First Steps

Commodity

 A commodity is a good for which there is demand, but which is supplied without qualitative differentiation across a market. It is a physical substance, such as food, grains, and metals, which is interchangeable with another product of the same type, and which investors buy or sell, usually through futures contracts. The price of the commodity is subject to supply and demand. Risk is actually the reason exchange trading of the basic agricultural products began. Commodities are often substances that come out of the earth and maintain roughly a universal price. A commodity is fungible, that is, equivalent no matter who produces it.

In the broadest sense, a commodity is anything that has value, from watches to time to oranges. In a more specific market sense, however, a commodity is an item which is roughly the same market value across the board, with no difference based on quality.

The mainstream commodity market can be split into a number of different markets: precious metals, industrial metals, livestock, agricultural products, energy, and some commodities that don’t easily fall into a classification. Precious metals include gold, silver, platinum, and palladium. Industrial metals include aluminum, aluminum alloy, nickel, lead, zinc, tin, recycled steel, and copper. Livestock includes live cattle, feeder cattle, pork bellies, and lean hogs. Agricultural products include soybeans, soybean oil, soybean meal, wheat, cotton number two, sugar numbers eleven and fourteen, wheat, corn, oats, rice, cocoa, and coffee. Energy includes ethanol, heating oil, propane, natural gas, WTI crude oil, Brent crude oil, GulfCoast gasoline, RBOB gasoline, and uranium. The commodity market also includes rubber, wool, polypropylene, polyethylene, and palm oil.

Commodity derivatives market

commodity derivatives trade contracts for which the underlying assets is a commodity like, wheat, soyabean, cotton etc or precious metal like Gold and Silver. The commodity derivatives differ from the financial derivatives mainly in the following two aspects: Firstly, due to the bulky nature of the Underlying assets, physical settlement in commodity derivatives creates the need for warehousing. Secondly, in the case of commodities, the quality of the asset underlying a contract can vary largely.

Commodity market in India

India has a long history of future trading in commodities. In India, trading in Commodity future has been existence from the 19th Century with organised trading in Cotton, through the establishment at Bombay Cotton Association Ltd. in 1875. Over a period of time, other commodities were permitted to be traded in future exchanges. Spot trading in India occurs mostly in regional mandis and unorganized market, which are fragmented and isolated.

There were booming activities in this market at one time as many as 100 Unorganized exchanges were conducting forward trade in various commodities. The securities market was a poor competitor of this market as there were not many papers to be traded at that time.

However, many feared that derivatives fuelled unnecessary speculation and were detrimental to the healthy functioning of the market for the underlying commodities. As a result, after independence, commodity option trading and cash settlement of commodity future were banned in 1952.

A further blow come in 1960’s when following several years of several droughts has forced many farmers to default on forward contact and even caused some suicides, forward trading was banned in many commodities considered primary or essential. Consequently, the commodities derivatives market dismantled and remained dormant for about four decades until the new millennium when the Govt. in a complete change in policy, started actively encouraging the commodity derivatives market.

The year 2003 marked the real turning point in the policy frame work for commodity market when the government issued notifications for withdrawing all prohibitions and opening up forward trading in all commodities. This period also witnessed other reforms, such as, amendments to the Essential Commodities Act, Securities (contract) Rules, which have reduced bottlenecks in the development and growth of commodity markets of the country is total GDP, commodities related and dependent industries constitute about roughly 50-60% which itself cannot be ignored.

Why are commodity derivatives required:

India is among the top 5 producer of the most of the commodities in addition to being a major consumer of bullion and energy products. Agriculture contributes more than 23% to be GDP of Indian economy. It employees around 57% of the labour force on a total of 185 million hectares of land. Agriculture sector is an important factor to achieving a GDP growth of 8.10. All this indicates that India can be promoted as a major centre for trading of commodity derivatives.

It is common knowledge that prices of commodities, metals, shares and currencies fluctuate over time. The possibilities of adverse price change in future creates risk for business. Derivatives are used to reduce or eliminate price risk arising from unforeseen price change. A derivatives is a financial contract whose price depends on, or is derived from the price of another assets.

Two important derivatives are future and options

1. Commodity Future Contract:

A future contract is an agreement for buying or selling a commodity for a predetermined delivery price at a specific future time. Futures are standardized contract that are traded on organized facture exchanges that ensure performance of the contract and remove the default risk. The commodity futures have existed since the Chicago Board of Trade (CBOT) was established in 1848 to bring farmers and merchants together the major function of future market is toe transfer price risk from hedger to speculators. For example suppose a farmer who is expecting the crop of wheat to be ready in three months time, but is worried that the price of wheat may decline in this period, in order to minimize his risk, he can enter into a future contract to sell his crop in three months time at a price determined now.

Just take an another example. All we know that woolen garments demand picks up in winter season. A garment factory owner can by a factory contract of cotton to get the raw material for his products as predetermined price. This way both time is able to hedge their risk arising from a possible adverse change in the price of theirs commodity or raw material.

2. Commodity Option Contract:

Like futures, option are also financial instruments used for hedging and speculation. The commodity option holder has the right, but not the obligation to buy (or sell) a specified quantity of a commodity at specified price on or before a specified date. Option contract involve two parties – the seller of the option writes the option in favour of the buyer (holder) who pays a certain premium to the seller as a price for the option. There are two types of commodity options. A ‘call’ option gives the holder a right to buy a commodity at an agreed price, while a ‘put’ option gives the holder a right to sell a commodity at an agreed price on or before a specified date which is called expiry date.

The option holder will exercise the option only if it is beneficial to him, otherwise he will let the option lapse. Suppose a farmer buys a put option to sell 10 MT of wheat of Rs. 13000/- MT and pays a ‘premium’ of Rs. 500/- MT. If the price wheat decline, to say Rs. 1000/- MT before expiry, the farmer will the exercise his option and sell his wheat at the agreed price of Rs. 1300/- MT. However, if the market price of wheat increases by Rs. 1000/-MT, it will be better for the farmer to sell it directly in the open market at the spot price, rather than his option to sell at Rs. 13000/- MT.

Future and options trading therefore helps in hedging the price risk and also provide investment opportunity to speculators who are willing to assume risk for a possible return. Future trading and the ensuing discovery of price can help farmers to deciding which crops to grow.

Thus future and options market perform important functions that cannot be ignored in modern business environment. At the same time, it is true that too much speculative activity in essential commodities would destabilize the markets and therefore, these markets are normally regulated as per the law of the country. Commodity Options trading is not permitted in India till now.

Modern commodity exchange

To make up the loss of growth and development during the four decades of restrictive Govt. policies, FMC and the government encouraged setting up commodity exchanges using the most modern system and practices in the world. Some of the main regulatory measures imposed in the FMC include daily market to market system of margins, creation of trade guarantee fund, back office computerization for the existing single commodity exchanges , online trading for the new exchanges, demutualization for the new exchanges and one third representation of independent Directions the Board of existing Exchanges etc.

National Level Commodity Exchanges in India are:-

• NMCE : National Multi Commodity Exchange of India.
• NCDEX : National Commodity Derivatives Exchange Ltd.
• MCX : Multi Commodity Exchange of India Ltd.
• NSEL : National Stock Exchange Ltd.

NMCE: (National Multi Commodity Exchange of India Ltd It is the first demutualised electronic commodity exchange of India granted the National exchange on Govt. of India and operational since 26th Nov, 2002. The Head Office of NMCE is located in Ahmadabad. There are various commodity trades on NMCE Platform including Agro and non-agro commodities. NCDEX (National Commodity & Derivates Exchange Ltd
NCDEX is a public limited co. incorporated on April 2003 under the Companies Act 1956, It obtained its certificate for commencement of Business on May 9, 2003. It commenced its operational on Dec 15, 2003. NCDEX is located in Mumbai and currently facilitates trading in 57 commodity mainly in Agro product.

NSEL (National Spot Exchange Limited)

National Spot Exchange Limited (NSEL) is a National level Institutionalized, Electronic, Transparent Spot trading platform which commenced its live operations on 15th Oct, 2008. At present NSEL is operational in 13 states, providing delivery based spot trading of 26 commodities.

MCX Multi Commodity Exchange of India Ltd

Headquartered in Mumbai, the exchange started operation in Nov, 2003. MCX is a demutalised nation wide electronic commodity future exchange. Set up by Financial Technologies (India) Ltd. permanent recognition from government of India for facilitating online trading, clearing and settlement operations for future market across the country. MCX is well known for bullion and metal trading platform.
MCX offers futures trading in

• Metal
• Aluminium, Copper, Lead, Nickel, Sponge Iron, Steel Long (Bhavnagar), Steel Long (Govindgarh), Steel Flat, Tin, Zinc
• BULLION
• Gold, Gold HNI, Gold M, i-gold, Silver, Silver HNI, Silver
• FIBER
• Cotton L Staple, Cotton M Staple, Cotton S Staple, Cotton Yarn, Kapas
• ENERGY
• Brent Crude Oil, Crude Oil, Furnace Oil, Natural Gas, M. E. Sour Crude Oil
• SPICES
• Cardamom, Jeera, Pepper, Red Chilli
• PLANTATIONS
• Arecanut, Cashew Kernel, Coffee (Robusta), Rubber
• PULSES
• Chana, Masur, Yellow Peas
• PETROCHEMICALS
• HDPE, Polypropylene(PP), PVC

OIL & OIL SEEDS

Castor Oil, Castor Seeds, Coconut Cake, Coconut Oil, Cotton Seed, Crude Palm Oil, Groundnut Oil, Kapasia Khalli, Mustard Oil, Mustard Seed (Jaipur), Mustard Seed (Sirsa), RBD Palmolein, Refined Soy Oil, Refined Sunflower Oil, Rice Bran DOC, Rice Bran Refined Oil, Sesame Seed, Soymeal, Soy Bean, Soy Seeds

CEREALS

Maize

OTHERS

Guargum, Guar Seed, Gurchaku, Mentha Oil, Potato (Agra), Potato (Tarkeshwar), Sugar M

Regulator of commodity exchanges:

FMCL (Forward Market commission) headquarted in Mumbai, is regulation authority which is overseen by the minister of consumer affairs, food and public distribution Govt. of India, It is a statutory body set up in 1953 under the forward contract (Regulation) Act 1952.

Needs for future trading in commodities:

Commodity futures, which terms an essential component of commodity exchanges, can be broadly classified into precious metals, agriculture, energy and other metals. Current future volumes are miniscule compared to underlying spot market volumes and thus have a tremendous potential in the near future. Future trading in commodities result in transparent and fair price discovery. It reflects videos and expectations of wider section of people related to a particular commodity. It provides effective platform for price risk management for all segment of players ranging from producers, trades and processors of a commodity. It aids in improving the cropping platform for farmers, thus mimizing the losses to the farmers. It also acts as a smart investment choice in providing hedging, trading and arbitrage opportunities to market players. Historically, pricing, in Commodities future has been less volatile compared with equity and bonds, thus providing an efficient portfolio diversification option. Raw Materials form the most key element of industries. The significance of raw materials can further be strengthened by the fact that the increase in raw material cost means reduction in share prices. Industry in India a today runs the raw material price risk. Hence going forward the industry can hedge this risk by trading in commodities market.

Risk associated with commodities market:

No risk can be eliminated, but the same can be transferred to someone who can handle it better or to someone who has the appetite for risk. Commodity enterprises primarily face the following classes of risk. Namely: The price Risk, the quantity risk, the yield/output risk and the political risk, talking about the nationwide commodity exchanges, the risk of the counter party not fulfilling his obligations on due date or at any time therefore is the most common risk.
This risk is mitigated by collection of the following margins:-

• Initial margins
• Exposure margins
• Mark to Market on daily positions.
• Surveillance.

Key factors for success of commodities market:

The following are source of the key factors for the success of the commodities market:

• How can one make the business grow
• How many products are covered
• How many people participate in the Platform.

Key factors for success of commodity exchanges:

Strategy, method of execution, background of promoters, credibility of the institution, transparency of platforms, scaleable technology, robustness of settlement structure, wider participation of Hedgers, speculators and arbitragers, acceptable clearing mechanism, financial soundness and capability, covering a wide range of commodity, reach of the organization and adding value to the ground.

Basic terminologies in commodities

Arbitrage: The simultaneous purchase and sale of similar commodities in different markets to take advantage of a perceived price discrepancy.

Basis: The difference between the current cash price and the futures price of the same commodity for a given contract month.

Bear Market: A period of declining market prices.

Bull Market: A period of rising market prices.

A company or individual that executes futures and options orders on behalf of financial and commercial institutions and/or the general public.

Call Option: An option that gives the buyer the right, but not the obligation, to purchase (go "long") the underlying futures contract at the strike price on or before the expiration date of the option.

Cash (Spot) Market: A place where people buy and sell the actual (cash) commodities, i.e., grain elevator, livestock market, etc.

Commission (Brokerage) Fee: A fee charged by a broker for executing a transaction.

Convergence: A term referring to cash and futures prices tending to come together as the futures contract nears expiration.

Cross-hedging: Hedging a commodity using a different but related futures contract when there is no futures contract for the cash commodity being hedged and the cash and futures markets follow similar price trends

Daily Trading Limit: The maximum price change set by the exchange each day for a contract.

Day Traders: Speculators who take positions in futures or options contracts and liquidate them prior to the close of the same trading day.

Delivery: The transfer of the cash commodity from the seller of a futures contract to the buyer of a futures contract.

Forward (Cash) Contract: A cash contract in which a seller agrees to deliver a specific cash commodity to a buyer at a specific time in the future

Fundamental Analysis: A method of anticipating future price movement using supply and demand information.

Futures Contract: A legally binding agreement, made on the trading floor of a futures exchange, to buy or sell a commodity or financial instrument sometime in the future. Futures contracts are standardized according to the quality, quantity and delivery time and location for each commodity. The only variable is price, which is determined on an exchange trading floor.

Hedger: An individual or company owning or planning to own a cash commodity - corn, soybeans, wheat, etc. and concerned that the costs of the commodity may change before they intend to either buy or sell it in the cash market. A hedger achieves protection against changing cash prices by purchasing (selling) futures contracts of the same or similar commodity and later offsetting that position by selling (purchasing) futures contracts of the same quantity and type as the initial transaction and at the same time as the cash transaction occurs.

Hedging: The practice of offsetting the price risk inherent in any cash market position by taking an equal but opposite position in the futures market. Hedgers use the futures markets to protect their business from adverse price changes.

Margin: Margin is the percentage amount required by the exchange from the trading member for carrying out trading activities in the particular contract. The member in turn collects the margin from the client entering into trade in that contract. Though the margin amount as a whole is more significant, it can be broken into 4 kinds of margin:

• Initial Margin
• Exposure Margin
• Additional Margin
• Special Margin

Initial Margin: The amount a futures market participant must deposit into his/her margin account at the time he/she places an order to buy or sell a futures contract.
In-the-Money Option: An option having intrinsic value. A call option is in-the-money if its strike price is below the current price of the underlying futures contract. A put option is in-the-money if its strike price is above the current price of the underlying futures contract.

Intrinsic Value: The difference between the strike price and the underlying futures price for an option that is in-the-money.

Liquidate: Selling (or purchasing) futures contracts of the same delivery month purchased (or sold) during an earlier transaction or making (or taking) delivery of the cash commodity represented by the futures contract.

Long: One who has bought futures contracts or plans to own a cash commodity.

Lot Size: There are generally 2 kind of lots associated with commodity futures

Trading lot

It is the lot size in which trading activities are carried out. It means that the minimum quantity in which trading would be conducted for any particular contract of a commodity. Eg. With lot size of Crude Oil being 100 barrels, any trader / investor would have to buy / sell a minimum of 100 barrels of crude oil on the trading platform. No fractions are allowed to trade on the exchanges and the trading is carried out in multiples of lot size only.

Delivery lot

It is the minimum size for conducting delivery in the particular commodity. It can differ from the trading lot but would be always in the multiples of the trading lot. It can’t be smaller than trading lot as the delivery would not be possible in that case. Generally, the delivery lot is decided on the basis of the standards of the delivery procedure carried out in spot markets.

Maintenance Margin: A set minimum margin (per outstanding futures contract) that a customer must maintain in his margin account.

Nearby (Delivery) Month: The futures contract month closest to expiration. Also referred to as spot month.

Open Interest: The total number of futures or options contracts of a given commodity that have not yet been offset by an opposite futures or option transaction nor fulfilled by delivery of the commodity or option exercise. Each option transaction has a buyer and a seller, but for calculation of open interest only one side of the contract is counted.
Option: A contract that conveys the right, but not the obligation, to buy or sell a futures contract at a certain price for a specified time period. Only the seller (writer) of the option is obligated to perform.

Option Premium: The price of an option-the sum of money that the option buyer pays and the option seller receives for the rights granted by the option.

Out-of-the-Money Option: An option with no intrinsic value, i.e., a call whose strike price is above the current futures price or a put whose strike price is below the current futures price.

Purchasing Hedge (long hedge): Buying futures contracts to protect against a possible price increase of cash commodities that will be purchased in the future. At the time the cash commodities are bought, the open futures position is closed by selling an equal number and type of futures contracts as those that were initially purchased.

Put Option: An option that gives the option buyer the right but not the obligation to sell (go short) the underlying futures contract at the strike price on or before the expiration date of the option.

Price Limit: Price Limit is put into the place by the Exchanges on directives from FMC, the regulatory body, to keep a check on extreme price movements within a single trading session.

A price limit is defined for each commodity in percentage terms which is calculated from the previous close of the contract. If the prices hit the circuit limit on either side, the trading is halted for 15 minutes, which is often termed as cooling period. Then the trading limit gets relaxed for another 50% of the initial limit specified and margin on the contract gets increased. The revised limit is the maximum price on the higher / lower side at which trading can take place.

Different commodities have different price limits. Same commodity might be having different price limits on different exchanges but different contracts of same commodity can’t have varying price limits (in percentage terms) on same exchange
Selling Hedge (short hedge): Selling futures contracts to protect against possible declining prices of commodities that will be sold in the future. At the time the cash commodities are sold, the open futures position is closed by purchasing an equal number and type of futures contracts as those that were initially sold.

Short Position: One who has sold futures contracts or plans to sell a cash commodity. Selling futures contracts or initiating a cash forward contract sale without offsetting a particular market position.

Speculator: A market participant who tries to profit from buying and selling futures and option contracts by anticipating future price movements. Speculators assume market price risk and add liquidity and capital to the futures markets. They do not hold equal and opposite cash market risks.

Spread: The price difference between two related markets or commodities. For example, the April-August live cattle spread.

Strike Price: The price at which the futures contract underlying a call or put option can be purchased (call) or sold (put). Also called exercise price.

Symbol: Exchange provides symbol to each commodity traded on its platform. These symbols are unique within the exchange.

Symbols on MCX are quite simple and easy to identify as the name is the symbol in most cases. Eg. Gold is written as 'GOLD', Silver as 'SILVER', Copper as 'COPPER' and Crude Oil as 'CRUDEOIL' On the other hand, NCDEX has a different method of allotting symbols. Each symbol carries alphabets from the following:

• Name of the commodity
• Quality of the commodity
• Delivery centre

Technical Analysis: Anticipating future price movements using historical prices, trading volume, open interest, and other trading data to study price patterns.

Time Value: The amount of money option buyers are willing to pay for an option in the anticipation that, over time, a change in the underlying futures price will cause the option to increase in value. In general, an option premium is the sum of time value and intrinsic value. Any amount by which an option premium exceeds the option's intrinsic value can be considered time value.

Tick Size: Tick size is the minimum price movement permissible for the particular contract. It means that the minimum price fluctuation (if any) in a commodity would be the tick size. Eg. Tick Size for Wheat at NCDEX is Rs. 0.20 which means that if the wheat is quoting at Rs. 850, then the next price on the higher side should be minimum Rs. 850.2. It cannot be Rs. 850.10.

Underlying Futures Contract: The specific futures contract that can be bought or sold by exercising an option.

Volatility: A measurement of the change in price over a given time period. It is often expressed as a percentage and computed as the annualized standard deviation of percentage change in daily price.

Volume: The number of purchases or sales of a commodity futures contract made during a specified period of time, often the total transactions for one trading day.

Initial Public Offer IPO or Initial Public Offer is a way for a company to raise money from investors for its future projects and get listed to Stock Exchange. It is the selling of securities to the public in the primary stock market. An Initial Public Offering (IPO) referred to simply as an "offering" or "flotation," is when a company (called the issuer) issues common stock or shares to the public for the first time. They are often issued by smaller, younger companies seeking capital to expand, but can also be done by large privately-owned companies looking to become publicly traded. Company raising money through IPO is also called as company ‘going public'. Initial Public Offerings (IPOs) represent the transition point of companies from a private status to a publicly held status. Thus, IPOs represent one of the most closely observed events in the stock market since they mark the inception of a new trading opportunity. Since every business starts as a small enterprise, the new player on the stock market issues only a few stocks, which results in a relatively small number of stockholders. In an IPO the issuer may obtain the assistance of an underwriting firm, which helps it determine what type of security to issue (common or preferred), best offering price and time to bring it to market. From an investor point of view, IPO gives a chance to buy shares of a company, directly from the company at the price of their choice (In book build IPO's). Many a times there is a big difference between the price at which companies decides for its shares and the price on which investor are willing to buy share and that gives a good listing gain for shares allocated to the investor in IPO. An IPO can be a risky investment. For the individual investor it is tough to predict what the stock or shares will do on its initial day of trading and in the near future since there is often little historical data with which to analyze the company. Also, most IPOs are of companies going through a transitory growth period, and they are therefore subject to additional uncertainty regarding their future value. From a company prospective, IPO help them to identify their real value which is decided by millions of investor once their shares are listed in stock exchanges.

Reasons for listing When a company lists its shares on a public exchange, it will almost invariably look to issue additional new shares in order at the same time. The money paid by investors for the newly-issued shares goes directly to the company. An IPO, therefore, allows a company to tap a wide pool of stock market investors to provide it with large volumes of capital for future growth. The company is never required to repay the capital, but instead the new shareholders have a right to future profits distributed by the company and the right to a capital distribution in case of a dissolution. The existing shareholders will see their shareholdings diluted as a proportion of the company's shares. However, their capital investment will make their shareholdings more valuable in absolute terms. In addition, once a company is listed, it will be able to issue further shares via a rights issue, thereby again providing itself with capital for expansion without incurring any debt. This regular ability to raise large amounts of capital from the general market, rather than having to seek and negotiate with individual investors, is a key incentive for many companies seeking to list. Benefits of being a public company

• Bolster and diversify equity base
• Enable cheaper access to capital
• If there were no uncertainties, there would be no need for insurance.
• Exposure and prestige
• Attract and retain the best management and employees
• Facilitate acquisitions
• Create multiple financing opportunities

Company registration The first step a company should take in order to become publicly traded includes registration with the Securities and Exchange Commission (the SEC). After this a public offering is prepared, which should include a company's prospectus and other legal documents that are required by the SEC. Every potential investor has the right to receive a company's prospectus. The latter represents a legal and accounting document, which explains in detail the situation in the company, including information about the senior staff, majority stockowners and the potential risks the company faces. Life cycle of an IPO prospectus

Stage 1: draft offer document "Draft Offer document" is prepared by Issuer Company and the Book Building Lead Manager of the public issue. This document is submitted to SEBI for review. After reviewing this document either SEBI ask lead managers to make changes to it or approve it to go ahead with IPO processing. It is usually a PDF file having information of an investor who needs to know about the public issue. It mainly contain information about the company, its business, management, risk involve in applying to this issue, company financials and the reason why company is raising money through IPO.

Stage 2: offer document Once the ‘Draft Offer document' cleared by SEBI, it becomes "Offer Document". Offer Document is the modified version of ‘Draft Offer document' with SEBI suggestions. "Offer Document" is submitted to the registrar of the issue and stock exchanges where Issuer Company is willing to list.

Stage 3: red herring prospectus Once "Offer Document" gets clearance from Stock Exchanges, Issuer Company add Issue size and price of the issue to the document and make it available to the public. The issue prospectus is now called "Red Herring Prospectus". Issue A company that is planning an IPO appoints lead managers to help it decide on an appropriate price at which the shares should be issued. There are two ways in which the price of an IPO can be determined: either the company, with the help of its lead managers, fixes a price or the price is arrived at through the process of book building. Book Building is basically a process used in IPOs for efficient price discovery.It is a mechanism where,during the period for which the IPO is open, bids are collected from investors at various prices, which are above or equal to the floor price. The offer price is determined after the bid closing date. Date of the issue Once ‘Draft Prospectus' of an IPO is cleared by SEBI and approved by Stock Exchanges then it's up to company going public to finalize the date and duration of an IPO. Company consult with the Lead Managers, Registrar of the issue and Stock Exchanges before decides the date. Life cycle of an IPO Below is the detail process flow of a 100% Book Building Initial Public Offer IPO. This process flow is just for easy understanding for retail IPO investors. The steps provided below are most general steps involve in the life cycle of an IPO 1.Issuer company - IPO process initialization

• Appoint lead manager as book runner
• Appoint registrar of the issue
• Appoint syndicate members

2.Lead manager's - pre issue role - part 1

• Prepare draft offer prospectus document for IPO
• File draft offer prospectus with SEBI
• Road shows for the IPO

3.SEBI – prospectus review

• SEBI review draft offer prospectus
• Revert it back to Lead Manager if need clarification or changes (Step 2).
• SEBI approve the draft offer prospectus, the draft offer prospectus is now become Offer Prospectus.

4.Lead manager - pre issue role - part 2

• Submit the Offer Prospectus to Stock Exchanges, registrar of the issue and get it approved
• Decide the issue date & issue price band with the help of Issuer Company
• Modify Offer Prospectus with date and price band. Document is now called Red Herring Prospectus
• Red Herring Prospectus & IPO Application Forms are printed and posted to syndicate members; through which they are distributed to investors

5.Investor – bidding for the public issue

• Public Issue Open for investors bidding
• Investors fill the application forms and place orders to the syndicate members
• Syndicate members provide the bidding information to BSE/NSE electronically and bidding status gets updated on BSE/NSE websites
• Syndicate members send all the physically filled forms and cheques to the registrar of the issue
• Investor can revise the bidding by filling a form and submitting it to Syndicate member
• Syndicate members keep updating stock exchange with the latest data.
• Public Issue Closes for investors bidding

6.Lead manager – price fixing

• Based on the bids received, lead managers evaluate the final issue price
• Lead managers update the 'Red Herring Prospectus' with the final issue price and send it to SEBI and Stock Exchanges

7.Registrar - processing IPO applications

• Registrar receives all application forms & cheques from Syndicate members
• They feed applicant data & additional bidding information on computer systems.
• Send the cheques for clearance.
• Find all bogus application
• Finalize the pattern for share allotment based on all valid bid received
• Prepare 'Basis of Allotment'
• Transfer shares in the demat account of investors
• Refund the remaining money though ECS or Cheques

8.Lead manager – stock listing Once all allocated shares are transferred in investors dp accounts, Lead Manager with the help of Stock Exchange decides Issue Listing Date Finally share of the issuer company gets listed in Stock Market. Difference between book building issue and fixed price issue Initial Public Offering can be made through the fixed price method, book building method or a combination of both. Difference between shares offered through book building and offer of shares through normal public issue (Source: BSE):

Difference between floor price and cut-off price for a book building issue Company coming up with Book Building Public Issue decide a price band for the issue. The price band usually contains an upper level and a lower level. Floor Price is the minimum price (lower level) at which bids can be made for an IPO. Investors can bid for the Book Build IPO at any price in the price band decided by the company. In Book Build process retail investors have an addition option to choose "Cut-Off" price for bidding. Cut-off price means the investor is ready to pay whatever price is decided by the company at the end of the book building process. Retail investor has to pay the highest price while placing the bid at Cut-Off price. Role of registrar of an IPO Registrar of a public issue is a prime body in processing IPO's. They are independent financial institution registered with SEBI and stock exchanges. They are appointed by the company going public. Responsibility of a registrar for an IPO is mainly involves processing of IPO applications, allocate shares to applicants based on SEBI guidelines, process refunds through ECS or cheque and transfer allocated shares to investors Demat accounts. Categories of investors in an IPO Investors can apply for shares in an IPO in 4 different categories- 1.Retail Individual Investor (RII) In retail individual investor category, investors can not apply for more then Rs one lakh (Rs 1,00,000) in an IPO. Retail Individual investors have an allocation of 35% of shares of the total issue size in Book Build IPO's. NRI's who apply with less then Rs 1,00,000 /- are also considered as RII category. 2.High Networth Individual (HNI) If retail investor applies more then Rs 1,00,000 /- of shares in an IPO, they are considered as HNI. 3.Non-institutional bidders Individual investors, NRI's, companies, trusts etc who bid for more then Rs 1 lakhs are known as Non-institutional bidders. They need not to register with SEBI like RII's. Non-institutional bidders have an allocation of 15% of shares of the total issue size in Book Build IPO's. 4.Qualified Institutional Bidders (QIB's) Financial Institutions, Banks, FII's and Mutual Funds who are registered with SEBI are called QIB's. They usually apply in very high quantities. QIBs are mostly representatives of small investors who invest through mutual funds, ULIP schemes of insurance companies and pension schemes. QIB's have an allocation of 50% of shares of the total issue size in Book Build IPO's.

Risks involved in an IPO

• Stock list at lower then issue price
• Issue oversubscribed heavily and investor doesn't get allotment
• Any mishandling in processing refund could delay in getting the money back for shares not allocated

Tips to choose right IPO for investment

• The issue size has to be big, the bigger the issue, the higher is the capability of the promoters
• Money begets more money, so if they have raised more money, be sure, they will be able to earn more
• A higher promoters stake is a must, instills a sense of responsibility
• A background check on the promoters capabilities
• Size of projects in the pipeline, will indicate the scalability of the company
• Last but not the least, in big companies, look for long term wealth creation and not speculative gains

What are mutual funds?

Mutual fund is a managed group of owned securities of several corporations. It is a body corporate that pools the savings of a number of investors and invests the same in a variety of different financial instruments. Using a mutual fund is one way to invest in the stock or bond market without buying individual stocks or bonds. Income earned through these investments and the capital appreciations realized are shared by its unit holders. They are operated by an investment company which raises money from the public and invests in a group of assets (shares, debentures etc.), in accordance with a stated set of objectives. It is a substitute for those who are unable to invest directly in equities or debt because of resource, time or knowledge constraints.

These corporations receive dividends on the shares that they hold and realize capital gains or losses on their securities traded. Investors purchase shares in the mutual fund as if it was an individual security. After paying operating costs, the earnings (dividends, capital gains or loses) of the mutual fund are distributed to the investors, in proportion to the amount of money invested. Investors hope that a loss on one holding will be made up by a gain on another. Mutual fund shares are able to collectively gain the advantage by diversifying their investments.

The units of mutual funds are also tradable securities. Mutual fund units are issued and redeemed by the Fund Management Company based on the fund's net asset value (NAV) which is declared periodically by the issuer of the fund. NAV is calculated as the value of all the shares held by the fund, minus expenses, divided by the number of units issued. Buying and selling into funds is done on the basis of NAV-related prices. Mutual Funds are usually long term investment vehicle.

Each mutual fund will have a pre-defined objective, so you can choose a fund that is aggressive, conservative, a fund that invests only in stocks or only in bonds; or a fund that can invest in a multitude of things depending on what the fund's management committee thinks would be bes

Mutual funds are financial intermediaries

• They collect savings from a large no. of small investors
• They then invest these funds in a diversified portfolio
• The investment in a diversified portfolio allows the minimisation of risk
• Thus they minimize risk and maximise returns for their participants

History of mutual funds

The modern mutual fund was first introduced in Belgium in 1822. This form of investment soon spread to Great Britain and France. Mutual funds became popular in the United States in the 1920s and continue to be popular since the 1930s, especially open-end mutual funds. Mutual funds experienced a period of tremendous growth after World War II, especially in the 1980s and 1990s.

Role of RTA and exchanges in mutual funds

Registrar & Transfer Agent

Mutual fund (MF) houses have to maintain meticulous records of every transaction made by each of their investors. Registrar and Transfer agents (R&T agents) help them do this

Keeping records

Every mutual fund house has a large number of investors and it is essential to maintain records of all transactions made by each investor. Registrar and Transfer agent (R&T agent) is a body that maintains these records on behalf of the fund house. There are two main R&T agents in India—Computer Age Management Services (Cams) and Karvy. Few MFs, such as Franklin Templeton MF, have their own in-house R&T agents.

How an R&T agent works

Function

An R&T agent acts as a third-party on behalf of a fund house and has a vital role to play. It has a wide network through which it helps investors with their transactions, for example, getting the forms of various fund houses, transacting with fund houses or providing account statements. An R&T agent also provides technology-based services like online transaction or account statement facilities. It acts as single-window system for investors.

An R&T agent also helps investors with information on various corporate actions like details on new fund offers, dividend distributions or even maturity dates of investments. This information is also available with the fund houses, but an R&T Agent is a one-stop shop for all the information. Investors can get information about his various investments into different schemes of different fund house at a single place.

Importance

An R&T agent helps MF investors in submitting forms. This is very useful, especially for those investors who want to invest in many MFs. As per the Securities and Exchange Board of India’s (Sebi) rules, there is a cut-off time by when the investment has to be made for that day. So, if an investor has to make multiple investments, he can use an R&T agent’s single window system instead of rushing to different fund houses to submit applications.

R & T agents also help MFs reduce costs. Since they are present across the country, they also double as branches for their affiliated MFs as point-of-sale terminals.

Trading mutual funds on stock exchanges – what the investor needs to know

SEBI has recently allowed registered stockbrokers to transact mutual fund units on behalf of their clients through the stock exchange mechanism. The market regulator has now allowed mutual funds to be traded on stock exchanges so that more investors can access them and have a basket of various categories of securities to get assured of maximum returns. When the systems are in place there are a few points the investor has to consider while investing in mutual funds through Stock Exchanges (NSE and BSE)

Existing mutual fund investors who intend to buy more units will also benefit as this system will allow them to keep track of all investments under a single statement

Investors can hold units of mutual fund schemes in dematerialised form. Buying and selling will become more efficient and transparent , particularly if investors choose to transact through a demat account

Though cost seems to be a factor for those who do not have a demat account, the impact will be minimal for those who already are demat account holders

End users can use the convenience of their neighboring broker’s office for their mutual fund transactions

In reduces the clutter of paperwork and speedy execution

Mutual fund prospectus

The prospectus is a legal document that includes information about the mutual fund, terms of the offer, the issuer, and its objectives. The information in the prospectus is usually lengthy, packed with tables and graphs, and written in technical and legal language. This document is provided to help you make an informed investment decision before you invest in a mutual fund.

Following key sections have to be taken into consideration before investing in a Mutual fund:

Investment objective

A short statement of the fund's investment objectives. Some funds intend to achieve short-term growth while others might focus on long-term stability.

Investment strategy

Exactly how the fund plans to accomplish the objectives. This section describes the types of assets that the fund purchases.

Fees and expenses

Although mutual funds aim to make money for their investors, their ultimate goal, just like any other business, is to make money for themselves. In order to do so, funds charge their shareholders a variety of fees and expenses, all of which must be documented in the prospectus. A table at the front of every prospectus contains a breakdown of the different fees and expenses, along with a hypothetical projection of how the fees would impact a $10,000 investment over a 10-year period. This enables you to compare fees and expenses across mutual funds.

Risks

The level of risk that the fund takes and the risks that are associated with the specific investments made by the fund are one of the most important sections in the prospectus.

Performance

Information about the fund's performance over the last 10 years is included. Investors should be aware that past performance is not necessarily an indicator of future results. As important is how well the fund has traditionally performed compared to an index, such as the S&P 500. A fund's performance is also related to the fund's volatility, dividend payments, and turnover.

Management

The names the managers and some additional information about their experience and qualifications is reported. It can be helpful to know whether or not they have managed other funds in the past and their success or failure in order to get a sense of their past strategies and results.

Statement of additional information

Mutual funds split their prospectuses into two parts -- the "prospectus" (described above) and the Statement of Additional Information (SAI). In 1983, the Securities and Exchange Commission required mutual funds to supply much more detailed information about the fund. These are included in the SAI. For legal purposes it is assumed that you have read it. If you don't receive the SAI with the prospectus, you should request one. It provides great detail about the fund's board of directors, any limitations on the fund's investments, and the fees and expenses that are mentioned in the prospectus.

Professional management of mutual funds

Mutual funds use professional managers to make the decisions regarding which companies' securities should be bought and sold. The managers of the mutual fund decide how the pooled funds will be invested. Investment opportunities are abundant and complex. Fund managers are expected to know what is available, the risks and gains possible, the cost of acquiring and selling the investments, and the laws and regulations in the industry. The ability of the managers to select profitable investments and to sell those likely to decline in value is a key factor for the mutual fund to earn money for the investors.

Mutual fund annual report

Every year mutual funds send each investor an Annual Report. The Annual Report includes a list of the fund's financial statements, a list of the fund's securities, and explanations from the fund's management as to why the fund performed as it did for the previous year.

(a) On the basis of objective

Equity funds/ growth funds

Funds that invest in equity stocks from firms with higher low Price to Earning (P/E) Ratio which usually pay small dividends are called equity funds. The investor is looking for capital gains rather than income. They carry the principal objective of capital appreciation of the investment over the medium to long-term. In growth funds, the dividend accrued, if any, is reinvested in the fund for the capital appreciation of investments made by the investor.

Different types of mutual funds

• Diversified funds
• Sector specific funds
• Index based funds.
• Diversified funds
• These funds invest in companies spread across sectors. These funds are generally meant for risk-averse investors who want a diversified portfolio across sectors.
• Sector funds
• These funds invest primarily in equity shares of companies in a particular business sector or industry. They are targeted at investors who are bullish or fancy the prospects of a particular sector.
• Index funds

The money collected from the investors is invested only in the stocks,which represent the indices like S&P CNX Nifty or CNX Midcap 200.The objective of such funds is to give a return equivalent to the market returns.

Tax saving funds

These funds offer tax benefits to investors under the Income Tax Act. They aim to minimize tax bills, such as keeping turnover levels low or shying away from companies that provide dividends, which are regular payouts in cash or stock that are taxable in the year that they are received. These funds still shoot for solid returns; they just want less of them showing up on the tax returns.

Debt/Income funds

These funds invest predominantly in high-rated fixed-income-bearing instruments. The investor is looking for income which usually come from dividends or interest. These stocks are from firms which pay relative high dividends. This fund may include bonds which pay high dividends. They are best suited for the medium to long-term investors who are averse to risk and seek capital preservation. They provide a regular income to the investor.

Liquid funds/money market funds

These funds invest exclusively in certain kinds of highly liquid short-term instruments like money market. Investment period could be as short as a day. They provide easy liquidity.

Gilt funds

These funds invest in Central and State Government securities. Since they are Government backed bonds they give a secured return and also ensure safety of the principal amount. They are best suited for the medium to long-term investors who are averse to risk.

Balanced funds

The investor may wish to balance his risk between various sectors such as asset size, income or growth. A balanced fund invests equally in fixed income and equity in order to earn a minimum return to the investors. They provide a steady return and reduce the volatility of the fund. They are ideal for medium to long-term investors who are willing to take moderate risks.

b) On the basis of flexibility

Open-ended funds

Investors are allowed to enter and exit the fund even after the fund has closed. These funds do not have a fixed date of redemption. Generally they are open for subscription and redemption throughout the year. Their prices are linked to the daily net asset value (NAV).

Close-ended funds

These funds are open initially for entry during the Initial Public Offering (IPO) and thereafter closed for entry as well as exit. Once the fund closes investment can be withdrawn only at the end of the time period of the MF. These funds have a fixed date of redemption. One of the characteristics of the close-ended schemes is that they are generally traded at a discount to NAV; but the discount narrows as maturity nears. The units of these funds are listed on stock exchanges, are tradable.

Advantages of investing in mutual funds:

• Invest on-line in all mutual funds without the hassles of filling application forms or any signatures or proof of identity for investing.
• Portfolio Diversification : Mutual funds help to reap the benefit of returns by a portfolio spread across a wide spectrum of companies
• Professional management and research to select quality securities
• Spreading Risk: Mutual fund will spread its risk by investing a number of sound stocks or bonds. A fund normally invests in companies across a wide range of industries, so the risk is diversified.
• Transparency: Provides complete portfolio disclosure of the investments made by various schemes and also the proportion invested in each asset type.
• Choice: Offer the investor a wide variety of schemes to choose from. An investor can pick up a scheme depending upon his risk/ return profile.
• Regulations: Registered with SEBI and function within the provisions of strict regulation designed to protect the interests of the investor
• No manual processes involved. Bank funds are automatically debited or credited while simultaneously crediting or debiting the unit holdings.
• Control over your investments with online order confirmations and order status tracking.
• Online updation of MF portfolio with current NAV to check the performance of investments.
• Disadvantages of mutual funds
• No control over costs, customized solutions
• Managing a portfolio of funds
• The investor must rely on the integrity of the professional fund manager
• Fund management fees may be unreasonable for the services rendered
• The fund manager may not pass transaction savings to the investor
• The fund manager is not liable for poor judgment when the investor's fund loses value
• There may be too many transactions in the fund resulting in higher fee/cost to the investor - This is sometimes call "Churn and Earn"
• Prospectus and Annual report are hard to understand
• Investor may feel a lost of control of his investment dollars
• There may be restrictions on when and how an investor sells/redeems his mutual fund shares
• Market risk: If the overall stock or bond markets fall on account of overall
• Economic factors: the value of stock or bond holdings in the fund's portfolio can drop, thereby impacting the fund performance
• Non-market risk: Bad news about an individual company can pull down its stock price, which can negatively affect fund holdings
• Interest rate risk: When the interest rates rise, bond prices fall and this decline in underlying securities affects the fund negatively
• Credit risk: When the funds invest in corporate bonds, they run the risk of the corporate defaulting on their interest and principal payment obligations

Transactions in mutual funds

Purchase / Redemption: Purchase simply means buying mutual fund scheme units

Switch: To suit your changing needs ,transfer of cash between different schemes is possible. You can switch your cash online from one scheme to another in the same fund family without any hassles.

Systematic Investment plans (SIP): SIP allows to invest a certain sum of money over a period of time periodically by just filling in the investment amount, the period of investment, the frequency of investing.

Rupee Cost Averaging Adv.

Small Amount of Investment.

Disciplined Investing.

• Advantages of an SIP
• Rupee Cost Averaging Adv.
• Small Amounts of Investment
• Disciplined Investing
• Mutual fund expenses
• Mutual fund fees

In order to cover their expenses mutual funds charge fees to the investors. Although these fees are only a few percentage points a year and seem like a minor expense, they create a serious drain on the performance over a period of years.

Some fees to consider are:

Redemption fees

A mutual fund may charge fees when the investor sells shares back to the mutual fund.

Contingent deferred sales charge

A mutual fund may charge sales charges that are reduced at certain time intervals. For example, the fund may charge 6% of the sale price the first year after the shares are bought. Each year thereafter the fee would be reduced by 1% until no fee would be charged. This is an incentive for investors to leave their money in the fund.

Management fees

Mutual funds may charge fees to cover expenses such as advertising, brokers' costs and toll-free telephone lines. These are 12b-1 fees, regulated by law.

Transfer fees

A fee is charged each time the investor transfers money within the company.

Distribution of capital gains and dividends

After paying operating costs, the earnings and losses of the mutual fund are distributed to the investors in proportion to the amount of money invested. An investor may chose to receive dividends as cash, or he can reinvest them into the fund. Many funds will automatically reinvest dividends with the investor authorization.

Mutual fund taxation

The mutual fund manager must send the investor a tax information statement so the investor can declare taxes. The investor must account for all capital gains or loses and dividends even if the dividends and capital gains are reinvested into the mutual fund. When mutual funds shares are sold/redeemed the mutual fund manager should aid the investor in determining the purchase bases for the shares sold/redeemed.

Tips for investing in a mutual fund

Do’s

Draw down your investment objective. There are various schemes suitable for different needs. This will explain the mandate and scope of investment. Whether the fund is equity or debt oriented, whether the fund will be multi-, large, mid- or small-cap specific, the level of diversification, the option to the fund manager to invest overseas and other such issues.

Once you have decided on a plan or a couple of them, collect as much information as possible on them from different sources offering them through funds' prospectus and advisors

Pick out companies consistently performing above average. Mutual funds industry indices are helpful in comparing different funds as well as different plans offered by them

Get a clear picture of fees & associated cost, taxes (for non-tax free funds) for all your short listed funds and how they affect your returns. Best mutual funds have lower cost out go.

Best mutual funds maximize returns and minimize risks. A number called as Sharpe Ratio explains whether a fund is risk free based on its expected returns compared against a risk free money market fund.

Invest in funds that have the advantage of low minimum initial investments for building asset bases over a long period with small regular investments.

Don’ts
Don't go by the past performance alone
Don't go by blindly by hearsay about the reputations of a fund. There are various rating agencies which index the mutual funds regularly based on multiple factors
Don't invest huge sums of money in a single fund or all the money in one go. Spread out your investments rationally.
Don't chase a mutual fund because it is performing great in a bull run in the stock market. Once the market stagnates or the trend reverses these funds might crash.
Don't compare a mutual fund across the category. While choosing a best one compare funds from the same category regardless of the promoting companies.

#01 THE MARKET PAYS YOU TO BE DISCIPLINED

Trading with discipline will put more money in your pocket and take less money out. The one constant truth concerning the markets is that discipline = increased profits.

#02 BE DISCIPLINED EVERY DAY, IN EVERY TRADE, AND THE MARKET WILL REWARD YOU. BUT DON’T CLAIM TO BE DISCIPLINED IF YOU ARE NOT 100 PERCENT OF THE TIME

Being disciplined is of the utmost importance, but its not a sometimes thing, like claiming you quit a bad habit, such as smoking. If you claim to quit smoking but you sneak a cigarette every once in a while, then you clearly have not quit smoking. If you trade with discipline nine out of ten trades, then you cant claim to be a disciplined trader. It is the one undisciplined trade that will really hurt your overall performance for the day. Discipline must be practiced on every trade.

When I state that “the market will reward you, typically it is in recognizing less of a loss on a losing trade than if you were stubborn and held on too long to a bad trade. Thus, if I lose $200 on a trade, but I would have lost $1,000 if I had remained in that losing trade, I can claim that I “saved” myself $800 in additional losses by exiting the bad trade with haste.

#03 ALWAYS LOWER YOUR TRADE SIZE WHEN YOU’RE TRADING POORLY

All good traders follow this rule. Why continue to lose on five lots (contracts) per trade when you could save yourself a lot of money by lowering your trade size down to a one lot on your next trade? If I have two losing trades in a row, I always lower my trade size down to a one lot. If my next two trades are profitable, then I move my trade size back up to my original lot size.

Its like a batter in baseball who has struck out his last two times at bat. The next time up he will choke up on the bat, shorten his swing and try to make contact. Trading is the same: lower your trade size, try to make a tick or two — or even scratch the trade — and then raise your trade size after two consecutive winning trades.

#04 NEVER TURN A WINNER INTO A LOSER

We have all violated this rule. However, it should be our goal to try harder not to violate it in the future. What we are really talking about here is the greed factor. The market has rewarded you by moving in the direction of your position, however, you are not satisfied with a small winner. Thus you hold onto the trade in the hopes of a larger gain, only to watch the market turn and move against you. Of course, inevitably you now hesitate and the trade further deteriorates into a substantial loss.

There’s no need to be greedy. Its only one trade. You’ll make many more trades throughout the session and many more throughout the next trading sessions. Opportunity exists in the marketplace all of the time. Remember: No one trade should make or break your performance for the day. Don’t be greedy.

#05 YOUR BIGGEST LOSER CAN’T EXCEED YOUR BIGGEST WINNER

Keep a trade log of all your trades throughout the session. If, for example, you know that, so far, your biggest winner on the day is five e-Mini S&P points, then do not allow a losing trade to exceed those five points. If you do allow a loss to exceed your biggest gain then, effectively, what you have when you net out the biggest winner and biggest loss is a net loss on the two trades. Not good.

#06 DEVELOP A METHODOLOGY AND STICK WITH IT. DON’T CHANGE METHODOLOGIES FROM DAY TO DAY

I require my “students” to actually write down the specific market prerequisites (setups) that must take place in order for them to make a trade. I don’t necessarily care what the methodology is, but I do want them to make sure that they have a set of rules, market setups or price action that must appear in order for them to take the trade. You must have a game plan.

If you have a proven methodology but it doesn’t seem to be working in a given trading session, don’t go home that night and try to devise another one. If your methodology works more than one-half of the trading sessions, then stick with it.

#07 BE YOURSELF. DON’T TRY TO BE SOMEONE ELSE

In all of my years as a trader I never traded more than a 50 lot on any individual trade. Sure, I would have liked to be able to trade like colleagues in the pit who were regularly trading 100 or 200 lots per trade. However, I didn’t possess the emotional or psychological skill set necessary to trade such big size. That’s OK. I knew that my comfort zone was somewhere between 10 and 20 lots per trade. Typically, if I traded more than 20 lots, I would “butcher” the trade. Emotionally I could not handle that size. The trade would inevitably turn into a loser because I could not trade with the same talent level that I possessed with a 10 lot.

Learn to accept your comfort zone as it relates to trade size. You are who you are.

#08 YOU ALWAYS WANT TO BE ABLE TO COME BACK AND PLAY THE NEXT DAY

Never put yourself in the precarious position of losing more money than you can afford. The worst feeling in the world is wanting to trade and not being able to do so because the equity in your account is too low and your brokerage firm will not allow you to continue unless you submit more funds.

I require my students to place daily downside limits on their performance. For example, your daily loss limit can never exceed $500. Once you reach the $500 loss limit, you must turn your PC off and call it a day. You can always come back tomorrow.

#09 EARN THE RIGHT TO TRADE BIGGER

Too many new traders think that because they have $25,000 equity in their trading account that they somehow have the right to trade five or ten e-Mini S&P contracts. This cannot be further from the truth. If you can’t trade a one lot successfully, what makes you think that you have the right to trade a 10 lot?

I demand that my students show me a trading profit over the course of ten consecutive trading days trading a one lot only. When they have achieved a profitable ten-day period, in my eyes, they have earned the right to trade a two lot for the next ten trading sessions.

Remember: if you are trading poorly with two lots you must lower your trade size down to a one lot.

If you have a proven methodology but it doesn’t seem to be working in a given trading session, don’t go home that night and try to devise another one.

#10 GET OUT OF YOUR LOSERS

You are not a “loser” because you have a losing trade on. You are, however, a loser if you do not get out of the losing trade once you recognize that the trade is no good. Its amazing to me how accurate your gut is as a market indicator. If, in your gut, you have the idea that the trade is no good then its probably no good. Time to exit.

Every trader has losing trades throughout the session. A typical trade day for me consists of 33 percent losing trades, 33 percent scratches and 33 percent winners. I exit my losers very quickly. They don’t cost me much. So, although I have either lost or scratched over two-thirds of my trades for the day, I still go home a winner.

#11 THE FIRST LOSS IS THE BEST LOSS

Once you come to the realization that your trade is no good its best to exit immediately. “Its never a loser until you get out” and “Not to worry, it’ll come back” are often said tongue in cheek, by traders in the pit. Once the phrase is stated, it is an affirmation that the trader realizes that the trade is no good, it is not coming back and it is time to exit.

#12 DON’T HOPE AND PRAY. IF YOU DO, YOU WILL LOSE

When I was a new and undisciplined trader, I cant tell you how many times that I prayed to the “Bond god.” My prayers were a plea to help me out of a less-than-pleasant trade position. I would pray for some sort of divine intervention that, by the way, never materialized. I soon realized that praying to the “Bond god” or any other “futures god” was a wasted exercise. Just get out!

#13 DOESN’T WORRY ABOUT NEWS. IT’S HISTORY

I have never understood why so many electronic traders listen to or watch CNBC, MSNBC, Bloomberg News or FNN all day long. The “talking heads” on these programs know very little about market dynamics and market price action. Very few, if any, have ever even traded a one lot in any pit on any exchange. Yet they claim to be experts on everything.

Before becoming a “trading and markets expert,” the guy on CNBC reporting hourly from the Bond Pit, was a phone clerk on the trading floor. Obviously this qualifies him to be an expert! He, and others, can provide no utility to you. Treat it for what it really is Entertainment.

The fact is: The reporting that you hear on the business programs is “old news.” The story has already been dissected and consumed by the professional market participants long before the “news” has been disseminated. Do not trade off of the reporting. Its too late.

#14 DOESN’T SPECULATE. IF YOU DO, YOU WILL LOSE

In all of the years that I have been a trader and associated with traders, I have never met a successful speculator. It is impossible to speculate and consistently print large winners. Don’t be a speculator. Be a trader.

Short-term scalping of the markets is the answer. The probability of a winning day or week is greatly increased if you trade short term: small winners and even smaller losses.

#15 LOVE TO LOSE MONEY

This rule is the one that I get the most questions and feedback on by traders from all over the world. Traders ask, “What do you mean, love to lose money. Are you crazy?”

No, I’m not crazy. What I mean is to accept the fact that you are going to have losing trades throughout the trading session. Get out of your losers quickly. Love to get out of your losers quickly. It will save you a lot of trading capital and will make you a much better trader.

#16 IF YOUR TRADE IS NOT GOING ANYWHERE IN A GIVEN TIMEFRAME, IT’S TIME TO EXIT

This rule relates to the theory of capital flow. It is trading capital that pushes a market one way or another. An oversupply or imbalance of buy orders will push the market up. An oversupply of sell orders will push the market lower.

When price stagnation is present (as typically happens many times throughout the trading session), the market and its participants are telling us that, at the present time, they are happy or satisfied with the prevailing bid and offer.

You don’t want to be in the market at these times. The market is not going anywhere. It is a waste of time, capital and emotional energy. Its much better to wait for the market to heat up a little and then place your trade.

#17 NEVER TAKE A BIG LOSS. ONLY A BIG LOSS CAN HURT YOU

Please review rules #5, #8, #10, #11 and #15. If you follow any one of these rules you will never violate rule #17.

Big losses prevent you from having a winning day. They wipe out too many small winners that you have worked so hard to achieve. Big losses also “kill you” from a psychological and emotional standpoint. It takes a long time to get your confidence back after taking a big loss on a trade.

#18 MAKE A LITTLE BIT EVERYDAY. DIG YOUR DITCHES. DON’T FILL THEM IN

When I was a young bond trader, my goal every day was to make 10 bond tics. A tic is $31.25, so if I made 10 tics on the day, I would be up $312.50.

It may not sound like a lot of money to you, but it surely was to me. My mentor, David Goldberg, told me that if I could make 10 bond tics every trading day of the year, at the end of the year I would be up $72,500 in my trading account. Not bad for a 23-year old kid in 1982.

It is amazing how quickly your trading account will build up over time just by making a little bit every day. If you are a new e-Mini S&P trader try to make just 5 or 6 points per day. If you can do that you’ll have that $72,000 at the end of the year.

#19 HIT SINGLES NOT HOME RUNS

Just as I don’t know of any successful speculators, I don’t know of any trader who goes into a trade expecting to hit a home run and then actually having it happen.

You should never approach a trade with the idea that its going to be a huge winner. Sometimes they turn out that way, but the times that I have a hit a home run on a position is most definitely luck, not skill. My intent on the trade was to produce a small winner but, because I had the trade on, and at the same time (as luck would have it), the Fed unexpectedly entered the market, I unwittingly had a huge winner. This probably has happened to me less than five times in 20 years.

#20 CONSISTENCY BUILDS CONFIDENCE AND CONTROL

How nice is it to be able to turn on your PC in the morning knowing that if you play by the Rules, trade with discipline and stick to your methodology, the probability of a successful day is high.

I’ve had years where I could count on one hand the number of losing days that I had. Don’t you think that this consistency allowed me to be extremely confident? I knew that I was going to make money on any given day. Why would I think otherwise? Making a little bit everyday (Rules #18 and #19) will allow you to trade throughout the trading session with confidence and control.

Remember Rule #9: If you make a little bit every day, then you have earned the right to trade bigger. Thus, by following the Rules of Discipline, your “little bit” can soon turn into much more profitable days.

#21 LEARN TO SWEAT OUT (SCALE OUT) YOUR WINNERS

The net effect of scaling out of your winners will be an increased average win per trade while keeping your losses to your pre-defined risk parameters.

You should never scale out of your losers. If your trade size is more than a one lot and your trade is a loser, you must exit the entire position en masse. If your trade size is more than a one lot and your trade is a winner, it is best to exit one-half of your position at your first price target.

If you trade with protective stop-loss orders, you should amend the order to reflect the change in trade size (remember you have exited onehalf of your position) and raise or lower the stop price, depending on whether it’s a long or short position, to your original initiating trade entry price. You now are essentially “playing with the house’s money.” You can’t lose on the remaining position, and that’s obviously a fantastic position in which to put yourself. Place a limit order a few tics above or below the market, depending on your position, sit back and relax.

I can’t tell you how many times traders have come into my office terribly depressed because they “knew” the market was going one way or another; however, they failed to put a position on.

#22 MAKE THE SAME TYPE OF TRADES OVER AND OVER AGAIN – BE A BRICKLAYER

A bricklayer shows up for work every day of his working life and executes with the same methodology— brick by brick by brick.

The same consistency applies to traders, as well. Please review Rules #6 and #20. I have not changed my trading methodology and execution strategy in 20 years. I guess I’m the bricklayer.

#23 DON’T OVER-ANALYZE. DON’T PROCRASTINATE. DON’T HESITATE. IF YOU DO,YOU WILL LOSE

I can’t tell you how many times traders have come into my office terribly depressed because they “knew” the market was going one way or another; however, they failed to put a position on. When I ask them why they did not put the trade on, their responses are always the same: they did not want to chase the market. They were waiting to be filled at the absolute best possible price (and never got filled), or only two out of three of their market indicators were present and they were waiting for the third.

The net result of all this procrastination and hesitation is the trader was correct in deducing market direction but his profit on the trade was zero. We don’t get paid in this business unless we put the trade on. Don’t overanalyze the trade. Place the trade and then manage it. If you’re wrong, get out. But you’ll never be right unless you actually make the trade.

A bricklayer shows up for work every day of his working life and executes with the same methodology— brick by brick by brick.

#24 ALL TRADERS ARE CREATED EQUAL IN THE EYES OF THE MARKET

We all start out the day the same. We all start out at zero. Once the bell rings and trading begins, it’s how we conduct ourselves from a behavioral standpoint that will dictate whether or not we will make money on the day. If you follow the 25 Rules, you should do well. If you do not, you will do poorly.

#25 IT’S THE MARKET ITSELF THAT WIELDS THE ULTIMATE SCALE OF JUSTICE

The market moves wherever it wants to go. It does not care about you or me. It does not play favorites. It does not discriminate. It does not intentionally harm any one individual. The market is always right.

You must learn to respect the market. The market will mercilessly punish you if you do not play by the Rules. Learn to condition yourself to play by the 25 Rules of Trading Discipline and you will be rewarded.
* Disclaimer: These recommendations are based on the theory of technical analysis and outlook of the market perfor