A STUDY ON IMPACT OF ONLINE

STOCK TRADING ON DISCOUNT

BROKERAGE INDUSTRY WITH
REFERENCE TO ZERODHA
BROKING PRIVATE LIMMITED
A STUDY ON IMPACT OF ONLINE STOCK TRADING ON DISCOUNT BROKERAGE INDUSTRY

CHAPTER NO. 1
Introduction to Online Stock Trading
and Discount Brokerage Industry

1. Introduction to the Capital Market

In today’s 21 century growing financial market increase in overall economic and capital
development of the country. India is one of the highest saving countries globally. the wealth
creation makes it necessary for the people or professional to look beyond the term bank and

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fixed deposit. There is were Capital Markets come into picture. Capital Markets in India and
globally have been immensely growing at phenomenal rate.

The capital market is the market for securities, where companies and the government can
raise long term funds. The capital market includes the stock market and the bond market.
Financial regulators ensure that investors are protected against fraud. The capital markets
consist of the primary market, where new issues are distributed to investors, and the
secondary market, where existing securities are traded.

Capital market thus plays a vital role in channelizing the savings of individuals for
Investment in the economic development of the country. As a result, the investors are not
constrained by their individual abilities, but by the abilities of the companies, which in turn
enhance the savings and investments in the country, liquidity of capital market is an
important factor affecting growth.

Since projects require long term finance, but on the other hand, the investor may not like to
relinquish control over their savings for a long time. A liquid stock market ensures a quick
exit without incurring heavy losses or costs. Thus, development of efficient market system is
necessary for creating conductive climate for investment and economic growth.

To understand Stock Brokerage Industry its essential to learn background of Indian stock
Markets. Evolution of Indian Stock Markets can be traced way back in History from initial
stages of East India company. In Pre-Independence era Stock Market was mostly dealing in
Debt securities. Post-Civil War in USA concept of Shares Started to gain popularity
thereafter following such trend share trading started in India in 1875.

1.1 History of the Indian Stock Market - The Origin

One of the oldest stock markets in Asia, the Indian Stock Markets have a 200 years old
history.

18th East India Company was the dominant institution and by end of the
Century century, business in its loan securities gained full momentum
Business on corporate stocks and shares in Bank and Cotton presses
1830's:
started in Bombay. Trading list by the end of 1839 to broader

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1840's: Recognition from banks and merchants to about half a dozen brokers
Rapid development of commercial enterprise saw brokerage business
1850's:
attracting more people into the business
1860's: The number of brokers increased to 60
The American Civil War broke out which caused a stoppage of cotton
1860-61. supply from United States of America; marking the beginning of the
"Share Mania" in India
1862-63: The number of brokers increased to about 200 to 250
A disastrous slump began at the end of the American Civil War (as an
1865. example, Bank of Bombay Share which had touched Rs. 2850 could
only be sold at Rs. 87)

Pre-Independence Scenario Establishment of Different Stock Exchanges

With the rapidly developing share trading business, brokers used to gather
1874: at a street (now well known as "Dalal Street") for the purpose of
transacting business.
"The Native Share and Stock Brokers' Association" (also known as "The
1875:
Bombay Stock Exchange") was established in Bombay
1880's: Development of cotton mills industry and set up of many others
1894 Establishment of "The Ahmedabad Share and Stock Broker’s Association"
Sharp increase in share prices of jute industries in 1870's was followed by
1880-90:
a boom in tea stocks and coal
1908: "The Calcutta Stock Exchange Association" was formed
Madras witnessed boom and business at "The Madras Stock
1920.
Exchange" was transacted with 100 brokers.
1923: When recession followed, number of brokers came down to 3 and the
Exchange was closed down
1934. Establishment of the Lahore Stock Exchange
1936: Merger of the Lahore Stock Exchange with the Punjab Stock Exchange
Re-organisation and set up of the Madras Stock Exchange Limited (Pvt.)
1937: Limited led by improvement in stock market activities in South India with
establishment of new textile mills and plantation companies
1940: Uttar Pradesh Stock Exchange Limited and Nagpur Stock
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Exchange Limited was established

1944: Establishment of "The Hyderabad Stock Exchange Limited"
"Delhi Stock and Share Brokers' Association Limited" and "The Delhi
1947: Stocks and Shares Exchange Limited" were established and later on
merged into "The Delhi Stock Exchange Association Limited"

Post-Independence Scenario

1.1.1Capital market Segment — Primary And Secondary

Broadly, the comprises of two segments — the new issue market which is commonly known
as primary market and the stock market which is known as secondary market.

Primary Market

A primary offering, such as with a corporate bond, means you are buying it directly from the
issuer, at par value, usually. A secondary market is where you sell or buy existing issues. I.E.
If you bought a bond last year, now need to get your principal, you can sell it in the
secondary market. You may not get par value. If rates are up since you bought the bond, then
you will likely have to sell it at a discount to be able to get rid of it. If rates have fallen since
you bought it, you could get a premium for it.

Secondary Market

The market where securities are traded after they are initially offered in the primary market.
Most trading is done in the secondary market. To explain further, it is trading in previously
issued financial instruments. An organized market for used securities. Bombay Stock
Exchange (BSE), National Stock Exchange NSE, bond markets, over-the-counter markets,
residential mortgage loans, governmental guaranteed loans etc

Secondary Market refers to a market where securities are traded after being initially offered
to the public in the primary market and/or listed on the Stock Exchange. Majority of the
trading is done in the secondary market. Secondary market comprises of equity markets and

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the debt markets. For the general investor, the secondary market provides an efficient
platform for trading of his securities. For the management of the company, Secondary equity
markets serve as a monitoring and control conduit—by facilitating value-enhancing control
activities, enabling implementation of incentive-based management contracts, and
aggregating information (via price discovery) that guides management decisions.

1.1.2 ABOUT THE STOCK EXCHANGES

Stock Exchange is a market like any other centralized market where both buyers and sellers
come and conduct their business of purchase and sale of shares & securities. In other words,
it is a market place for shares and securities where trading takes place in a controlled and
protected environment.

MEANING OF STOCK EXCHANGE

A stock exchange, share market or bourse is a corporation or mutual organization which

provides "trading" facilities for stock brokers and traders, to trade stocks and other securities.
Stock exchanges also provide facilities for the issue and redemption of securities as well as
other financial instruments and capital events including the payment of income and
dividends. The securities traded on a stock exchange include: shares issued by companies,
unit trusts and other pooled investment products and bonds. To be able to trade a security on
a certain stock exchange, it has to be listed there. Usually there is a central location at least
for recordkeeping, but trade is less and less linked to such a physical place, as modern
markets are electronic networks, which gives them advantages of speed and cost of
transactions. Trade on an exchange is by members only. The initial offering of stocks and
bonds to investors is by definition done in the primary market and subsequent trading is done
in the secondary market. A stock exchange is often the most important component of a stock
market. Supply and demand in stock

markets are driven by various factors which, as in all free markets, affect the price of stocks
(see stock valuation).

There is usually no compulsion to issue stock via the stock exchange itself, nor must stock be
subsequently traded on the exchange. Such trading is said to be off exchange or over-the-

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counter. This is the usual way that bonds are traded. Increasingly, stock exchanges are part of
a global market for securities.

Functions of Stock Exchange

Stock exchange is established into the main purpose of providing a market place for the
members to deal in securities under well laid down regulations and to protect the interest of
the investors. The main functions of stock exchange are;

1. It brings the companies and investors together so that the investors can put risk capital
into companies and thus, companies can use the capital.
2. It provides an orderly regulated market for securities.
3. It provides continuous, ready and open market for selling and buying securities.
4. It promotes savings and investment in the economy by attracting funds from the
investors.
5. It facilitates take overs by means of acquiring majority of shares traded on the stock
market.
6. It acts as a clearing house of business information.
7. It motivates the managers of well reputed companies, to retain their shares in 'A'
group, to improve performance.
8. It induces the managers to improve performance for converting nonspecified shares
into specified shares in the exchange.
9. It enables the investors to evaluate the net worth of their holdings.
10. It also allows the companies to float their shares in the market

1.1.3 CONCEPT OF STOCK BROKING

The concept of share broking emerged after the establishment of the joint stock companies.
The ownership of the companies was divided into small parts and that every part was called
share. So, the term "Share" denominates some part in the ownership of the company. The
shares are freely transferable subject to the some certain restrictions. When the need was felt
to sell the shares by the owner of the shares, it was difficult to find out the buyers of the
shares who want to buy the shares at the price the seller want to sell. At that time a need was
felt to bring the buyers and sellers on a common platform. To solve this problem, a group of
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persons came into picture, which used to bring the buyers and sellers together for the trade of
the shares. These persons are called the share Brokers who find the persons who wish to buy
or sell their securities. The whole process of finding the buyers and sellers of the securities by
the brokers is called the Share Broking. The origination of the Indian securities market may
be traced back to 1975, when 22 enterprise brokers under a Banyan tree established the
Bombay Stock Exchange (BSE). Over the last 130 years, the Indian securities market has
evolved continuously to become one of the most dynamic, modern international standards
both in terms of structure and in terms of operating efficiency.

BSE is the first exchange in India and the second in the world to obtain an ISO 9001 :2000
certifications. It is also the first Exchange in the country and second in the world to receive
Information Security Management System Standard BS 7799-2-2002 certification for its BSE
On-Line trading System (BOLT). Presently, we are ISO 27001 :2005 certified, which is a
ISO version of BS 7799 for Information Security.

1.2 Features of Online Stock Trading

National Stock Exchange

In order to lift the Indian stock market trading system on par with the international standards.
On the basis of the recommendations of high powered Pherwani Committee, the National
Stock Exchange was incorporated in 1992 by Industrial Development Bank of India,
Industrial Credit and Investment Corporation of India, Industrial Finance Corporation of
India, all Insurance Corporations, selected commercial banks and others.

NSE provides exposure to investors in two types of markets, namely:

1.Wholesale debt market

2.Capital market

Trading at NSE

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 Fully automated screen-based trading mechanism

 Strictly follows the principle of an order-driven market

 Trading members are linked through a communication network

 This network allows them to execute trade from their offices

 The prices at which the buyer and seller are willing to transact will appear on
the screen

 When the prices match the transaction will be completed

 A confirmation slip will be printed at the office of the trading member

 Advantages of trading at NSE

 Integrated network for trading in stock market of India

 Fully automated screen-based system that provides higher degree of

transparency

 Investors can transact from any part of the country at uniform prices

 Greater functional efficiency supported by totally computerized network.

Features of Stock Broking Industry

Stock Broking industry was one of the most high margin and high risk business in the times
when Over the Counter (OTC) Trading of Stocks taking place the prices of shares sold in
OTC Market were inclusive of brokerage charged by the Main broker to Sub-level Brokers
which makes end client to pay hefty prices of shares also the counterfeit share certificates had
framed the stock markets as close ended group of Dalal’s making money out of it. Traditional
Brokerage Industry Was always giving personal advice to their client providing analytical
charts, research to enable trade the order entry was done on single call from client, the
facilities leading to incurrence of cost to brokers and ultimately such cost were recovered
from client in form of brokerage by Traditional Brokers in market.

Discount brokers carry out orders at cheaper costs, but they typically just execute orders for
their clients. They do not offer personal consultations, advice, research, tax planning,
and estate planning services for customers. Aside from not providing extra wealth

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management services, discount brokers can offer lower fees because they do not spend
money closing deals with high-net-worth individuals. Plus, most of them today operate their
businesses online, resulting in low overhead.

In the securities industry, discount brokerages provide clients with their own accounts to
enter orders for execution. These investors usually do not interact with a live broker. If they
do, the communication is minimal and are only done for trade executions. The services
provided by discount brokers are aimed at self-directed traders and investors, and the
electronic trading platforms are built in a way that is beneficial for active traders with
charting and position monitoring services.

1.3 Importance of Online Trading

As per the title suggest the project report has been prepared as a study on online stock trading
in India using the current technology which has a great influence in growth of primitive stock
trading which was earlier part of few specialized stock brokers has been thrown open to
common people in India and across the globe. Online trading was initiated by NSE in India
and soon after the other exchanges also followed it.

There was a major boom in yr. 2000 when lots of online trading companies came with a bang
but only few were survived because of lack of computer knowledge and low internet
penetration. There are two types of online trading companies one is the banking online
trading companies and the other is non-banking trading. A few examples of banking online
trading companies are HDFC securities, ICICI direct.com, UTI securities etc.

On the other hand, non -banking trading companies are ICICDirect, Zerodha, Indiabulls,
Religare securities Angel Broking, etc. A study was undertaken to determine the growth of
various online trading companies in India in terms of trade done by them through online and
services provided by them.

Major findings indicates that out of a survey of 75+ respondents (Friends & colleagues) it
was seen that most of the investors prefer online trading because of few major factors such as
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time saving convenience, protection through Freudian brokers etc. although during my
research project I've seen that most of the respondents feel online trading, a secure way of
investing into stock market still a few of them feel that it's unsafe and a bit complicated but
they possess information about online trading. Today the online trading companies having
cut-throat competition in our offering whose brokerage discounts lower margin money and
zero balance accounts. Due to the rising education awareness and use of internet there is a
huge potential for online trading in future and companies must come up with innovative
offerings to capture the untapped market.

Importance of Discount Broking

Basically, Discount brokers are nothing but the app driven market terminal provided to
individuals to access the stock market at very cheaper Brokerage. There is no requirement of
huge set up of offices and its branches as broking services are provided through application
over the Internet. Also, online Know Your Client (KYC) Procedures have made easy way to
pave in retail participant’s without incurring heavy promotional activities. The lower
brokerage acts as advertisement for existing traders as they can earn more profits with lower
cost of Transaction. As compared to traditional stock brokers, discount brokers are more
flexible to client for Margins and pay-in payout of funds. Almost all types of online payments
are accepted by discount brokers including IMPS, NEFT, P2P Fund Transfer which attracts
younger population generally below 30 years which provides them convenience to trade from
their Mobiles.

The equity broking industry is getting disrupted with the rapid rise of discount brokers in
general and Zerodha in particular. Within just 5 years Zerodha has clocked 15% volume
market share. 5 PAISA, the second largest discount broker is now around 1.3% of the overall
market. Zerodha now has the largest active customer base of ~0.9mn.With the growing
customer base of discount brokers and the announced entry plan of PayTM Money, the low
fixed rate broking model is poised to grow further. The largest discount brokers in the US-
Schwab, Fidelity, TD Ameritrade, and Pershing already control ~62% of the broking market.

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over the next few years as the disruption picks pace incumbents will be forced to reduce
broking charges even for the cash product.

Discount brokers continue to invest in new apps- Zerodha has recently on-boarded Smallcase
(index creating and investing platform), Sensibull (option strategy trading platform) and
Streak (algo-creation, back-testing platform). Additionally, Zerodha’s new product plans
include de-construction of ULIP and selling term insurance and direct mutual funds
separately, launching investing platform for US equities, margin funding and direct retail
investing in Indian government bonds, Assuring exciting times ahead.

1.4 Advantages of online stock trading with Discount Brokers

1. Lower fees

One of the clearest advantages of online trading is the reduction in transaction costs and high
fees associated with traditional brick-and-mortar brokerage firms. Typically, client pay
between Rs. 5 and Rs.20 to buy and sell stocks and exchange-traded funds at online discount
brokerages, according to a Bloomberg report.

2. More control and flexibility

Time is often of the essence when you trade stocks, so the speed of using online trading
portals is a benefit to many investors. With online trading, you can execute a trade almost
immediately. Traditional brick-and-mortar brokers might require appointments, either online,
over the phone or in person, just to initiate a trade.

3. Ability to avoid brokerage bias

By taking trading into your own hands, you can eliminate brokerage bias. Bias sometimes
occurs when a broker gives financial advice that benefits the broker — such as in the form of
a commission for selling specific mutual funds and other products.

4. Access to online tools

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In the world of online trading, a lower cost does not necessarily mean a shoddy product.
Many of today’s online trading companies offer customers an impressive suite of tools
providing valuable information and helping optimize trades.

5. Option to monitor investments in real time

Many online trading sites offer stock quotes and trade information that make it easy for
people to see how their investments are doing in real time. Advance portfolio Tracking tools
help to avoid probable losses and taking correct decision on Realtime basis.

1.5 Dis-advantages of online stock trading with Discount Brokers

1. Easier to invest too much too fast

Because online trading is so easy — you basically push a button — there is the risk of
making poor investment choices or overinvesting.

Online investors can protect themselves by understanding the stocks they are buying and
setting up safeguards in fast-paced markets. Placing a limit order on your account is one way
to control what you buy and how much of it.

2. No personal relationships with brokers

From getting help on how to create an investment strategy to understanding how the results
of feedback mechanisms affect the market, online traders are left to their own devices. For
some, this kind of autonomy can be unsettling.

Experts often stress the importance of research, particularly for new traders. You need to
learn as much as you can about the companies in which you invest.

3. Addictive nature

Online traders can experience a certain high when trading that is similar to what people
experience when gambling, according to a recent study on excessive trading published in the
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journal Addictive Behaviors. The study noted that some investors choose short-term trading
strategies that involve investing in risky stocks offering the potential for large gains but also
significant losses. “The structure itself of the two activities (gambling and trading) is very
close,” the study concluded.

4. Internet-dependent

The nature of online trading means that, ultimately, you’re at the mercy of your internet
connection. If the internet connection is too slow or is interrupted, you can lose out on a
potentially important or lucrative trade.

5. Buying errors due to computer missteps

With online trading, to simply assume a trade was not completed can cost you money.
Investors who believe their trade was not completed might make the trade again and end up
investing twice as much as they intended. Assuming a trade was completed without seeing
confirmation of the fact also is a mistake. Make sure you understand how to verify trades and
review statements before you begin using an online investing system.

1.6 Types of Online Trading Systems offered by brokers

The Internet revolution has been changing the fundamentals of the society. It changes the
shape of communication and also trading process. It shifts closer and closer to vital sources of
information and new trading environment by the name of "online trading". It provides users
with means to directly interact with service- oriented computer systems tailored to their
specific needs; therefore, they can serve themselves better by making their own decisions.
There are lots of definitions for online trading. Hereby, three main definitions are mentioned:

 The increasingly popular activity of buying and selling securities over the internet, or
to a lesser extent, through a broker’s proprietary software.
-(www.investsmartindia.com)
 The 'online trading' is defined as a process of trading financial products especially
stocks over the Internet, and online stock trading site is a web site that helps traders or
customers to buy and sell the financial products over the Internet.
-(www.investopedia.com)

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 Furthermore, there is another definition for online trading which defines it in this way:
Online trading is placing an order for a trade using the internet. Online trading is not a
strategy, but a means to enter a trade. Online trading can be used to enter a short trade
or day trade, or a longer-term position in a stock, bond, commodity or option.
-(www.investorwords.com)

Each of these definitions describe online trading from somehow different aspect, but
something is common and that the services which have provided to traders.

They divided into three categories:

1. Full-service
2. Discount
3. Online

Investors who do not have time to research investments on their own will likely rely on a full-
service broker to help them construct an investment portfolio, manage their investments, or
make recommendations regarding which investments to buy. Full-service brokers have access
to a wide range of reports and analyses from the company's large staff of financial analysts.
These analysts research companies and recommend investments to people with different
financial needs. Persons who prefer to select their own investments generally use a discount
or online broker and pay lower commission charges. Discount firms usually do not offer
advice about specific securities. Online brokerage firms make their trades over the Internet in
order to keep costs down and fees low. Discount brokerage firms usually have branch offices,
while online firms do not. Most brokerage firms now have call centers staffed with both
licensed sales agents and customer service representatives who take orders and answer
questions at all hours of the day.

There are two basic ways to day trade electronically. The first is through "Conventional
Online Trading", using your Internet browser and a Web based broker. The second is by way
of "Direct Access Trading systems", using specialized software and a private network. It is
important for day traders to understand the key features of, and the differences between these
two forms of electronic trading.
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1.7 Elements of Indian Stock Exchanges and applied Online Trading

Systems

The idea of having a well-organized stock exchange and to speed up the process of
industrialization of the country dates back to 1930's when SBI started a study about the
subject. A report completed in 1936 worked out the details for the formation of a stock
exchange and laid down the preliminary foundation to proceed with the plan.

The outbreak of the World War Il and subsequent economic and political events delayed the
establishment of the stock exchange up to the year 1967 when the Stock Exchange Act was
ratified. The Indian Stock Exchange opened in April 1968. Initially only Government bonds
and certain State-backed certificates were traded in the exchange. During 1970's the demand
for capital boosted the demand for stocks. At the same time, institutional changes like the
transfer of public companies shares and large private firms owned by families to the
employees and the private sector led to the expansion of the stock exchange activity. The
restructuring of the economy following the Industrial revolution boosted up set up of Online
Stock Trading

Step 1: Offline/Online communication with brokers

BROKER BUYER
SELLER BROKER

Step 2: Entering order and Matching Process

(9:00 AM To 3:45 PM) MARKET
TRADE ENTRY

(BROKERS ENTER THHE

ORDER INTO
AUTOMATED TRADING
FLOOR)

TRADE
Step 3: Transaction Process

SETTLEMENT CLEARING

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