Understand 6 points before any investments

In the modern and digital world, we have several options available to invest our savings. Each person has different objectives on their investment. Here are 6 most important factors that you should consider before letting your money work for you.

Safety

Perhaps, there is truth to the axiom that there is no such thing as a completely safe and secure investment. Yet, we can get close to ultimate safety for our investment funds through the purchase of government-issued securities in stable economic systems, or through the purchase of the highest quality corporate bonds issued by the economy’s top companies. Such securities are arguably the best means of preserving principle while receiving a rate of return. Safety investment is usually found in the money market and include Treasury bills (T-bills), Certificate of Deposits (CD), Commercial Paper or the fixed income bonds in the form of municipal and other government bonds, and corporate bonds. The securities listed above are ordered according to the typical spectrum of increasing risk and, in turn, increasing potential yield. To compensate for their higher risk, corporate bonds return a greater yield than T-bills and Government bonds.

Income

Safety investment often have the lowest rate of income return or yield. Investors must inevitably sacrifice a degree of safety if they want to increase their yields. There is an inverse relationship between safety and yield; as yield increases, safety generally goes down, and vice versa. In order to increase their rate of investment return and take on risk above that of money market instruments or government bonds, investors may choose to purchase corporate bonds or preferred shared with lower investment ratings. Investment grade bonds rated at A or AA are slightly riskier than AAA bonds, but presumably also offer a higher income return than AAA bonds. Most investors, even the most conservative-minded ones, want some level of income generation in their portfolios, even if it’s just to keep up with the economy’s rate of inflation. But maximizing income return can be an overarching principle for a portfolio, especially for individuals who require a fixed sum from their portfolio every month.

Growth of Capital

The growth of Capital is most closely associated with the purchase of common stock, particularly growth securities, which offer low yields but considerable opportunities for an increase in value. For this reason, common stock generally ranks among most speculative of investments as their return depends on what will happen in an unpredictable future. Blue- chip stocks, by contrast, can potentially offer the best of all worlds by possessing reasonable safety, modest income and potential for growth in capital generated by the long-term increase in corporate revenues and earnings as the company matures. Yet, rarely is any common stock able to provide the near absolute safety and income generation of government bonds.

Tax Minimisation

An investor shall pursue certain investments in order to adopt tax minimisation as part of his or her investment strategy. A highly paid individual seek investments with favourable tax treatment in order to lessor his or her overall income tax burden.

Liquidity

Liquidity refers to an investment ready to convert into cash position. In other words, it is available immediately in cash form. Liquidity means that investment is easily realisable, saleable or marketable. When the liquidity is high, then the return may be low.

Marketability

Marketability refers to buying and selling of Securities in the market. Marketability means transferability or saleability of an asset. Securities are listed in a stock market which is more easily marketable than which are not listed. Public Limited Companies shares are more easily transferable than those of private limited companies.

Concealability

Concealability means investment to be safe from social disorders, government confiscations or unacceptable levels of taxation, the property must be concealable and leave no record of income received from its use or sale. Gold and precious stones have long been esteemed for these purposes because they combine high value with small bulk and are readily transferable.

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Let us know in comment section what are the other points you consider before investing.

Where to collect information of a listed company or listed stock?

Stock market is sensitive to information. It gets volatile when new information flows in to the market. A investor should always have close eyes on the scripts that he/she has put his hard earned money. So, in this post I will highlight places where a an investor can gather information.

Red Herring Prospectus (RHP)

RHP is good place to start, this provides key information about a company. It contains the purpose of issuing shares, industry overview, company background, detailed financial statements (Balance sheet and earning statements), Information about directors, underwriters and significant stock holders, Legal opinion on issue and etc. In India, the RHP’s are available on the SEBI website. Using the below link you can search any company that is listed in BSE and NSE. The document is available in pdf format. You can download and go thoroughly to understand the nature of business that the company carries.

SEBI link for Red Herring Prospectus of any company

Quarterly results

For every 3 months public listed companies publish quarterly reports that includes an income statement, balance sheet, and cash flow statement for the quarter and the year-to-date (YTD), as well as comparative results for the prior quarter/ year. By analysing the Quarterly report an investor can understand the company’s performance and growth. Generally, quarters end in March, June, September, and December, and these reports are filed a few weeks later after audited. These quarterly reports can be found in company’s website and stock exchange’s website.

Annual Reports

An annual report is a detailed report on a company's activities throughout the preceding year. It is intended to give information about the company's activities, strategy, business outlook and financial performance. A detailed financial statements is presented for the current and previous financial year. Annual reports are available on the respective company websites and with stock exchange website.

Investor Presentations

Many publicly listed companies provide detailed investor presentations that cover company background, company strategy, business outlook and detailed financial statements of the current and preceding financial period.

Earnings conference calls

Many companies conduct conference calls after quarterly results wherein management provides guidance of performance over the medium term and take questions from investors and analysts.

Interviews in print media/Television

Management interviews provide clues on management’s focus on performance, transparency and shareholder friendliness.

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What is a Contract Note in Share trading?

Contract Note is a confirmation of trades done on a particular day on behalf of the client by a trading member. It imposes a legally enforceable relationship between the client and the trading member with respect to purchase/sale and settlement of trades. It also helps to settle disputes/claims between the investor and the trading member. It is a prerequisite for filing a complaint or arbitration proceeding against the trading member in case of a dispute. A valid contract note should be in the prescribed form, contain the details of trades, stamped with requisite value and duly signed by the authorized signatory. Contract notes are kept in duplicate, the trading member and the client should keep one copy each. After verifying the details contained therein, the client keeps one copy and returns the second copy to the trading member duly acknowledged by him.

What is a Stock Swap?

First it is need to be known Who is an acquiree and acquirer.

Acquiree is the company that is being acquired or purchased in a merger or acquisition process.

Acquirer is the company that is purchasing another company in a process of merger or acquisition.

Acquiring a business or company may be paid in various forms, such as cash, securities or by taking over the liabilities of the acquiree. When the share-holders in the acquiree company are given shares of the acquirer company as part of the acquisition, it is called a stock swap.

A benefit of stock swap is that the cash outflow for the acquirer company is minimized. Higher the value of the acquirer company’s shares, the fewer the shares it needs to issue for the acquisition. However, the share issue does cause dilution of promoter’s stake in the acquirer company. Further, even earnings per share (EPS) of the acquirer company may be diluted, if the earnings of the acquiree company are not adequate.

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What is Beta in finance? Formula for Beta

Statistically Beta shows the sensitivity of a security. The Beta is a measure of the systematic risk of a security. Systematic risk refers to the risk that cannot be avoided through diversification. Hence, Beta measures non-diversifiable risk. It is a relative measure of risk. Beta is a statistical measurement indicating the volatility of a stock’s price relative to the price movement of the overall market. Beta is an extremely useful tool to consider when building a portfolio.

Higher-beta stocks are more volatile and are therefore considered to be riskier but are in turn supposed to provide a potential for higher returns.

Low-beta stocks are less riskier but also they are expected to give lower returns.

The market itself has a beta value of 1; in other words, its movement is exactly equal to itself (a 1:1 ratio). Stocks may have a beta value of less than, equal to, or greater than one. An asset with a beta of 0 means that its price is not at all correlated with the market; that asset is independent.

A positive beta means that the asset generally tracks the market.

A negative beta shows that the asset inversely follows the market; the asset generally decreases in value if the market goes up.

Formula to measure Beta

= Beta of the security with market

= Covariance between security and market

= Variance of market returns

This can also be written as

= Coefficient of Correlation between security and market returns

Consider the stock of XYZ Ltd has a beta of 0.75. This points to the fact that based on past trading data, XYZ Ltd as a whole has been relatively less volatile as compared to the market as a whole. Its price moves less than the market movement. Suppose Sensex index moves by 1% (up or down), XYZ Ltd’s price would move 0.75% (up or down respectively). If XYZ Ltd has a Beta of 1.3, it is theoretically 30% more volatile than the market. Beta can also considered to be an indicator of expected return on investment. Given a risk-free rate of 4%, for example, if the market (with a beta of 1) has an expected return of 8%, a stock with a beta of 1.4 should return 9.6% (= 4% + 1.4(8% - 4%)).

Downside of Beta

The Beta is just a tool and as is the case with any tool, is not infallible. While it may seem to be a good measure of risk, there are some problems with relying on beta scores alone for determining the risk of an investment.

     •Beta is not a sure thing. For example, the view that a stock with a beta of less than 1 will do better than the market during down periods may not always be true in reality. Beta scores merely suggest how a stock, based on its historical price movements will behave relative to the market. Beta looks backward and history is not always an accurate predictor of the future.

     •Beta also doesn’t account for changes that are in the works, such as new lines of business or industry shifts. Indeed, a stock’s beta may change over time though usually this happens gradually. 

As a fundamental analyst, you should never rely exclusively on beta when picking stocks. Rather, beta is best used in conjunction with other stock-picking tools.

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List of Market Participants in India

Below list provides details on Market participants in India.
Market Participants
Investors
     Individual Investors
     Corporate Investors
     Foreign Venture Capital Investors
     FIIs
Depositories
Stock Exchanges
     With Equities Trading
     With Debt Market Trading
     With Derivative Trading
     With Currency Derivatives
Brokers
Corporate Brokers
Sub-brokers
Portfolio Managers
Custodians
Registrars to an issue & Share Transfer Agents
Primary Dealers
Merchant Bankers
Bankers to an Issue
Debenture Trustees
Underwriters
Venture Capital Funds
Mutual Funds
Collective Investment Schemes

Also read: WHO ARE THE PARTICIPANTS IN STOCK MARKET?

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Stock Market Dictionary buy at Amazon

Hello all my readers, It's my pleasure to announce you My first Book publication. 

Stock Market Dictionary has been produced to aid beginners in the challenging task of becoming familiar with new vocabulary and terminology that is used in Stock exchanges. This could be a valuable reference tool that can be used when attending seminars, watching or listening to financial programs and reading the financial market material. The book contains 587 glossary and 123 commonly used abbreviations and acronyms in finance and the stock market.

Kindle version

Paperback version: Stock-Market-Dictionary-collection-abbreviations
Share the links to your friends and your librarian. Motivate to buy, its just Rs.99 (Kindle version).
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Who are the participants in Stock market?

Anyone who transacts i.e. Trade or Invests in the stock market is called a Market Participant. The stock market attracts individuals and institutions from diverse backgrounds.  The market participant can be classified into various categories. Some of the categories of market participants are as follows:

1. Domestic Retail Participants – These are people like you and me Buying and Selling, Trading and Investing in Share Market.
2. NRI’s, PIO and OCI (Overseas Citizen of India) – These are people of Indian origin but based outside India.
3. Domestic Institutions – These are large corporate entities based in India. A perfect example would be the LIC of India.
4. Domestic Asset Management Companies (AMC) – Typical participants in this category would be the mutual fund companies such as SBI Mutual Funds, Canara Robeco Mutual Fund, HDFC AMC,  etc.
5. Foreign Institutional Investors – These are Non-Indian corporate entities. These could be foreign asset management companies, hedge funds, and other investors. These could be an institution or even a Government. For example: Government of Singapore, Franklin Templeton Investment Funds.

Also read: LIST OF MARKET PARTICIPANTS IN INDIA

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What is OHLC? Understanding Open High Low and closing price of a share | Sulthan Academy

In this Post I will explain you about Open, high, low and closing price of a share. So this is just a basic terms that u need to understand while looking for technical analysis of a stock and to understand different types of chart.
You know in India Market opens at 9:15 AM and closes at 15:30 PM during which there were many trades. It will be practically impossible to track all these different price points. So the fact is one needs a summary of the trading action and not really the details on all the different price points.
By tracking the Open, high, low and close we can draw a summary of the price action and how the stock is perfuming.

O - The open is when the markets open for trading, the first price at which a trade executes is called the opening Price.

H - The high represents the highest price at which the stock was traded on the given day.

L – The low represents the lowest level at which the stock was traded on the given day.

C - The close represents the closing price  and it is the most important price because it is the final price at which the market closed for a particular period of time. The close serves as an indicator for the intraday strength. If the close is higher than the open, then it is considered a positive day else it is a negative day for the particular share.  The closing price also shows the market sentiment and serves as a reference point for the next day’s trading. For these reasons, closing price is more important than the Open, High or Low prices.

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How Sensex and Nifty are Calculated? Free-Float Methodology

Sensex and Nifty two major stock indices of Indian share markets are trading in its all time time as of June 2017.  BSE SENSEX - 31,273.27 - 2 Jun, 11:26 AM IST and NIFTY 50 - 9,648.50 - 11:27 AM IST.

Understanding Sensex and Nifty

Both Sensex and Nifty are Calculated using Free-float methodology.

Free float methodology – Explained

Free-float methodology is a method to calculate market capitalization index for particular market. It is calculated by taking the equity's price and multiplying it by the number of shares readily available in the market i.e excluding the following categories 

1. Shares held by founders/directors/acquirers which has control element
2. Shares held by persons/ bodies with “Controlling Interest”
3. Shares held by Government as promoter/acquirer
4. Holdings through the FDI Route
5. Strategic stakes by private corporate bodies/ individuals
6. Equity held by associate/group companies (cross-holdings)
7. Equity held by Employee Welfare Trusts
8. Locked-in shares and shares which would not be sold in the open market in normal course.

The free-float methodology has been adopted by most of the world's major indexes.

Step by Step process

Step - 1 Determining the market capitalization for each company

Market Capitalization = Shares outstanding * Price

Step - 2 Weights of company is determined by NSE (for nifty). Weights is a multiple by which company’s Market capitalization is multiplied to arrive at Free-float market capitalization. The weights for each company in the index are determined based on the public shareholding of the companies as disclosed in the shareholding pattern submitted to the stock exchanges on quarterly basis. Weights are between 0.05 to 1.

Step – 3 Calculation of Free Float Market Capitalization

FFMC= Shares outstanding * Price * IWF

IWF - Investible weight factors (weights used in Nifty)

Step –4 Calculating the Index Value

Index value = Current Market Value / Base Market Capital * Base Index Value 

Base Date and Value

Base market capital of the Index is the aggregate market capitalisation of each scrip in the Index during the base period. The market cap during the base period is equated to an Index value of 1000 known as the base Index value.  The base period selected for NIFTY 50 index is the close of prices on November 3, 1995, which marks the completion of one year of operations of NSE's Capital Market Segment. The base value of the index has been set at 1000 and a base capital of Rs.2.06 trillion.

The method also takes into account constituent changes in the index and importantly corporate actions such as stock splits, rights, etc without affecting the index value. The index is reviewed every six months (on half-yearly basis) and a four weeks’ notice is given to the market before making changes to the index set. The Index Maintenance Sub-committee takes all decisions on addition/ deletion of companies in any Index.

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Capital market: Primary Market and Secondary Market

A capital market is a financial market in which long-term debt or equity-backed securities are bought and sold. Capital market is segmented in to two market Primary Market and Secondary Market.

Primary Market

Primary market provides an opportunity to Government and corporations, to raise funds through issue of securities. The securities may be issued in the domestic or international markets, at face value, or at a discount (below their face value) or at a premium (above their face value). The primary market issuance is done either through a public issue or private placement. Under the Companies Act, 1956, an issue is referred to as public, if it results in allotment of securities to 50 investors or more. However, when the issuer makes an issue of securities to a select group of persons not exceeding 49, and if it is neither a rights issue (i.e. issued only to existing investors) nor a public issue (i.e. made available to any member of the general public to invest in), it is called a private placement. When a company makes a public issue of its equity shares for the first time, it is called an initial public offer (IPO). Subsequent issues are Follow-on public offers (FPO).

Secondary Market

Secondary market refers to a market, where securities that are already issued by the Government or corporations, are traded between buyers and sellers of those securities. The securities traded in the secondary market could be in the nature of equity, debt, derivatives etc. It is to be noted that primary market transactions directly affect the issuing company’s balance sheet (i.e. the financial statement of its assets and liabilities as on any date). For instance, if the company issues equity shares, the equity share capital in its balance sheet will increase. On the other hand, a secondary market transactions in those equity shares have no impact on the issuing company’s balance sheet. The ownership of the shares will move from the seller to the buyer .

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When and How to use P/E ratio (Price-Earning ratio)

Which stock and when to invest? A key question every person about to invest has in their mind. The answer to these issues is Price-Earning (PE) ratio and popular in the investment community. However, it is not entirely reliable.

PE ratio is one widely used tool for stock selection. One key thing you need to remember is this ratio is only useful in comparing companies in the same industry. A higher P/E ratio means that investors are paying more for each unit of net income, so the stock is more expensive compared to one with lower P/E ratio.

Calculation

The PE is calculated by dividing the market price per share by the earnings per share (EPS).

As mentioned above higher PE ratio refers that the stock is expensive which means it is possible that share is overpriced and Lower price ratio, on the other hand, may refer to the poor performance of the company. That is the reason why I said PE is completely reliable. You have to look at the background of the company, before investing.

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Why Macroeconomics is important for the Investors?

For Investors or people in finance, understanding macroeconomics and its factor is very important because each of the major macroeconomic factors such as growth, inflation, business cycles etc.., have strong impact on the financial markets. They also have strong impact on the financial sector.

For example, when the economy gets into downturn, many firms find it difficult to repay their loans and as a result, the financial health of banks gets affected. Furthermore, changes in macroeconomic policies influence key variables of financial markets such as interest rates, liquidity and capital flows.

On the other hand, what is happening in the financial market can have a strong impact on the rest of the economy. Some examples of such transmission can be observed during the financial crises. In the United States, weaknesses in the financial sector stemming from a sudden and substantial decline in the prices of real estate, led to a downturn for the entire economy. In fact, almost all the countries of the world were affected because of this problem in the United States. In many countries across the world, this crisis hit not only the financial markets but also the entire economy, causing major recession and unemployment. The governments of these countries had to undertake serious coordinated policy measures to pull their economies out from recession.
As finance and macroeconomics are intimately interlinked, it becomes imperative for a finance professional to have at least a working knowledge of macroeconomics, so that they can better predict how firms and individuals behave in different situations, what risks and opportunities arise in what macroeconomic situation, how changes in policy changes can affect different macroeconomic variables and so on.

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what is T+2 or T+3 days settlement in share trading?

Indian and European capital markets follows T+2 Rolling Settlement whereas countries like South Africa and United States follows T+3 settlement.

• T is the transaction date
• ‘+2’ or ‘+3’ denotes the number of days for settlement

Thus, trades done on Monday are settled 2 working days later viz. Wednesday and In case of T+3 days, settlement is made after 3 working days i.e. on Thursday.

All transactions executed on the stock exchanges are to be settled through the Clearing Corporation/House of the stock exchanges. However, the following exceptions are provided:

• Total connectivity failure to the exchange/STP (Specific connectivity issues of the custodians and members are not to be considered as valid exceptions).
• International Holidays that may be decided upfront by the stock exchanges in consultation with the custodians.
• Closing down of national/international centres due to calamities.

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Hedge funds–Simple and Easy explanation

Hedge funds are generally created by a limited number of wealthy investors who agree to pool their funds and hire experienced professionals (fund managers) to manage their portfolio. These funds are private agreements and generally have little or no regulations governing them. This gives a lot of freedom to the fund managers.

For example, hedge funds can go short (borrow) funds and can invest in derivatives instruments which mutual funds cannot do.

Hedge funds generally have higher management fees than mutual funds as well as performance based fees. The management fee (paid to the fund managers), in the case of hedge funds is dependent on the assets under management (generally 2 - 4%) and the fund performance (generally 20% of the excess returns over the market return generated by the fund).

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Open ended and closed-ended funds–Explained

Funds are usually open or closed-ended.

In an open-ended fund, the units are issued and redeemed by the fund, at any time, at the NAV prevalent at the time of issue / redemption. The fund discloses the NAV on a daily basis to facilitate issue and redemption of units.

Unlike open-ended funds, closed-ended funds sell units only at the outset and do not redeem or sell units once they are issued. The investors can sell or purchase units to (or from) other investors and to facilitate such transactions, such units are traded on stock exchanges. Price of closed ended schemes are determined based on demand and supply for the units at the stock exchange and can be more or less than the NAV of the units.

We now examine the different kind of funds on the basis of their investments. Mutual fund investments represented as units in a single portfolio, in real life, fund houses float various schemes from time-to-time, each a constituting a portfolio where inputs translate into units. These schemes are differentiated by their charter which mandates their investment into asset classes. Beyond the type of instruments they invest in, fund houses are also differentiated in terms of their investment styles. The approaches to equity investing could be diversified or undiversified, growth, income, sector rotators, value, or market-timing based.

Each mutual fund scheme has a particular investment policy and the fund manager has to ensure that the investment policy is not breached. The policy is laid right at the outset when the fund is launched and is specified in the prospectus, the ‘Offer Document’ of the scheme. The investment policy determines the instruments in which the money from a specific scheme will be primarily invested. Based on these securities, mutual funds can be broadly classified into equity funds (growth funds and income funds), bond funds, money market funds, index funds, etc. Generally, fund houses have dozens of schemes floating in the market at any given time, with separate investment policies for each scheme.

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List of free and premium websites for financial and economic data

Data is so much important for researchers, Investment analyst, Quants and in Academia. We are in information age. Data is everywhere in internet. The thing is it depend for where you look for the data. Here I bring you a list of best websites, free and paid platforms  where you can retrieve Financial and economic (macro and micro) data.

1. Yahoo Finance (free): If you are looking for stock market data like historical share price, ETF, and Mutual funds then Yahoo finance is perfect and free platform. Many Excel sheets and R scripts use Yahoo finance API to get data. To understand how to download read my post DOWNLOADING SHARE PRICES METHOD 1 YAHOO FINANCE TO EXCEL SHEET .
2. Economagic (free): Economagic provides over 400,000 data files, with charts and excel files for economic data related to most of the country around the world. The site was started in 1996 to help students in an Applied Forecasting class. Majority of the data is related to USA macro economic factors.
3. Econstats(free): Econstats holds large source of historical data on US and other economies, both economic and financial data presented in a spreadsheet.
4. Bankscope(Paid): Bankscope specially holds data of almost all banks around the globe. It may be commercial, private, public, central, Islamic, or of any kind. Still the database holds financial details of banks.
5. Worldbank(free): World bank database is named as DataBank that contains collections of time series data on a variety of economic and social data of countries. You can create your own queries; generate tables, charts, and maps; and easily save, embed, and share them.
6. IMF(free): Its a Superb resource for economic data contains 32,000 macro times series covering over 200 countries, and trade stats.
7. WTO(free): If you are looking for trade data then its perfect location that includes exports and imports by product group, trade in services and tariff related data.
8. International Labor Office(free): This website Collects huge amounts of labour related data that includes employment, wages, Child labour stat, labour productivity, income distribution and more.
9. Trading Economics(free): Provides economic data on over 230 countries along with historical data on some 300,000 economic indicatorsincluding bond yields, stock indices and commodity prices.
10. United nations database (free): United Nations has data covering, crime, education, energy, environment, gender, health, population, tourism and trade and much more.

The above mentioned are some of the commonly used database where you can find and retrieve data for your research. Share your list of database in comment section. Subscribe Sulthan Academy for weekly updates. Share with your friends.

Levels of Market Efficiency / EMH

Economists have defined different levels of efficiency according to the type of information, which is reflected in prices. To understand what is efficient market . First, I recommend you to read  EFFICIENT MARKET HYPOTHESIS AND ITS TYPES . There are three levels of market efficiencies, they are discussed below:

Weak-form efficiency

In this form of market the share prices fully reflect all information contained in past price movements. It is pointless to predict share price based on historical share price.

Recommended: How to download historical share price

Semi-strong form efficiency

In this form, All the publicly available information are reflected in Share prices already. This includes not only past price changes but also the earnings and dividend announcements, rights issues, technological advancements, appointments of directors, and more.

This implies that there is no use in analyzing publicly available information after it has been released, because the market has already absorbed and reflected it into the price.

To estimate the intrinsic value of a share the fundamental analyst gather as much relevant information as possible. This may include: macroeconomic growth projections, industry conditions, company accounts and announcements, details of company’s personnel, tax rates, technological and social change and so on.

Strong-form of efficiency

All relevant information, including that which is privately held, is reflected in the share price. Insider trading comes in to play in this form of market.which means few privileged individuals (directors) trade in shares, as they know more than the normal investor in the market. In a strong-form efficient market even insiders are unable to make abnormal profits.

Example: It is well known that it is possible to trade shares on the basis of information not in the public domain and thereby make abnormal profits. In this respect stock markets are not strong form efficient. Trading on inside knowledge is thought to be a “bad thing”. It makes those outside of that charmed circle feel cheated.

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Efficient Market Hypothesis and its types

EMH (Efficient Market Hypothesis) elaborates that all relevant information is fully and immediately reflected in market price of a security where an investor will receive stable rate of return. In other words, an investor should not expect to earn an abnormal return (above the market return) through either technical analysis or fundamental analysis.
The efficient market hypothesis (EMH) implies that if new information is revealed about a firm it will be incorporated into the share price rapidly and rationally, with respect to the direction of the share price movement and the size of that movement. In an efficient market no trader will be presented with an opportunity for making a return on a share (or other security) that is greater than a fair return for the riskiness associated with that share (or any other security). The absence of abnormal profit possibilities arises because current and past information is immediately reflected in current prices. It is only new information, which causes prices to change.

Note:  Stock market efficiency does not mean that investors have perfect powers of prediction; all it means is that the current level is an unbiased estimate of its true economic value based on the information revealed. In the major stock markets of the world prices are set by forces of supply and demand. There are hundreds of analysts and thousands of traders, each receiving new information on a company through electronic and paper media. The moment an unexpected, positive piece of information leaks out investors will act and prices will rise rapidly to a level that gives no opportunity to make further profit.

Types of Efficiency

There are Three types of Efficiency such as Operational efficiency, allocation efficiency and Pricing Efficiency. Do not confuse these with the levels of market efficiency such as Weak form, Semi-strong form and Strong form of market efficiencies. Lets discuss the types here

1. Operational efficiency – refers to the cost to buyers and sellers of transactions in securities on the exchange. It is desirable that the market carries out its operations at as low a cost as possible. This may be promoted by creating as much competition between market makers and brokers as possible so that they earn only normal profits and not excessively high profits. It may also be enhanced by competition between exchanges for secondary-market transactions.
2. Allocation efficiency – Our society has a scarcity of resources (that is, they are limited) and it is important that we find mechanisms, to allocate those resources to where they can be most productive. Those industrial and commercial firms with the greatest potential to use investment funds effectively need a method to channel funds their way. Stock markets help in the process of allocating society’s resources between competing real investments. For example, an efficient market provides vast funds for fast-growth sectors such as Information Technology, Automobiles and Banking industries (through IPO, Right issues and etc..,) whereas allocates only small amounts for slow-growth industries.
3. Pricing efficiency – In a pricing efficient market the investor can expect to earn merely a risk-adjusted return from an investment as prices move instantaneously and in an unbiased manner to any news. It is pricing efficiency that is the focus of this section and the term efficient market hypothesis applies to this form of efficiency only.

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Measurement of Risk in Stocks

The uncertainty of a future outcome is the simplest and most accurate way to describe risk. The anticipated return from an investment is known as the expected return. Whereas, the actual return over some past period is known as the realized return. The simple fact that dominates investing is that the realized return on an asset with any risk attached to it may be different from what was expected.

Volatility

Volatility may be described as the range of price movement or price fluctuation from the expected level of return. The more a stock  goes up and down in price, the more volatile that stock is. Because wide price swings create more uncertainty of an eventual outcome, increased volatility can be equated with increased risk. Being able to measure and determine the past volatility of a security is important in that it provides some insight into the riskiness of that security as an investment.

Standard Deviation

Investors and analysts need to be familiar with the study of probability distributions. standard deviation is used as an indicator of market volatility . Since the return is not known, it must be estimated. Standard deviation is high for more volatile securities.

Beta

Beta is a measure of the systematic risk that cannot be avoided through diversification. It is important to note that beta measures a security’s volatility, or fluctuations in price, relative to a benchmark, the market portfolio of all stocks. Securities with different slopes have different sensitivities to the returns of the market index. If the slope of this relationship for a particular security is a 45-degree angle, the beta is 1.0. This means that for every one percent change in the market’s return, on average this security’s returns change 1 percent. The market portfolio has a beta of 1.0. A security with a beta of 1.5, indicates that, on average, security returns are 1.5 times as volatile as market returns, both up and down. This would be considered an aggressive security because when the overall market return rises or falls 10 percent, this security, on average, would rise or fall 15 percent. Stocks having a beta of less than 1.0 would be considered more conservative investments than the overall market. Beta is useful for comparing the relative systematic risk of different stocks and, in practice, is used by investors to judge a stock’s riskiness. Stocks can be ranked by their betas’. Because the variance of the market is a constant across all securities for a particular period, ranking stocks by beta is the same as ranking them by their absolute systematic risk. Stocks with high betas are said to be high-risk securities.

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