For generations, the eyes of investors worldwide have drifted to the investment opportunities found in the Far East.
Today, many retail investors hold an unnecessarily U.S.-centric portfolio, but the wisest investors know better than centralizing all of their investments in a single economy.
While the most significant and most exciting investment opportunities have traditionally called the Middle Kingdom their home, with political tensions high and China’s economic stability uncertain, investors are now looking to other parts of Asia for investment opportunities.
The tropical subcontinent of India is becoming an increasingly popular destination for those investors who wish to diversify their portfolios beyond the shores of the United States.
This post will seek to explain the basics of investing in the Indian stock markets and the rules and regulations for doing so.
What is the Stock Market in India?
Most people reading this post will already be familiar with the concept of a stock exchange.
Many countries will have their stock markets where traders and investors can buy or sell securities. The NASDAQ, NYSE, and LSE are some of Earth’s largest and most widely traded stock markets.
Much like dozens of other countries, India too has its stock markets. While many countries have one or two stock exchanges, India currently boasts 17 different exchanges, although the Indian authorities recognize only eight.
India’s two largest stock exchanges are the Bombay Stock Exchange (BSE), which was established in 1875, and the National Stock Exchange (NSE), which was created after the BSE fell into disrepute following a market manipulation scandal in the early 90s.
Today, the Indian stock markets are among the most sophisticated equity markets in the developing world.
Indian stock exchanges are regularly counted among the top three exchanges on Earth regarding the number of processed transactions, and recent times have not known a single settlement failure.
The standards of governance and regulation applied to these markets are comparable to those you would expect to find in any developed financial market.
All listed companies are required to report their earnings quarterly and disclose any significant transactions or activities to the regulator.
The latest meaningful development in trading the Indian markets took place in 2008 when the Indian equity markets finally introduced high-frequency and algorithmic trading.
The Indian regulator permitted direct market access to the Indian stock exchanges in 2007 and shortly after ushered in a new era of trading.
Indian Stock Market Basics
Contrary to popular belief, stock markets were not created to make wealthy individuals even more prosperous than they already are.
In theory, the reasoning behind the creation of stock markets was to provide companies with a market to raise capital.
In exchange for equity ownership of their corporations in shares, investors would provide the company with capital.
These shares are designed to be digital representations of ownership that provide the investor with an asset that they hope will increase in value over time and grow with the company’s success.
The capital that companies raise from the sale of those shares would ideally be used to fund their projects and promote the company’s growth.
Even though stock markets were not created solely to help individuals grow their wealth, wealth accumulation is the primary force behind any investment.
There are generally two ways an investor can grow their wealth by investing in shares; capital gains and dividends. Let’s explore each of these now.
Capital gains is an excellent example of a complicated term being used to describe a relatively simple concept.
Capital gains mean that you purchase an asset for X and then sell it for X +1. The +1 represents your capital gains.
For example, you purchase shares of Apple (AAPL) for $20,000 (X) and then sell them a year later for $25,000 (+1).
The value of the shares you purchased has increased by $5000 over the year. These $5000 represent your capital gains. The concept of capital gains is not exclusive to stocks and can be applied to any assets that increase in value over time.
A dividend is a distribution of a company’s profits to its shareholders. Essentially, a company makes a profit and pays you a portion of that profit for being an investor in the company.
The amount you receive will depend on the number of shares you own, the company’s dividend yield, and whether or not that company has the profits to pay out a dividend.
Dividends will account for a large portion of the total wealth created through investing in the stock market.
While not regularly discussed, there is a third (less common) way of making money through the stock market. A passive income stream can be generated by investors through the lending out of their shares by their brokerage.
Not every brokerage will afford their clients this option, and the terms of engaging in this practice will differ depending on your specific brokerage.
However, you can participate in a share lending scheme whereby your brokerage lends your shares to third parties and pays you a certain amount of interest for having agreed to allow them to do so.
While this income will be negligible compared to the returns promised by dividends and capital gains, it is still an entirely viable form of income from the stock market that should not be discounted.
How to Trade the Stock Market in India
As technology has improved, so too has the ease with which individuals can access the Indian financial markets.
These days, to trade in any financial market, a trader will only need three main things; a computer, an internet connection, and a brokerage account. Admittedly, you may also need some capital to trade with unless you are using a demo account.
Brokerages are our gateway into the financial system; they are online platforms that connect buyers and sellers to facilitate a transaction.
Choosing the right brokerage for you is an important decision every trader must make because it impacts everything from the fees you pay to the trading tools you have at your disposal when trading.
With the growing interest in trading and investing, it is now more vital than ever that traders sign up to a reputable broker when trading in the financial markets.
We will highlight some reputable brokerages in India in one of the sections below.
Once you have your brokerage account, you will also be required to set up a Demat Account. A Demat Account, otherwise known as a Dematerialised Account, provides investors with the ability to hold shares and securities electronically.
Demat Accounts are necessary to facilitate trading in India. They will hold all the investments an individual makes in shares, government securities, exchange-traded funds, bonds, and mutual funds in one place.
Thankfully, most brokerages in India will have the infrastructure to help clients create one of these accounts through their brokerage.
Please note that each brokerage will have different Demat Account chargers that vary depending on the size of the account, type of subscription, and broker-specific terms and conditions.
Once you have secured a brokerage and Demat Account, you will be able to begin trading in the Indian equity markets.
Indian Stock Market Rules and Regulations
Every financial market has its watchdog, a regulator capable of ensuring a level playing field and enforcing the game’s rules where individuals attempt to color outside the lines.
In India, this role is filled by the Securities Exchange Board of India (SEBI).
Formed in 1988, SEBI received its statutory powers through an Act of Parliament in 1992. The regulatory body was modeled after the British and American regulators in the hopes that they would enjoy comparably robust regulatory frameworks.
The formation of the SEBI was met with considerable resistance from both the trading community and the then Indian Government members.
Initially, the SEBI was little more than a meaningless charade designed to do nothing but provide the appearance of regulation. In reality, the SEBI had little power to provide the kind of regulated markets expected in the developed economies we know today.
In the years since it was founded, the powers of the SEBI have been significantly expanded to ensure the interests of investors and other stakeholders are as protected as possible. Thankfully, the SEBI is no longer the toothless tiger it once was, and the Indian equity markets are all the better for it.
Two years after SEBI was formed, the Indian Government began to permit foreign investment into the Indian equity markets. In India, foreign investments are subdivided into foreign direct investment (FDI) and Foreign Portfolio Investment (FPI).
Any investments in which an investor takes an active part in the day-to-day management and operations of the company are classified as Foreign Direct Investment (FDI). Similarly, any investments in shares that do not transfer control over managing and processes are treated as Foreign Portfolio Investment (FPI).
Foreign investors can gain exposure to the Indian equity markets through institutional investors.
There is a wide range of India-centric funds that have grown in popularity among retail investors. Currently, two of the most prominent ETFs based on the Indian markets are iShares MSCI India ETF (INDA) and the Wisdom-Tree India Earnings Fund (EPI).
Alternatively, investments could also be made through some legally creative offshore financial instruments such as:
- Participatory Notes (P.N.s);
- American Depositary Receipts (ADRs);
- Global Depositary Receipts (GDRs);
- Exchange-Traded Notes (ETNs).
According to the current regulatory framework, participatory notes representing underlying Indian stocks can only be issued offshore by FIIs to regulated entities.
However, any investor can invest in the ADRs that represent the underlying stocks of some of the most prominent Indian companies listed on both the NYSE and the NASDAQ.
Investors should be aware that when purchasing ADRs (or other instruments of a similar nature), they are not purchasing the shares of these companies but rather a financial instrument that represents ownership in the underlying shares.
In other words, you own shares in a company in the Cayman Islands that holds shares in an Indian company that has shares in the company that you wish to invest in. These ADRs are essentially cross-border legal maneuvering designed to get around regulations that would otherwise prevent you from investing in these companies.
Stock Market Brokers in India
As we noted above, brokerages are our gateway into the financial system. They effectively act as digital middlemen that connect buyers and sellers to facilitate a transaction.
Here are some of the most well-regarded stock market brokerages in India.
India Stock Market Index
A stock market index is a measurement of a stock market or a subset of a stock market that assists investors in comparing past and present prices to calculate the market’s overall performance.
A stock market index is calculated using the prices of specific stocks. For example, the S&P 500 is calculated based on the performance of the 500 largest companies in the United States.
In India, the two most widely referenced market indexes are the Sensex and the Nifty.
The Sensex is the oldest of the two and includes 30 companies listed on the Bombay Stock Exchange. These companies represent approximately 47% of Sensex’s free-float market capitalization. It was created in 1986 and can provide price data from as far back as April 1979.
The Nifty index measures the performance of the 50 companies on India’s other major stock exchange, the National Stock Exchange.
The companies on the index represent approximately 46% of their free-float market capitalization. It was created in 1996 and can provide price data from July 1990.
Lastly on Trading the Stock Market in India
Investors in the Indian economy have enjoyed a phenomenal amount of wealth creation over the past few decades, and the growth shows little sign of slowing down.
Currently, only a small percentage of Indian household savings are invested in the domestic markets.
However, the Indian GDP growing at a rate of 7-8% per year coupled with a stable financial market may foster the perfect environment for new investors to begin taking advantage of India’s success.
It may be time for domestic and foreign investors alike to consider expanding their portfolios and gaining some exposure to the Indian markets.
As with any investment or trade, you must do your research before putting any capital at risk.
When investing in foreign markets, some financial instruments can be more complex than others. Be sure you understand the instrument you are purchasing and be fully aware of the risks involved.