The traders and investors, who directly access the trading platforms of brokers, are reminded and forced to acknowledge, every time they log in to the trading system, “9 out of 10 individual traders in the Equity Futures and Options Segment, incurred net losses”. This is in fact one of the conclusions of a study conducted by the Securities and Exchange Board of India (SEBI) (published in January 2023). From my study of the Indian stock markets in the past three decades, I understand that this conclusion is no exaggeration.
This state of affairs raises two pertinent questions:
(i) How sustainable a market is where 90% of participants are losing money consistently?
(ii) Does not this pose a material systemic risk for our markets, especially under the present circumstances where the global financial and geopolitical conditions are worsening every day, and the probability of an eight-sigma event like 9/11 attack and Lehman Collapse etc. is increasing?
Sustainability of market
In my view, the fact that about 90% of the participants are losing money consistently does not pose any risk whatsoever to the sustainability of the markets.
(a) There is strong empirical evidence to suggest that a large number of traders on the losing side may have actually aided the market growth in the past twenty-three years.
· The derivative segment turnover at the National Stock Exchange of India (NSE) has grown from Rs2365cr in FY01 to a staggering Rs3,82,22,86,018cr in FY23 – a CAGR of 91.4%. In simple terms almost doubling every year from the previous year for 23 years.
· The transaction cost incurred by the ever-rising derivative traders has evidently contributed materially to the development of the capital markets. Brokers have been able to invest significant capital in technology and trading infrastructure, The regulator has also earned a tremendous amount of fees, enabling it to invest in technology and investor protection & education programs; the National Stock Exchange has become one of the most valuable financial service corporations.
(b) This 10:90 ratio has been true ever since the financial markets came into existence in India. While doing research for my PhD during the early 2000s, I discovered that about 90% of the Indian households participating in the stock markets were actually not serious investors. They would “bet” some money on some random stock to test their luck. They seldom differentiated between buying a lottery ticket, a roll of dice in a casino, and buying stock of a company. However, since the amount of ‘bet” is usually very small in relation to their networth, a loss of 100% of their bet never deters them from testing their luck repeatedly.
(c) Moreover, over the years the “investment” part of their exposure to the securities market has become increasingly institutionalized. In the past 10 years, the share of retail investors in the total NSE turnover has reduced from over 55% to close to 40% now.
Systemic risk
The rise in derivative turnover and a large number of traders losing money may not be contributing much to the systemic risk of the Indian stock markets. In the past two decades, the Indian markets have been best regulated and safest amongst the global peers. In fact, the Indian market was perhaps the only major market globally that did not impose any trading restrictions, or face any closure or trading halt, during the global financial crisis or during Covid-19 pandemic.
We have hardly seen moves of more than 3% on a daily closing basis in the past 5 years. Despite all the global noise and domestic issues, the implied volatility index (VIX) is persisting at its lowest level.
There are two key reasons for this remarkable stability in our markets.
(i) Indian markets follow one of the strictest margining systems in the world. The chances of a contagion, in case any market participant defaults, are negligible. Besides, the regulators have also implemented a very extensive surveillance mechanism to identify and control unusual movements in stocks.
(ii)
The composition of market activity has materially changed since the global financial crisis days when 3-5% daily moves in the index were not uncommon. In FY08 prior to the global financial crisis, the single stock futures (inarguably the most risky derivative product) comprised 58% of the total derivative segment turnover, where the safest product index options were just 10%. In FY23 Index options were 97.7% of the derivative segment turnover, while stock futures were just 0.5%. Obviously, the systemic risk is now minimal. The potential losses are very well defined and adequately provided for through margins.
To conclude, I am not worried about any systemic or sustainability risk to Indian markets. However, I am also not sure about the utility of the warning flashed on trading screens at every login. To deter people from stretching their luck too much and losing money consistently, much more serious efforts and paradigm shifts would be needed.
