DON’T GET TRAPPED BY CIRCUIT FILTERS!

Many investors, especially the retail ones, have been blaming circuit filters for the loss incurred to their portfolio in the scrips that have been transferred on a trade-to-trade settlement basis or reduction of circuit filters by exchanges as a surveillance action. In the present situation of the markets, apart from a portfolio creation strategy, the focus of investors and traders should also be on the quantum of trades, the fluctuation of price in a particular stock, and volumes. This is quite important due to the fact that the particular stock in which you are dealing and trading may move to the ‘T’ group or its filter limit may be changed abruptly by the exchanges if they detect potential market abuses in the stock.

If this happens, investors dealing in these stocks get stuck in a trap that will not allow them to square their positions due to very low circuit filters. Given the fact that we have been receiving complaints from retail investors suspecting some kind of foul play in the stocks transferred to the ‘T’ group, DSIJ decided to go deeper into this market mechanism of lowering and raising the circuit filters. What we have found is that though at times it seems that these circuit filters are against the interest of some investors, these actually are a part of market dynamism and certainly in favour of the wider base of investors, who otherwise could be exploited by punters.

How do Circuits Work?

Retail investors must first understand the logic behind the filter mechanism of exchanges since it is in the interest of their investments. Actually both BSE and NSE have a price monitoring cell that continuously carries out surveillance of the price movement of stocks. If this cell finds anything ‘fishy’ in relation to the price of any stock or volume it immediately gets into the action mode and initiates a measure like reduction of the circuit filter, imposition of special margin, transferring scrips on a trade-to-trade settlement basis, and even suspension of scrips or members.

The monitoring cell collects various market data like trading of stocks, price movement, promoters’ holding, trading volume of stocks, frequency of trading, new highs and lows, and also tracks various rumours in the market. “Based on this information, we pick scrips for in-depth analyses and the information is forwarded to the investigation cell for further examination,” informs a BSE official. If the surveillance cell deems fit, various actions are flagged off in relation to any particular stock from time to time. The most common is the reduction of circuit filters. Circuit filters are usually reduced to contain volatile price movement. This can be reduced to 10, 5 or even 2 per cent as decided by any of the exchanges.

A point to note is that there are no circuits for stocks in the F&O segment while there is a 20 per cent circuit filter in case of the other scrips. However exchanges do impose a dynamic circuit filter of 10 per cent in F&O scrips to avoid punching errors by market participants. Quite in line with circuit filters, exchanges can also impose special margin requirements for scrips that witness abnormal price and volume fluctuations. As such, traders or investors have to provide increased margins of up to 25, 50 or even 75 per cent on net outstandings to trade in volatile stocks. These margins are applicable to both purchase and sale.

In fact, just to safeguard the interest of investors, SEBI has introduced price bands for shares that are listed on the bourses. It is common knowledge that price manipulation in IPOs can go to the extreme and the first day of trading usually witnesses huge fluctuations in price. To curtail this manipulation, SEBI has placed IPOs in the pre-opening session and their normal trading session starts after the conclusion of the one hour call auction at 10 am. Also, for determining the price pre-call, an auction process has been put in place and for an IPO of size up to Rs 250 crore the price band will be 5 per cent of the equilibrium price discovered through the call auction, while it will be 20 per cent for bigger issues. Further, for the first 10 days trading takes place only in the trade-to-trade segment.

Beware of ‘T’ Group Stocks

Trade-to-trade scrips or ‘T’ group stocks are those in which buying and selling can be done only through actual delivery with no intra-day squaring off. More importantly, trading of ‘Z’ group scrips is compulsory on a T2T basis while it is in the power of the exchanges to transfer any scrip into a T2T settlement mode as part of its surveillance measure. Usually exchanges review their surveillance mechanism on a monthly basis and move scrips to and from the T2T mode on the basis of various information like market capitalisation, price-earning ratio, price variation as against market movement, volatility, volume variation, client concentration and the number of non-promoter shareholders.

Since the adoption of this pro-active and dynamic approach of shifting scrips into the T2T mode, the exchanges are being continuously blamed by investors of using a subjective approach to move scrips into this category, resulting in huge losses to retail investors. The explanation provided by the exchanges is simple: “Once we detect some kind of abusive practice in any stock such as price manipulation, increased activity of operators, etc. our surveillance department shifts a particular stock into the T2T mode so that the activity of the operators can be curtailed and lead to price stabilisation. Our sole objective is to put a stop to any kind of manipulation so that no investor gets trapped in a scrip due to speculation arising out of greed.” The transfer of any scrip to a T2T basis of settlement does not imply action against a company. Once the price stabilises, the scrip is shifted to the normal trading mode.

Shifting Scripts to T2T Mode

Based on the fact that investors have often blamed the exchanges of using anti-investor tactics while shifting stocks to the T2T mode, the exchanges in consultation with SEBI have devised a transparent mechanism to move stocks to and from the T2T mode. “It is important for investors to be very vigilant about their investments. At any sign of sharp volatility in price and volume, they should immediately opt out of that stock since it could entail taking a huge risk and also for the fact that the exchange may subject that script to some kind of surveillance measure,” alerts a BSE official.

As far as the criteria of shifting scrips into the T2T mode is concerned, there are two conditions that apply. First, the stock should be in a 5 per cent price band for at least 22 trading days and secondly it must also satisfy any of the criteria related to PE valuation, variation, volatility, market capitalisation and number of non-promoter shareholders. Exchanges follow these criteria on a monthly basis and stocks can be moved to and from the T2T segment on the basis of their reviews. The price band for these stocks would also be decided on this review date. Exchanges also have a calendar for the monthly trade-to-trade review and investors should take note of it.