrestle with when it comes to managing your money.

Thinking about Saving - Think Again?

The things we need to consider, as investors, when thinking about saving for retirement and managing portfolio risks.  Here is a list of things to consider. 

• "Buy and Hold" investing will not work. Active management to participate in cyclical upswings, and avoid the majority of downswings, will be key.

• "Save More & Spend Less."  Savings will make a large chunk of your total retirement nest egg. This has always been the case.

• "Lump Sum Invest Vs. Rupee Cost Averaging."  Accumulate cash and invest in lump sums when things have become undervalued during the cyclical bear markets.  This will provide better returns over time especially when combined with an active management strategy.

• "Income Over Growth."  The income theme will continue to dominate investor psychology particularly in the baby boomer generation.

• "The Inflation Benchmark."  The real benchmark for investors to focus on is inflation - not an index.  Inflation, except in rare instances, actually compounds annually - stock markets don't.  Managing portfolios to limit losses and pace inflation will be key to ensure future purchasing power parity. 

• "Diversification."  Real diversification between non-corollary assets will be key in the future to hedge off market volatility and reduce emotional mistakes.

• "Real Assets."  Investing in physical real assets such as income producing properties, oil and gas wells, precious metals, private equity, etc. will perform better in a rising inflationary environment.  The key here is having a "real asset" behind the investment that will retain value even in deflating market environments.

• "Fixed Income"  Even in a rising interest rate environment actual fixed income, not bond funds, will provide income, low volatility and principal protection to portfolios.  Short duration ladders that can ratchet up as interest rates rise will provide portfolios with an edge over long only equity portfolios.

Of course, there are many other investments that will do well and these are just a few ideas to start the thinking process.  Furthermore, there will be fantastic and tradable bull market rallies like we have seen twice so far this century.  Being able to capitalize on those rallies will be critical in offsetting the rate of inflation and creating portfolio returns.  Unfortunately, the ensuing declines will also destroy all the gains and then some so being vigilant and disciplined in your risk management process will be critical.

However, the most important asset destroyed by reversion processes is "time".  It is the one commodity that you have a very limited supply of and no ability to replace.  Reversion doesn't mean that the markets "crash", although they certainly can, but the slow grind through the process will be like "Chinese water torture" for investors slowly destroying valuable assets over time.  Understanding the environment that we are in today, and will continue to face going forward, can help us make better decisions in both our planning and investment process.  Ignore the reversion process at your own risk.

Fibonacci Retracements

Leonardo Pisano Bogollo (1170-1250), an Italian mathematician from Pisa, is credited with introducing the Fibonacci sequence to the West. Leonardo of Pisa, nicknamed, Fibonacci was one of the best known mathematicians of his time. His greatest find was Fibonacci series.

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597, ...

This sequence is constructed by choosing the first two numbers (the "seeds" of the sequence) then assigning the rest by the rule that each number be the sum of the two preceding numbers. This simple rule generates a sequence of numbers having many surprising properties, of which we list but a few.

• Take any three adjacent numbers in the sequence, square the middle number, multiply the first and third numbers. The difference between these two results is always 1.
• Take any four adjacent numbers in the sequence. Multiply the outside ones. Multiply the inside ones. The first product will be either one more or one less than the second.
• The sum of any ten adjacent numbers equals 11 times the seventh one of the ten. Mesoamericans thought the numbers 7 and 11 were special.What can we get out of these numbers. Try picking any number and divide it by the next number in the series and see what you get.

For example: 21/34 = 0.6176 or 34/55 = 0.6182 or 144/233 = 0.6180

Or the 62% retracement level. Similarly, if you take the previous number and divide it by the next number you get another important retracement level 38%.

For example: 21/55 = 0.382 or 34/89 = 0.382

And you can go on like this. But the most important retracement levels are 38% and 62%.The sequence extends to infinity and contains many unique mathematical properties.

• After 0 and 1, each number is the sum of the two prior numbers (1+2=3, 2+3=5, 5+8=13 8+13=21 etc…).
• A number divided by the previous number approximates 1.618 (21/13=1.6153, 34/21=1.6190, 55/34=1.6176, 89/55=1.6181). The approximation nears 1.6180 as the numbers increase.
• A number divided by the next highest number approximates .6180 (13/21=.6190, 21/34=.6176, 34/55=.6181, 55/89=.6179 etc….). The approximation nears .6180 as the numbers increase. This is the basis for the 61.8% retracement.
• A number divided by another two places higher approximates .3820 (13/34=.382, 21/55=.3818, 34/89=.3820, 55/=144=3819 etc….). The approximation nears .3820 as the numbers increase. This is the basis for the 38.2% retracement. Also, note that 1 - .618 = .382
• A number divided by another three places higher approximates .2360 (13/55=.2363, 21/89=.2359, 34/144=.2361, 55/233=.2361 etc….). The approximation nears .2360 as the numbers increase. This is the basis for the 23.6% retracement.
• The 50% retracement is not based on a Fibonacci number. Instead, this number stems from Dow Theory's assertion that the Averages often retrace half their prior move.

1.618 refers to the Golden Ratio or Golden Mean, also called Phi. The inverse of 1.618 is .618.

Practical Significance of Fibonacci levels on charts. Focus will be on moderate retracements (38.2-50%) and golden retracements (61.8%) :

38.2% Retracement on Nifty. After taking the support at 38.2% retracement, nifty continues it's uptrend. 

50% Retracement on Nifty - Corrective Pullback only to fall after that. 

61.8% Retracement on Nifty - After decline from 6111.80 to 5663, Nifty bounces back to 61.8% (corrective Pullback) to face a stiff resistance around those level, only to fall after that. 

50% Corrective Advance in Bear Market on Gold

Conclusion

Fibonacci retracements are often used to identify the end of a correction or a counter-trend bounce. Corrections and counter-trend bounces often retrace a portion of the prior move. While short 23.6% retracements do occur, the 38.2-61.8% covers the more possibilities (with 50% in the middle). This zone may seem big, but it is just a reversal alert zone. Other technical signals are needed to confirm a reversal. Reversals can be confirmed with candlesticks, momentum indicators, volume or chart patterns. In fact, the more confirming factors the more robust the signal.

VIX - Volatility Index

VIX

Volatility Index is a measure of market's expectation of volatility over the near term. Volatility is often described as the "rate and magnitude of changes in prices" and in finance often referred to as risk. Volatility Index is a measure, of the amount by which an underlying Index is expected to fluctuate, in the near term, (calculated as annualised volatility, denoted in percentage e.g. 20%) based on the order book of the underlying index options.

India VIX is a volatility index based on the NIFTY Index Option prices. From the best bid-ask prices of NIFTY Options contracts, a volatility figure (%) is calculated which indicates the expected market volatility over the next 30 calendar days. India VIX uses the computation methodology of CBOE, with suitable amendments to adapt to the NIFTY options order book using cubic splines, etc.

The VIX Measures FEAR
High VIX readings mean that fear is also high, whereas low VIX readings mean that fear is low.  Backtesting various VIX reversal signals has proven that the VIX can be used to predict market direction about 60 to 70% of the time, the more VIX signals the better.  What this means is that when the VIX is at an extreme (meaning everyone thinks the market will continue in that direction), a top or bottom is usually in place and what usually happens is the market reverses in the opposite direction.

Volatility (VIX) Tends to Trend
This means that if the VIX rises today, it has a higher than average chance of rising tomorrow. This is even more significant at market extremes and right before market reversals.

The VIX is Dynamic
What this means is that you can not predict market direction simply by the level of the VIX.  In the past, many traders simply bought the market when the VIX goes above 30 and sold the market when it traded down to 20. Because the VIX and volatility is constantly changing this strategy simply doesn't work.  Now, more than ever, it is the relative level of the VIX that is important, not the absolute value.

Volatility is Mean Reverting
This means that periods of high volatility will be followed by periods of low volatility.  This was academically proven over 50 years ago and is one of many market truths.  This is important because when the VIX has a low reading and begins to revert to its mean, it is also accompanied by a market that begins to sell off.  It is the same for when the VIX has a high reading and changes direction, this typically is accompanied by a market that begins to rally.

VIX Reversal Signals
There have been many books written about the VIX and signals have been developed that help traders pinpoint when the market is most likely to reverse.  What all of these signals have in common is that they use various means to determine when the VIX is at an extreme and either reversing or about to reverse.  While historically these individual VIX Signals have worked 60 to 70% of the time, that is no longer the case in today's market. Why is this? Because EVERYBODY knows about them and is watching them.  Whenever a system or strategy becomes known to too many people, it often fails to live up to the results it once had.  However, that being said, when multiple VIX Signal are generated, there is still a very high probability of the market reversing.

Practical Importance of VIX for tracking the market:-

https://www.facebook.com/photo.php?fbid=10151182070943583&set=o.277991142250706&type=1&theater

Beta

In finance, the Beta (β) of a stock or portfolio is a number describing the correlated volatility of an asset in relation to the volatility of the benchmark that said asset is being compared to. This benchmark is generally the overall financial market and is often estimated via the use of representative indices, such as the S&P 500, Nifty, Sensex, etc. 

Beta is also referred to as financial elasticity or correlated relative volatility, and can be referred to as a measure of the sensitivity of the asset's returns to market returns, its non-diversifiable risk, its systematic risk, or market risk. On an individual asset level, measuring beta can give clues to volatility and liquidity in the marketplace. In fund management, measuring beta is thought to separate a manager's skill from his or her willingness to take risk.

The beta coefficient was born out of linear regression analysis. It is linked to a regression analysis of the returns of a portfolio (such as a stock index) (x-axis) in a specific period versus the returns of an individual asset (y-axis) in a specific year. The regression line is then called the Security characteristic Line (SCL).

• Beta < 0: Negative Beta - not likely.
• Beta = 0: Cash in the bank.
• Beta Between 0 and 1: Low-volatility
• Beta = 1: Matching the market.
• Beta > 1: More volatile than the market

Example of use: A fund with a beta of 1 is deemed to have the same volatility as the Nifty; therefore a fund with a beta of 4 is four times more volatile than the Nifty, and a fund with a beta of .25 is 25% as volatile as the Nifty.

This means that a fund with a beta of 4 would rise 40% if the Nifty rose 10% (the same is true of a drop).

The three basic interpretations of Beta are as follows: 

• Econometric Beta: The primary risk factor for the CAPM. Relevant to pricing and not valuation.

• Graphical Beta: The slope coefficient of the characteristic line.

• Statistical Beta: The measure of systematic risk in the CAPM.  

Beta depends on two factors, multiplied together:

1. the relative volatility of a security's returns compared to the market's returns, and
2. the correlation of the security's returns to the market's returns.

There are several misconceptions about beta. Amongst the most common are:

• Beta measures the relative volatility of a security's price compared to the price of the market. Beta is a measure that compares returns, not prices; a security with a positive beta can have a price that decreases while the market's price increases. The key is whether the security's returns are above or below its mean return when the market's returns are above or below its mean return; whether the security's mean return is positive or negative is not relevant to its beta.
• Beta measures the relative volatility of a security's returns compared to the volatility of the market's returns. Beta has two components: relative volatility of returns, and correlation of returns. Unless the correlation of returns is +1.0 or -1.0, beta does not measure the relative volatilities of returns.
• A positive beta means that a security's returns and the market's returns tend to be positive and negative together; a negative beta means that when the market's return is positive the security's return tends to be negative, and vice versa. The calculation of beta involves deviations of the market's returns and the security's returns about their respective mean returns. A security with a negative mean return can have a positive beta, and a security with a positive mean return can have a negative beta.
• A beta of 1.0 means that the security's returns have the same volatility as the market's returns. This could be true, or the security's returns could be twice as volatile as the market's returns, but their correlation of returns is +0.5. Beta, by itself, does not describe the relative volatility of returns.

Because beta is the product of the relative volatility of returns and the correlation of returns, it does allow for some useful conclusions:

• A beta of 1.0 could mean that the security's returns have the same volatility as the market's returns and their correlation is +1.0, or it could mean that the relative volatility is 2.0 and the correlation is +0.5, or it could mean that the relative volatility is 5.0 and the correlation is +0.2. It is certain that the volatility of the security's returns is at least as great as the volatility of the market's returns, and that the correlation of returns between the security and the market is positive.
• A beta higher than 1.0 means that the security's returns have been more volatile than the market's returns, and that the correlation of returns is positive. For example, a beta of 2.0 means that the security's returns have at least twice the volatility of the market's returns, probably more. The value of beta gives a lower limit to the relative volatility of the security's returns compared to the market's returns.
• A beta lower than 1.0 can mean that the security's returns are less volatile than the market's returns, or it could simply mean that the security's returns and the market's returns have a low correlation.
• A beta of 0 means that the correlation of returns of the security and the market is 0.0; i.e., they tend to move independently.
• A negative beta means that the security's returns tend to move opposite the market's returns; i.e., their correlation of returns is negative. The absolute value of beta gives a lower limit to the relative volatility of the security's returns compared to the market's returns.

Applications of Beta

Beta is a commonly used tool for evaluating the performance of a fund manager. Beta is used in contrast with Alpha to denote which portion of the fund's returns are a result of simply riding swings in the overall market, and which portion of the funds returns are a result of truly outperforming the market in the long term. For example, it is relatively easy for a fund manager to create a fund that would go up twice as much as the Nifty when the Nifty rose in value, but go down twice as much as the Nifty when the Nifty's price fell - but such a fund would be considered to have pure Beta, and no alpha. A fund manager who is producing Alpha would have a fund that outperformed the Nifty in both good times and bad.

Beta can also be used to give investors an estimate on a stock's expected returns relative to the market return. Consider some examples:

• Company ABC, a tech stock, has a beta of 1.8. Over a given year, the Nifty increases in value 17%. Assuming the beta value is accurate, ABC's value should have increased 30.1% or (1.8 x 17%) over the same time period.
• Company XYZ, a mid-sized oil company, has a beta of 1.0. Over a given year, the Nifty falls 10%. Assuming the beta value is accurate, XYZ's value would also have fallen 10% over the same period.
• Company LMN, a gold mining company, has a beta of -1.4. Over a given year, the Nifty increases in value 11%. Assuming the beta value is accurate, LMN's value would have declined 15.4% or (-1.4 x 11%) over the same period.

How to estimate Beta

For individual companies, beta can be estimated using regression analysis (line of best fit) against a stock market index. It is one of the required inputs to the Capital Asset Pricing Model (CAPM), which is used to calculate the expected return of an asset based on its beta and expected market returns. Essentially, to calculate beta for an individual security you take total stock returns for a given period, and simply plot it against the benchmark returns, and then fit a least squares regression line (line of best fit) through the data points. The slope of the line would then be your beta.

The beta for a portfolio of securities is simply the weighted average of each of the individual securities. The weight of each security is the value invested in that security divided by the value of the entire portfolio. A quick example would illustrate the concept. Assume you have Rs. 100 invested into two companies for a total investment of Rs. 200. The betas for the companies are 1.0 and 2.0 respectively. Therefore, the calculation would be (Rs.100/Rs.200)*1.0 + (Rs. 100/200)*2.0 = 1.5. Therefore, the beta of the portfolio is 1.5.

The two most widely used methods of estimating beta are:

1. Pure-Play Method
When using the pure-play method, a company seeks out companies with a product line that is similar to the line for which the company is trying to estimate the beta. Once these companies are found, the company would then take an average of those betas to determine its project beta.

2. Accounting-Beta Method
When using the accounting-beta method, a company would run a regression using the company's return on assets (ROA) against the ROA for market benchmark, such as the S&P 500. The accounting beta is the slope coefficient of the regression.

Variances in Beta

Values of Beta can vary depending on how they are calculated. Specifically, the main varying components are:

• Different time frame: Depending on how far back into history the beta calculation goes, the values will differ. For example, if one calculation includes the stock prices for the trailing 12 months versus the trailing 60 months; the two values will be different.
• Different time intervals: Depending on the interval between the stock prices used, beta calculations can differ. For example, one calculation which uses the monthly stock prices will differ from another calculation which uses weekly or daily stock prices.
• Different index: Beta calculations can vary depending on which index is used to measure the overall value in the market. For example, using the Nifty and the SENSEX will result in different values.
• Inclusion or exclusion of dividends: Depending on whether dividends are included in the calculation of the returns of the stock, the beta calculations can differ.

The result of each of these different choices can cause beta values to differ widely depending on how the calculation is made. This means that a beta value is not an exact value of how a stock varies with the market, but a representation.

Different types of Beta - Explained by various financial scholars

1. Classic beta – This is related to the 'beta' as referred to in past decades, though now corrupted to mean precisely matching the market. In the new parlance the word beta is equivalent to a beta of 1 under the older definition. It effectively means just matching the market, whether the market is the US stock market, the UK FTSE 100, Indian Market Nifty or SENSEX or the global MSCI-EAFA. Standard index funds come under this category. 

2. Bespoke beta – This refers to the same as 1 above except that the index no longer represents the broad market but particular sectors or other asset classes. For instance, the banking sector or a basket of commodities.

3. Alternative beta – The rationale is that there are systematic risk exposures which were previously not available to investors but which can be now accessed through ETFs. As an example, currency ETF linked to the price of the euro in terms of the dollar.

4. Fundamental beta – There is now a raging debate as to whether indices constructed by weighting the constituent stocks by market capitalisation are the best proxies for the market. A strongly supported school has sprung up which claims that fundamental indices, in which the constituents are weighted by fundamental factors such as revenue or dividends, are much better. It is better to match these fundamental indices as fundamental beta.

5. Cheap beta – This refers to a situation where beta cannot be produced by investing in an index or ETF, but where beta is embedded in a complex basket of risks within one security. An example is a convertible bond. This has the following elements of risk embedded in it: interest rate risk, stock market risk, credit risk, and volatility risk. Players in convertible bonds are effectively getting indirect exposure to all these different betas. Interestingly, here we take beta as numbers rather than as the concept of matching the market.

6. Active beta – it refers to long-short funds such as 130/30, where the overall exposure of the portfolio matches the market but additionally there is 30% additional long exposure in favour of stocks, counterbalanced by short exposures in unattractive stocks.

7. Bulk beta – This refers to traditional equity portfolio management of the standard type, where portfolios consist of a large element of beta, i.e. market exposure, as well as the ability to generate alpha through stock selection.

8. Levered beta = Risk of Equity. The beta of a company, including debt. The levered beta describes the capital structure of the company and volatility relative to the market.

9. Unlevered Beta = Risk of Entire Firm (Assets)

Unlevered Beta is basically a weighted average of the levered Beta and the debt Beta. Typically, the debt beta is thought to be 0, although it isn't always. The beta of a company after subtracting out the impact of its debt obligations. Unlevered beta removes the effects of the use of leverage on the capital structure of a firm, since the use of debt can result in tax rate adjustments that benefit a company. Removing the debt component allows an investor to compare the base level of risk between various companies.

Ub = [(1-L)Eb + (L)DB ]/ (1 - TL)

That's the general formula for conversion, with Ub being the unlevered (or Asset) beta, Eb being the levered (or equity) beta, and Db being the debt beta. L is the leverage ratio. From this equation, you can see the "weighted average" quality of asset beta.

Basically, there is a ton of information about the relation between levered and unlevered betas. For valuation purposes, I think it is important to know that when using the betas of comparable companies to find a beta for your private company, you would want to unlever them to make them "free" of the comparable companies' capital structure. After doing this, you would then take the average (or whatever) and relever it using your company's leverage ratio to find the appropriate equity beta, and thus amount of return that you need to get on your equity (usingCAPM).

Practical Application of Levered and Unlevered Beta can be better understood by this research article:

http://www.iese.edu/research/pdfs/di-0488-e.pdf

Practical Application on Excel:

http://www2.cob.ilstu.edu/kjbaue2/fil341/SV.pdf

Key highlights of the Union Budget 2013-14

Following are some of the key highlights of the Union Budget 2013-14 presented by Finance Minister P Chidambaram in Parliament on Thursday (February 28): 

*No change in income tax slabs 

*Relief of Rs 2,000 for tax payers in tax bracket of Rs 2-5 lakh 

*10 pc surcharge on persons with taxable income of over Rs 1 crore 

*Tobacco products, SUVs and mobile phones to cost more 

*Income limit under Rajiv Gandhi Equity Savings Scheme raised to 12 lakh from Rs 10 lakh 

*First home loan of up to Rs 25 lakh to get extra interest deduction of up to Rs 1 lakh 

*Duty free limit of gold import increased to Rs 50,000 for male passengers and Rs 1 lakh for female passengers 

*India's first women's bank to be set up by October 

* Concessional six per cent interest on loans to weavers 

* Rashtriya Swasthya Bima Yojana benefit extended to rickshaw pullers, auto and taxi drivers, among others 

* 'Nirbhaya Fund' of Rs 1,000 crore to empower women and provide safety in the wake of Delhi gang-rape incident 

*Fiscal deficit for 2013-14 pegged at 4.8 pc of GDP and 5.2 per cent in 2012-13 

*Plan expenditure pegged at Rs 5,55,322 crore and non-Plan at Rs 11,09,975 crore 

*New taxes to collect Rs 18,000 crore for government 

*Voluntary Compliance Encouragement Scheme launched for recovering service tax dues 

*Rs 14,000 crore earmarked for capital infusion in public sector banks in 2013-14 

*Refinance capacity of SIDBI raised to Rs 10,000 crore 

*TUF Scheme for textile sector to continue in 12th Plan with an investment of Rs 1.51 lakh crore 

*Rs 9,000 crore earmarked as first instalment of balance of CST compensation to states 

*Defence allocation at Rs 203,672 crore, education Rs 65,867 crore and Rural Development Ministry Rs 80,194 cr 

*Rs 10,000 crore earmarked for National Food Security towards incremental cost 

*Farm credit target set at Rs 7 lakh crore as against Rs 5.75 lakh crore in 2012-13 

*Direct Benefit Transfer scheme to be rolled out in the entire country during tenure of UPA government 

*Commodity transaction tax of 0.01 per cent proposed on non-agri futures traded on commodity bourses 

*Securities Transaction Tax brought down to 0.01 per cent 

*No change in basic customs duty; normal excise and service tax rates unchanged at 12 per cent 

*Handmade carpets and textile floor coverings of coir or jute exempted from excise duty 

*Excise duty on SUVs increased to 30 per cent from 27 per cent 

*Chidambaram says India to become USD 5 trillion economy, and among top five in the world by 2025 

*High current account deficit (CAD) a worry 

*Food inflation a worry, govt to take all possible steps to augment supply side bottlenecks 

*Govt proposes India's first Women's Bank as a public sector bank with Rs 1,000 crore initial capital; banking licence likely by October 

*Foreign Trade Policy next month 

*Two new major ports to come in West Bengal and Andhra Pradesh to add 100 million tonnes of capacity 

*Mid-Day Meal Scheme (MDM) to get Rs 13,215 crore 

*Post offices to come on core banking solution and offer real time banking services; Rs 532 cr allocated for 2013-14 

*Modified GAAR to be incorporated in Income-tax Act; the provisions to come into effect from April 2016 

*Govt proposes to expand scope of annual information returns, extend epayment facility through more banks, extend the refund banker system to refunds of more than Rs 50,000 

*E-filing mandatory for more categories of assessees 

*Direct Taxes Code (DTC) in the ongoing Budget session

Commodities Market

What is a market?
A market is conventionally defined as a place where buyers and sellers meet to exchange goods or services for a consideration. This consideration is usually money. In an Information Technology-enabled environment, buyers and sellers from different locations can transact business in an electronic marketplace. Hence the physical marketplace is not necessary for the exchange of goods or services for a consideration. Electronic trading and settlement of transactions has created a revolution in global financial and commodity markets.

What is a commodity?
A commodity is a product that has commercial value, which can be produced, bought, sold, and consumed. Commodities are basically the products of the primary sector of an economy. The primary sector of an economy is concerned with agriculture and extraction of raw materials such as metals, energy (crude oil, natural gas), etc., which serve as basic inputs for the secondary sector of the economy.

To qualify as a commodity for futures trading, an article or a product has to meet some basic characteristics:

• The product must not have gone through any complicated manufacturing activity, except for certain basic processing such as mining, cropping, etc. In other words, the product must be in a basic, raw, unprocessed state. There are of course some exceptions to this rule. For example, metals, which are refined from metal ores, and sugar, which is processed from sugarcane.
• The product has to be fairly standardized, which means that there cannot be much differentiation in a product based on its quality. For example, there are different varieties of crude oil. Though these different varieties of crude oil can be treated as different commodities and traded as separate contracts, there can be a standardization of the commodities for futures contract based on the largest traded variety of crude oil. This would ensure a fair representation of the commodity for futures trading. This would also ensure adequate liquidity for the commodity futures being traded, thus ensuring price discovery mechanism.
• A major consideration while buying the product is its price. Fundamental forces of market demand and supply for the commodity determine the commodity prices.
• Usually, many competing sellers of the product will be there in the market. Their presence is required to ensure widespread trading activity in the physical commodity market.
• The product should have adequate shelf life since the delivery of a commodity through a futures contract is usually deferred to a later date (also known as expiry of the futures contract).

Commodity Market: A Perspective

A market where commodities are traded is referred to as a commodity market. These commodities include bullion (gold, silver), non-ferrous (base) metals (copper, zinc, nickel, lead, aluminium, tin), energy (crude oil, natural gas), agricultural commodities such as soya oil, palm oil, coffee, pepper, cashew, etc.

Existence of a vibrant, active, liquid, and transparent commodity market is normally considered as a sign of development of an economy. It is therefore important to have active commodity markets functioning in a country.

Markets have existed for centuries worldwide for selling and buying of goods and services. The concept of market started with agricultural products and hence it is as old as the agricultural products or the business of farming itself. Traditionally, farmers used to bring their products to a central marketplace (called mandi / bazaar) in a town/village where grain merchants/ traders would also come and buy the products and transport, distribute, and sell them to other markets.

In a traditional market, agricultural products would be brought and kept in the market and the potential buyers would come and see the quality of the products and negotiate with the farmers directly on the price that they would be willing to pay and the quantity that they would like to buy. Deals were struck once mutual agreement was reached on the price and the quantity to be bought/ sold.

In traditional markets, shortage of a commodity in a given season would lead to increase in price for the commodity. On the other hand, oversupply of a commodity on even a single day could result in decline in price—sometimes below the cost of production. Neither farmers nor merchants were happy with this situation since they could not predict what the prices would be on a given day or in a given season. As a result, farmers often returned from the market with their products since they failed to fetch their expected price and since there were no storage facilities available close to the marketplace. It was in this context that farmers and food grain merchants in Chicago started negotiating for future supplies of grains in exchange of cash at a mutually agreeable price. This type of agreement was acceptable to both parties since the farmer would know how much he would be paid for his products, and the dealer would know his cost of procurement in advance. This effectively started the system of forward contracts, which subsequently led to futures market too. 

Cash Market
Cash transaction results in immediate delivery of a commodity for a particular consideration between the buyer and the seller. A marketplace that facilitates cash transaction is referred to as the cash market and the transaction price is usually referred to as the cash price. Buyers and sellers meet face to face and deals are struck. These are traditional markets. Example of a cash market is a mandi where food grains are sold in bulk. Farmers would bring their products to this market and merchants/traders would immediately purchase the products, and they settle the deal in cash and take or give delivery immediately. Cash markets thus call for immediate delivery of commodities against actual payment.

Forwards and Futures Markets
In this case, the agreements are normally made to receive the commodities at a later date in future for a pre-determined consideration based on agreed upon terms and conditions. Forwards and Futures reduce the risks by allowing the trader to decide a price today for goods to be delivered on a particular future date. Forwards and Futures markets allow delivery at some time in the future, unlike cash markets that call for immediate delivery. These advance sales help both buyers and sellers with long-term planning. Forward contracts laid the groundwork for futures contracts. The main difference between these two contracts is the way in which they are negotiated.

For forward contracts, terms like quantity, quality, delivery date, and price are discussed in person between the buyer and the seller. Each contract is thus unique and not standardized since it takes into account the needs of a particular seller and a particular buyer only. On the other hand, in futures contracts, all terms (quantity, quality, and delivery date) are standardized. The transaction price is discovered through the interaction of supply and demand in a centralized marketplace or exchange.

Forward contracts help in arranging long-term transactions between buyers and sellers but could not deal with the financial (credit) risk that occurred with unforeseen price changes resulting from crop failures, inadequate storage or bottlenecks in transportation, factors beyond human control (floods, natural calamities, etc.), or other economic factors that may result in unexpected changes, and hence counterparty default risks for parties involved. This, in turn, led to the development of futures market. As mentioned above, since futures are standardized contracts that are traded through an exchange, they can be used to minimize price risk by means of hedging techniques. Since the exchange standardizes the quality and quantity parameters and offers complete transparency by using risk management techniques (such as margining system with mark-to-market settlement on a real-time basis with daily settlement), the counterparty default risk has been greatly minimized.

Brief History of the Development of Commodity Markets
Global Scenario

It is widely believed that the futures trade first started about approximately 6,000 years ago in China with rice as the commodity.  Futures trade first started in Japan in the 17th century. In ancient Greece, Aristotle described the use of call options by Thales of Miletus on the capacity of olive oil presses. The first organized futures market was the Osaka Rice Exchange, in 1730.

Organized trading in futures began in the US in the mid-19th century with maize contracts at the Chicago Board of Trade (CBOT) and a bit later, cotton contracts in New York. In the first few years of CBOT, weeks could go by without any transaction taking place and even the provision of a daily free lunch did not entice exchange members to actually come to the exchange! Trade took off only in 1856, when new management decided that the mere provision of a trading floor was not sufficient and invested in the establishment of grades and standards as well as a nation-wide price information system. CBOT preceded futures exchanges in Europe.

In the 1840s, Chicago had become a commercial centre since it had good railroad and telegraph lines connecting it with the East. Around this same time, good agriculture technologies were developed in the area, which led to higher wheat production. Midwest farmers, therefore, used to come to Chicago to sell their wheat to dealers who, in turn, transported it all over the country.

Farmers usually brought their wheat to Chicago hoping to sell it at a good price. The city had very limited storage facilities and hence, the farmers were often left at the mercy of the dealers. The situation changed for the better in 1848 when a central marketplace was opened where farmers and dealers could meet to deal in "cash" grain—that is, to exchange cash for immediate delivery of wheat. Farmers (sellers) and dealers (buyers) slowly started entering into contract for forward exchanges of grain for cash at some particular future date so that farmers could avoid taking the trouble of transporting and storing wheat (at very high costs) if the price was not acceptable. This system was suitable to farmers as well as dealers. The farmer knew how much he would be paid for his wheat, and the dealer knew his costs of procurement well in advance.

Such forward contracts became common and were even used subsequently as collateral for bank loans. The contracts slowly got "standardized" on quantity and quality of commodities being traded. They also began to change hands before the delivery date. If the dealer decided he didn't want the wheat, he would sell the contract to someone who needed it. Also, if the farmer didn't want to deliver his wheat, he would pass on his contractual obligation to another farmer. The price of the contract would go up and down depending on what was happening in the wheat market. If the weather was bad, supply of wheat would be less and the people who had contracted to sell wheat would hold on to more valuable contracts expecting to fetch better price; if the harvest was bigger than expected, the seller's contract would become less valuable since the supply of wheat would be more.

Slowly, even those individuals who had no intention of ever buying or selling wheat began trading in these contracts expecting to make some profits based on their knowledge of the situation in the market for wheat. They were called speculators. They hoped to buy (long position) contracts at low price and sell them at high price or sell (short position) the contracts in advance for high price and buy later at a low price. This is how the futures market in commodities developed in the US. The hedgers began to efficiently transfer their market risk of holding physical commodity to these speculators by trading in futures exchanges.

The history of commodity markets in the US has the following landmarks:

• Chicago Board of Trade (CBOT) was established in Chicago in 1848 to bring farmers and merchants together. It started active trading in futures-type of contracts in 1865.
• The New York Cotton Exchange was started in 1870.
• Chicago Mercantile Exchange was set up in 1919.
• A legalised option trading was started in 1934.

Indian Scenario
History of trading in commodities in India goes back several centuries. But organized futures market in India emerged in 1875 when the Bombay Cotton Trade Association was established. The futures trading in oilseeds started in 1900 when Gujarati Vyapari Mandali (today's National Multi Commodity Exchange, Ahmedabad) was established. The futures trading in gold began in Mumbai in 1920. During the first half of the 20th century, there were many commodity futures exchanges, including the Calcutta Hessian Exchange Ltd. that was established in 1927. Those exchanges traded in jute, pepper, potatoes, sugar, turmeric, etc. However, India's history of commodity futures market has been turbulent. Options were banned in cotton in 1939 by the Government of Bombay to curb widespread speculation.  In mid-1940s, trading in forwards and futures became difficult as a result of price controls by the government. The Forward Contract Regulation Act was passed in 1952. This put in place the regulatory guidelines on forward trading. In late 1960s, the Government of India suspended forward trading in several commodities like jute, edible oil seeds, cotton, etc. due to fears of increase in commodity prices. However, the government offered to buy agricultural products at Minimum Support Price (MSP) to ensure that the farmer benefited. The government also managed storage, transportation, and distribution of agriculture products. These measures weakened the agricultural commodity markets in India.

The government appointed four different committees (Shroff Committee in 1950, Dantwala Committee in 1966, Khusro Committee in 1979, and Kabra Committee in 1993) to go into the regulatory aspects of forward and futures trading in India. In 1996, the World Bank in association with United Nations Conference on Trade and Development (UNCTAD) conducted a study of Indian commodities markets. In the post-liberalization era of the Indian economy, it was the Kabra Committee and the World Bank–UNCTAD study that finally assessed the scope for forward and futures trading in commodities markets in India and recommended steps to revitalize futures trading.

There are four national-level commodity exchanges and 22 regional commodity exchanges in India. The national-level exchanges are Multi Commodity Exchange of India Limited (MCX), National Commodity and Derivatives Exchange Limited (NCDEX), National Multi Commodity Exchange of India Limited (NMCE), and Indian Commodity Exchange (ICEX).

Relevance and Potential of Commodity Markets in India
Majority of commodities traded on global commodity exchanges are agri-based. Commodity markets therefore are of great importance and hold a great potential in case of economies like India, where more than 65 percent of the people are dependent on agriculture.

There is a huge domestic market for commodities in India since India consumes a major portion of its agricultural produce locally. Indian commodities market has an excellent growth potential and has created good opportunities for market players. India is the world's leading producer of more than 15 agricultural commodities and is also the world's largest consumer of edible oils and gold. It has major markets in regions of urban conglomeration (cities and towns) and nearly 7,500+ Agricultural Produce Marketing Cooperative (APMC) mandis. To add to this, there is a network of over 27,000+ haats (rural bazaars) that are seasonal marketplaces of various commodities. These marketplaces play host to a variety of commodities everyday. The commodity trade segment employs more than five million traders. The potential of the sector has been well identified by the Central government and the state governments and they have invested substantial resources to boost production of agricultural commodities. Many of these commodities would be traded in the futures markets as the food-processing industry grows at a phenomenal pace. Trends indicate that the volume in futures trading tends to be 5-7 times the size of spot trading in the country (internationally, it is much higher at 15 to 20 times).

Many nationalized and private sector banks have announced plans to disburse substantial amounts to finance businesses related to commodity trading. The Government of India has initiated several measures to stimulate active trading interest in commodities. Steps like lifting the ban on futures trading in commodities, approving new exchanges, developing exchanges with modern infrastructure and systems such as online trading, and removing legal hurdles to attract more participants have increased the scope of commodities derivatives trading in India. This has boosted both the spot market and the futures market in India. The trading volumes are increasing as the list of commodities traded on national commodity exchanges also continues to expand. The volumes are likely to surge further as a result of the increased interest from the international participants in Indian commodity markets. If these international participants are allowed to participate in commodity markets (like in the case of capital markets), the growth in commodity futures can be expected to be phenomenal. It is expected that foreign institutional investors (FIIs), mutual funds, and banks may be able to participate in commodity derivatives markets in the near future. The launch of options trading in commodity exchanges is also expected after the amendments to the Forward Contract Regulation Act (1952). Commodity trading and commodity financing are going to be rapidly growing businesses in the coming years in India.

With the liberalization of the Indian economy in 1991, the commodity prices (especially international commodities such as base metals and energy) have been subject to price volatility in international markets, since India is largely a net importer of such commodities. Commodity derivatives exchanges have been established with a view to minimize risks associated with such price volatility.

Commodity Markets Ecosystem
After studying the importance of commodity markets and trading in commodity futures, it is essential to understand the different components of the commodity markets ecosystem. The commodity markets ecosystem includes the following components:

1. Buyers/Sellers or Consumers/Producers: Farmers, manufacturers, wholesalers, distributors, farmers' co-operatives, APMC mandis, traders, state civil supplies corporations, importers, exporters, merchandisers, oil refining companies, oil producing companies, etc.
2. Logistics Companies: Storage and transport companies/operators, quality testing and certifying companies, valuers, etc.
3. Markets and Exchanges: Spot markets (mandis, bazaars, etc.) and commodity exchanges (national level and regional level)
4. Support agencies: Depositories/de-materializing agencies, central and state warehousing corporations, and private sector warehousing companies
5. Lending Agencies: Banks, financial institutions

The users are the producers and consumers of different commodities. They have exposure to the physical commodities markets, exposing themselves to price risk. In turn, they depend on logistics companies for transportation of commodities, warehouses for storage, and quality testing and certification agencies for assessment and evaluation of commodity quality standards. Commodity derivatives exchanges provide a platform for hedging against price risk for these users. 

Benefits of Trading in Commodity Derivatives
Trading in futures provides two important functions of price discovery and price risk management. It is useful to all the segments of the economy, particularly to all the constituents of the commodity market ecosystem. It is important to know how resorting to commodity trading benefits the constituents. 

Benefits to Investors, Producers, Consumers, Manufacturers:

• Price risk management: All participants in the commodity markets ecosystem across the value chain of different commodities are exposed to price risk. These participants buy and sell commodities and the time lag between subsequent transactions result in exposure to price risk. Commodity derivatives markets enable these participants to avoid price risk by utilizing hedging techniques.
• Price discovery: This is the mechanism by which a "fair value price" is determined by the large number of participants in the commodities derivatives markets.  This is the result of automation and electronic trading systems established on the commodities derivatives exchanges.
• High financial leverage: This is possible in commodity markets. For example, trading in gold calls for only 4% initial margin. Thus, if one gold futures contract (each gold futures contract lot size is 1 kg) is valued at Rs 900,000, the investor is expected to deposit an initial margin of only Rs 36,000 to be able to trade. If the price of gold goes up by even 2%, the investor would make a profit of Rs 18,000 on a deposit of Rs 36,000 before the expiry of the contract. This is the benefit of leveraged trading transactions. With futures contracts, the investor trades in the expectation of the price at a later date. This is possible with a margin deposit, which is usually between 5% and 10% of the value of the commodity. Correspondingly, the margins required for equity futures contracts are higher, due to higher volatility in equity markets as compared to commodities futures contracts. The reason for higher volatility in equity markets (especially in India) as compared to commodities derivatives transactions is due to the fact that delivery is possible in commodity derivatives transactions.
• Commodities as an asset class for diversification of portfolio risk: Commodities have historically an inverse correlation of daily returns as compared to equities. The skewness of daily returns favours commodities, thereby indicating that in a given time period commodities have a greater probability of providing positive returns as compared to equities. Another aspect to be noted is that the Sharpe ratio of a portfolio consisting of different asset classes is higher in the case of a portfolio consisting of commodities as well as equities. Even with a marginal distribution of funds in a portfolio to include commodities, the Sharpe ratio is greatly enhanced, thereby indicating a decrease in risk.
• Commodity derivatives markets are extremely transparent in the sense that the manipulation of prices of a commodity is extremely difficult due to globalization of economies, thereby providing for prices benchmarked across different countries and continents. For example, gold, silver, crude oil, etc. are international commodities, whose prices in India are indicative of the global situation.
• An option for high networth investors: With the rapid spread of derivatives trading in commodities, the commodities route too has become an option for high networth investors.
• Useful to the producer: Commodity trade is useful to the producer because he can get an idea of the price likely to prevail on a future date and therefore can decide between various competing commodities, the best that suits him. Farmers, for instance, can get assured prices, thereby enabling them to decide on the crop that they want to grow. Since there is transparency in prices, the farmer can decide when and where to sell, so as to maximize his profits.
• Useful for the consumer: Commodity trade is useful for the consumer because he gets an idea of the price at which the commodity would be available at a future point of time. He can do proper costing/financial planning and also cover his purchases by making forward contracts. Predictable pricing and transparency is an added advantage.
• Corporate entities can benefit by hedging their risks if they are using some of the commodities as their raw materials. They can hedge the risk even if the commodity traded does not meet their requirements of exact quality/technical specifications.
• Useful to exporters: Futures trading is very useful to the exporters as it provides an advance indication of the price likely to prevail and thereby help the exporter in quoting a realistic price and thereby secure export contract in a competitive market.
• Improved product quality: Since the contracts for commodities are standardized, it becomes essential for the producers/sellers to ensure that the quality of the commodity is as specified in the contract. The advent of commodities futures markets has also enabled defining quality standards of different commodities.
• Credit accessibility: Buyers and sellers can avail of the bank finances for trading in commodities. Nationalized banks and private sector banks have come forward to offer credit facilities for commodity trading.

Benefits to Indian Economy

As the constituents of the commodity market ecosystem get benefited, the Indian economy is also benefited. Growth in the organized commodity markets and their constituents implies that there would be tremendous advantages and benefits accrued to the Indian economy in terms of business generation and growth in employment opportunities. As India imports bulk of raw material (especially in base metals and energy), there is scope for minimizing price risk for international commodities. With the consumption of commodities increasing rapidly, especially in developing countries such as China and India, the prices of commodities are volatile, emphasizing the need for organized commodity derivatives exchanges.