The recent volatility and subsequent sharp rises and fall in the stock market have been attributed to various reasons. One of the reasons is excessive leveraging by investors and resultant inability to pay the margin calls. This can also be termed as Margin Trading. The second reason is the structure of Derivatives market. Let us examine the impact

of these two factors on volatility in the markets.

There are two very active players who do margin trading in the market, one is those brokers which has a Non Banking Finance Company (NBFC) attached to the broking house and second is broker themselves indulge in quasi margin trading by providing number of days credit to the investors. The NBFCs though are regulated by the RBI, do the margin trading activities through the broker. There are separate set of rules prescribed by each regulating authority namely the RBI and SEBI. RBI has rules for lending against shares and SEBI has rules for Margin Trading. Broadly these rules prescrib e that there should be an approved list of securities, Margins

are in the range of 50%, and there is a limit on maximum lending. Above all there are reporting requirements to stock exchanges / RBI giving details of lending under each of the schemes.

The NBFC which is an entity regulated by RBI and operating in an activity regulated by SEBI does not adhere to any of the rules prescribed by either regulator are in the range of 10 15%. There are no individual based limits such as Rs.20 lacs in the case o f lending against shares in the bank. So long as initial margin is paid unlimited funds are provided for the purpose of trading.

THE NBFCs are equipped with sophisticated software which triggers sales of shares moment the mark to market losses are in excess of margins available with the NBFC. The margins being low, there is very high leveraging and coupled with high volatility in the market sell off are very frequent and there is very little time available to the borrower to arrange for the short fall in margins. The small brokers on the other hand do not have such technology at disposal and do distress selling when the exchange shuts down the terminals for shortage in margins. Such distress selling by both the NBFC and broker, specially when there is d rastic fall, are

the main reasons of volatility.

THE NBFCs are equipped with sophisticated software which triggers sales of shares moment the mark to market losses are in excess of margins available with the NBFC. The margins being low, there is very high leveraging and coupled with high volatility in the market sell off are very frequent and there is very little time available to the borrower to arrange for the short fall in margins. The small brokers on the other hand do not have such technology at disposal and do distress selling when the exchange shuts down the terminals for shortage in margins. Such distress selling by both the NBFC and broker, specially when there is d rastic fall, are

the main reasons of volatility.

Volatility must be faced with calm and not panic. A sharp fall in prices should result in a review of the valuations of the stocks that you are holding. Has anything changed in the fundamentals of your stock that would result in deterioration of the company performance needs to be examined? If not then look for other factors that caused the fall. If it is a market wide phenomenon then be patient and look for signs of recovery. Though it is always advisable to have stop loss targets, but before acting on the same we should let the market stabilize. This takes about 4 -5 days of working to get a clear signal.

Such volatile times result in maximum loss to the day traders and those who leverage beyond their capacity to pay losses. Losses are more then the cash available to pay for the same, hence it results in compulsory squaring off. All such sales result in a flood of exit orders which results in an artificial panic in the market based purely on liquidity factors and not an underlying bear hug.

Volatility in the market will become a social problem if not addressed properly by the regulators. Greed to money is universal. Over indulgence has to be controlled. Proper regulation of margin trading and structural changes i n derivatives market would go along way permitting leveraging within prescribed responsible limits only.