1.

Introduction
Investment markets are becoming more risky and each and every passing
day makes investors behave differently upon different market dynamics.
The basic methods of market analysis (Fundamental, Technical and
Quantitative) though are playing an important role in investment
decisions, the behavior of the investors has become more important and
hence the study Behavioral Finance emerging and becoming the topic
of various researches and studies. In extension to the same, this study
reviews the literature on one of the most meaningful concepts in
behavioral finance, the decision factors which are influenced by market
movements and examines the perceptions, preferences and various
investment strategies adopted by investors in the Indian stock market on
the basis of a survey of 110 respondents based in Udaipur and are
investors in the stock market during September 2011-January 2012. The
study analyses the rationality of the investors of Udaipur during different
market expectations, dividend and bonus announcements, the impact of
age, income levels and other market related information on investment
decisions of investors from Udaipur.
Stock Market
A stock market, equity market or share market is the aggregation of
buyers and sellers (a loose network of economic transactions, not a
physical facility or discrete entity) of stocks (also called shares); these
1

may include securities listed on a stock exchange as well as those only

traded privately.
Size of the market
Stocks can also be categorized in various ways. One common way is by
the country where the company is domiciled. For example, Nestl and
Novartis are domiciled in Switzerland, so they may be considered as part
of the Swiss stock market, although their stock may also be traded at
exchanges in other countries.
At the close of 2012, the size of the world stock market (total market
capitalisation) was about US$55 trillion.[1] By country, the largest
market was the United States (about 34%), followed by Japan (about 6%)
and the United Kingdom (about 6%).[2] This went up more in 2013.[3]
There are a total of 60 stock exchanges in the world with a total market
capitalization of $69 trillion. Of these there are 16 exchanges that have a
market capitalization of $1 trillion each and they account for 87% of
global market capitalization. Apart from the Australian Securities
Exchange, all of these 16 exchanges are divided between three
continents: North America, Europe and Asia.
Stock exchange
A stock exchange is a place or organization by which stock traders
(people and companies) can trade stocks. Companies may want to get
their stock listed on a stock exchange. Other stocks may be traded "over

the counter" (otc), that is, through a dealer. A large company will usually
have its stock listed on many exchanges across the world.
Exchanges may also cover other types of security such as fixed interest
securities or interest derivatives.
Trade in stock markets means the transfer for money of a stock or
security from a seller to a buyer. This requires these two parties to agree
on a price. Equities (stocks or shares) confer an ownership interest in a
particular company.
Participants in the stock market range from small individual stock
investors to larger traders investors, who can be based anywhere in the
world, and may include banks, insurance companies or pension funds,
and hedge funds. Their buy or sell orders may be executed on their behalf
by a stock exchange trader.
Some exchanges are physical locations where transactions are carried out
on a trading floor, by a method known as open outcry. This method is
used in some stock exchanges and commodity exchanges, and involves
traders entering oral bids and offers simultaneously. The other type of
stock exchange is a virtual kind, composed of a network of computers
where trades are made electronically by traders. An example of such an
exchange is the NASDAQ.
A potential buyer bids a specific price for a stock, and a potential seller
asks a specific price for the same stock. Buying or selling at market
3

means you will accept any ask price or bid price for the stock,
respectively. When the bid and ask prices match, a sale takes place, on a
first-come-first-served basis if there are multiple bidders or askers at a
given price.
The purpose of a stock exchange is to facilitate the exchange of securities
between buyers and sellers, thus providing a marketplace (virtual or real).
The exchanges provide real-time trading information on the listed
securities, facilitating price discovery.
The New York Stock Exchange (NYSE) is a physical exchange, with a
hybrid market for placing orders electronically from any location as well
as the trading floor. Orders executed on the trading floor enter by way of
exchange members and flow down to a floor broker, who submits the
order electronically to the floor trading post for the Designated Market
Maker ("DMM") for that stock to trade the order. The DMM's job is to
maintain a two-sided market, meaning orders to buy and sell the security
if there are no other buyers and sellers. If a spread exists, no trade
immediately takes placein this case the DMM should use their own
resources (money or stock) to close the difference after they judged time.
Once a trade has been made the details are reported on the "tape" and sent
back to the brokerage firm, which then notifies the investor who placed
the order. Computers play an important role, especially for so-called
"program trading".
4

The NASDAQ is a virtual listed exchange, where all of the trading is

done over a computer network. The process is similar to the New York
Stock Exchange. One or more NASDAQ market makers will always
provide a bid and ask price at which they will always purchase or sell
'their' stock.
The Paris Bourse, now part of Euronext, is an order-driven, electronic
stock exchange. It was automated in the late 1980s. Prior to the 1980s, it
consisted of an open outcry exchange. Stockbrokers met on the trading
floor or the Palais Brongniart. In 1986, the CATS trading system was
introduced, and the order matching process was fully automated.
People trading stock will prefer to trade on the most popular exchange
since this gives the largest number of potential counterparties (buyers for
a seller, sellers for a buyer) and probably the best price. However, there
have always been alternatives such as brokers trying to bring parties
together to trade outside the exchange. Some third markets that were
popular are Instinet, and later Island and Archipelago (the later two have
since been acquired by Nasdaq and NYSE, respectively). One advantage
is that this avoids the commissions of the exchange. However, it also has
problems such as adverse selection. Financial regulators are probing dark
pools.
Market participant
5

The offices of Bursa Malaysia, Malaysia's national stock exchange

(known before demutualization as Kuala Lumpur Stock Exchange)
Market participants include individual retail investors, institutional
investors such as mutual funds, banks, insurance companies and hedge
funds, and also publicly traded corporations trading in their own shares.
Some studies have suggested that institutional investors and corporations
trading in their own shares generally receive higher risk-adjusted returns
than retail investors.[9]
A few decades ago,[when?] worldwide, buyers and sellers were
individual investors, such as wealthy businessmen, usually with long
family histories to particular corporations. Over time, markets have
become more "institutionalized"; buyers and sellers are largely
institutions (e.g., pension funds, insurance companies, mutual funds,
index funds, exchange-traded funds, hedge funds, investor groups, banks
and various other financial institutions).
The rise of the institutional investor has brought with it some
improvements in market operations. There has been a gradual tendency
for "fixed" (and exorbitant) fees being reduced for all investors, partly
from falling administration costs but also assisted by large institutions
challenging brokers' oligopolistic approach to setting standardised fees. A
current trend in stock market investments includes the decrease in fees
due to computerized asset management termed Robo Advisers within the
6

industry. The automation of investment management has decreased how

much human portfolio management costs by lowering the cost associated
with investing as a whole.
Trends in market participation
Stock market participation refers to the number of agents who buy and
sell equity backed securities either directly or indirectly in a financial
exchange. Participants are generally subdivided into three distinct sectors;
households, institutions, and foreign traders. Direct participation occurs
when any of the above entities buys or sells securities on its own behalf
on an exchange. Indirect participation occurs when an institutional
investor exchanges a stock on behalf of an individual or household.
Indirect investment occurs in the form of pooled investment accounts,
retirement accounts, and other managed financial accounts.
Indirect vs. direct investment
The total value of equity-backed securities in the United States rose over
600% in the 25 years between 1989 and 2012 as market capitalization
expanded from $2,789,999,902,720 to $18,668,333,210,000.[10] The
demographic composition of stock market participation, accordingly, is
the main determinant of the distribution of gains from this growth. Direct
ownership of stock by households rose slightly from 17.8% in 1992 to
17.9% in 2007 with the median value of these holdings rising from
$14,778 to $17,000.[11][12] Indirect participation in the form of
retirement accounts rose from 39.3% in 1992 to 52.6% in 2007 with the
7

median value of these accounts more than doubling from $22,000 to

$45,000 in that time.[11][12] Rydqvist, Spizman, and Strebulaev attribute
the differential growth in direct and indirect holdings to differences in the
way each are taxed. Investments in pension funds and 401ks, the two
most common vehicles of indirect participation, are taxed only when
funds are withdrawn from the accounts. Conversely, the money used to
directly purchase stock is subject to taxation as are any dividends or
capital gains they generate for the holder. In this way current tax code
incentivizes households to invest indirectly at greater rates.[13]
Participation by income and wealth strata
Rates of participation and the value of holdings differs significantly
across strata of income. In the bottom quintile of income, 5.5% of
households directly own stock and 10.7% hold stocks indirectly in the
form of retirement accounts.[12] The top decile of income has a direct
participation rate of 47.5% and an indirect participation rate in the form
of retirement accounts of 89.6%.[12] The median value of directly owned
stock in the bottom quintile of income is $4,000 and is $78,600 in the top
decile of income as of 2007.[14] The median value of indirectly held
stock in the form of retirement accounts for the same two groups in the
same year is $6,300 and $214,800 respectively.[14] Since the Great
Recession of 2008 households in the bottom half of the income
distribution have lessened their participation rate both directly and
8

indirectly from 53.2% in 2007 to 48.8% in 2013, while over the same
time period households in the top decile of the income distribution
slightly increased participation 91.7% to 92.1%.[15] The mean value of
direct and indirect holdings at the bottom half of the income distribution
moved slightly downward from $53,800 in 2007 to $53,600 in 2013.[15]
In the top decile, mean value of all holdings fell from $982,000 to
$969,300 in the same time.[15] The mean value of all stock holdings
across the entire income distribution is valued at $269,900 as of 2013.
[15]
Participation by head of household race and gender[12]
The racial composition of stock market ownership shows households
headed by whites are nearly four and six times as likely to directly own
stocks than households headed by blacks and Hispanics respectively. As
of 2011 the national rate of direct participation was 19.6%, for white
households the participation rate was 24.5%, for black households it was
6.4% and for Hispanic households it was 4.3% Indirect participation in
the form of 401k ownership shows a similar pattern with a national
participation rate of 42.1%, a rate of 46.4% for white households, 31.7%
for black households, and 25.8% for Hispanic households. Households
headed by married couples participated at rates above the national
averages with 25.6% participating directly and 53.4% participating
indirectly through a retirement account. 14.7% of households headed by
9

men participated in the market directly and 33.4% owned stock through a
retirement account. 12.6% of female headed households directly owned
stock and 28.7% owned stock indirectly.
Determinants and possible explanations of stock market participation
In a 2002 paper Anntte Vissing-Jorgensen from the University of Chicago
attempts to explain disproportionate rates of participation along wealth
and income groups as a function of fixed costs associated with investing.
Her research concludes that a fixed cost of $200 per year is sufficient to
explain why nearly half of all U.S. households do not participate in the
market.[16] Participation rates have been shown to strongly correlate with
education levels, promoting the hypothesis that information and
transaction costs of market participation are better absorbed by more
educated households. Behavioral economists Harrison Hong, Jeffrey
Kubik and Jeremy Stein suggest that sociability and participation rates of
communities have a statistically significant impact on an individuals
decision to participate in the market. Their research indicates that social
individuals living in states with higher than average participation rates are
5% more likely to participate than individuals that do not share those
characteristics.[17] This phenomena also explained in cost terms.
Knowledge of market functioning diffuses through communities and
consequently lowers transaction costs associated with investing.
History
10

Established in 1875, the Bombay Stock Exchange is Asia's first stock

exchange.
In 12th-century France, the courretiers de change were concerned with
managing and regulating the debts of agricultural communities on behalf
of the banks. Because these men also traded with debts, they could be
called the first brokers. A common misbelief is that in late 13th century
Bruges commodity traders gathered inside the house of a man called Van
der Beurze, and in 1409 they became the "Brugse Beurse",
institutionalizing what had been, until then, an informal meeting, but
actually, the family Van der Beurze had a building in Antwerp where
those gatherings occurred;[18] the Van der Beurze had Antwerp, as most
of the merchants of that period, as their primary place for trading. The
idea quickly spread around Flanders and neighboring countries and
"Beurzen" soon opened in Ghent and Rotterdam.
In the middle of the 13th century, Venetian bankers began to trade in
government securities. In 1351 the Venetian government outlawed
spreading rumors intended to lower the price of government funds.
Bankers in Pisa, Verona, Genoa and Florence also began trading in
government securities during the 14th century. This was only possible
because these were independent city-states not ruled by a duke but a
council of influential citizens. Italian companies were also the first to

11

issue shares. Companies in England and the Low Countries followed in

the 16th century.
The Dutch East India Company (founded in the year of 1602) was the
first joint-stock company to get a fixed capital stock and as a result,
continuous trade in company stock occurred on the Amsterdam
Exchange. Soon thereafter, a lively trade in various derivatives, among
which options and repos, emerged on the Amsterdam market. Dutch
traders also pioneered short selling a practice which was banned by the
Dutch authorities as early as 1610.[19]
There are now stock markets in virtually every developed and most
developing economies, with the world's largest markets being in the
United States, United Kingdom, Japan, India, China, Canada, Germany
(Frankfurt Stock Exchange), France, South Korea and the Netherlands.
[20]
Importance
Function and purpose
The main trading room of the Tokyo Stock Exchange,where trading is
currently completed through computers
The stock market is one of the most important ways for companies to
raise money, along with debt markets which are generally more imposing
but do not trade publicly.[21] This allows businesses to be publicly
traded, and raise additional financial capital for expansion by selling
shares of ownership of the company in a public market. The liquidity that
12

an exchange affords the investors enables their holders to quickly and

easily sell securities. This is an attractive feature of investing in stocks,
compared to other less liquid investments such as property and other
immoveable assets. Some companies actively increase liquidity by
trading in their own shares.[22][23]
History has shown that the price of stocks and other assets is an important
part of the dynamics of economic activity, and can influence or be an
indicator of social mood. An economy where the stock market is on the
rise is considered to be an up-and-coming economy. The stock market is
often considered the primary indicator of a country's economic strength
and development.[24]
Rising share prices, for instance, tend to be associated with increased
business investment and vice versa. Share prices also affect the wealth of
households and their consumption. Therefore, central banks tend to keep
an eye on the control and behavior of the stock market and, in general, on
the smooth operation of financial system functions. Financial stability is
the raison d'tre of central banks.[25]
Exchanges also act as the clearinghouse for each transaction, meaning
that they collect and deliver the shares, and guarantee payment to the
seller of a security. This eliminates the risk to an individual buyer or
seller that the counterparty could default on the transaction.[26]

13

The smooth functioning of all these activities facilitates economic growth

in that lower costs and enterprise risks promote the production of goods
and services as well as possibly employment. In this way the financial
system is assumed to contribute to increased prosperity, although some
controversy exists as to whether the optimal financial system is bankbased or market-based.[27]
Recent events such as the Global Financial Crisis have prompted a
heightened degree of scrutiny of the impact of the structure of stock
markets[28][29] (called market microstructure), in particular to the
stability of the financial system and the transmission of systemic risk.[30]
Relation to the modern financial system
The financial system in most western countries has undergone a
remarkable transformation. One feature of this development is
disintermediation. A portion of the funds involved in saving and
financing, flows directly to the financial markets instead of being routed
via the traditional bank lending and deposit operations. The general
public interest in investing in the stock market, either directly or through
mutual funds, has been an important component of this process.
Statistics show that in recent decades, shares have made up an
increasingly large proportion of households' financial assets in many
countries. In the 1970s, in Sweden, deposit accounts and other very liquid
assets with little risk made up almost 60 percent of households' financial
14

wealth, compared to less than 20 percent in the 2000s. The major part of
this adjustment is that financial portfolios have gone directly to shares but
a good deal now takes the form of various kinds of institutional
investment for groups of individuals, e.g., pension funds, mutual funds,
hedge funds, insurance investment of premiums, etc.
The trend towards forms of saving with a higher risk has been
accentuated by new rules for most funds and insurance, permitting a
higher proportion of shares to bonds. Similar tendencies are to be found
in other developed countries. In all developed economic systems, such as
the European Union, the United States, Japan and other developed
nations, the trend has been the same: saving has moved away from
traditional (government insured) "bank deposits to more risky securities
of one sort or another".
Behavior of the stock market
NASDAQ in Times Square, New York City
From experience it is known that investors may 'temporarily' move
financial prices away from their long term aggregate price 'trends'. Overreactions may occurso that excessive optimism (euphoria) may drive
prices unduly high or excessive pessimism may drive prices unduly low.
Economists continue to debate whether financial markets are 'generally'
efficient.[32]
According to one interpretation of the efficient-market hypothesis
(EMH), only changes in fundamental factors, such as the outlook for
15

margins, profits or dividends, ought to affect share prices beyond the

short term, where random 'noise' in the system may prevail. (But this
largely theoretic academic viewpointknown as 'hard' EMHalso
predicts that little or no trading should take place, contrary to fact, since
prices are already at or near equilibrium, having priced in all public
knowledge.) The 'hard' efficient-market hypothesis is sorely tested and
does not explain the cause of events such as the crash in 1987, when the
Dow Jones Industrial Average plummeted 22.6 percentthe largest-ever
one-day fall in the United States.[33]
This event demonstrated that share prices can fall dramatically even
though, to this day, it is impossible to fix a generally agreed upon definite
cause: a thorough search failed to detect any 'reasonable' development
that might have accounted for the crash. (But note that such events are
predicted to occur strictly by chance, although very rarely.) It seems also
to be the case more generally that many price movements (beyond that
which are predicted to occur 'randomly') are not occasioned by new
information; a study of the fifty largest one-day share price movements in
the United States in the post-war period seems to confirm this.[33]
A 'soft' EMH has emerged which does not require that prices remain at or
near equilibrium, but only that market participants not be able to
systematically profit from any momentary market 'inefficiencies'.
Moreover, while EMH predicts that all price movement (in the absence of
16

change in fundamental information) is random (i.e., non-trending), many

studies have shown a marked tendency for the stock market to trend over
time periods of weeks or longer. Various explanations for such large and
apparently non-random price movements have been promulgated. For
instance, some research has shown that changes in estimated risk, and the
use of certain strategies, such as stop-loss limits and value at risk limits,
theoretically could cause financial markets to overreact. But the best
explanation seems to be that the distribution of stock market prices is
non-Gaussian (in which case EMH, in any of its current forms, would not
be strictly applicable).[34][35]
Other research has shown that psychological factors may result in
exaggerated (statistically anomalous) stock price movements (contrary to
EMH which assumes such behaviors 'cancel out'). Psychological research
has demonstrated that people are predisposed to 'seeing' patterns, and
often will perceive a pattern in what is, in fact, just noise. (Something like
seeing familiar shapes in clouds or ink blots.) In the present context this
means that a succession of good news items about a company may lead
investors to overreact positively (unjustifiably driving the price up). A
period of good returns also boosts the investors' self-confidence, reducing
their (psychological) risk threshold.
Another phenomenonalso from psychologythat works against an
objective assessment is group thinking. As social animals, it is not easy to
17

stick to an opinion that differs markedly from that of a majority of the

group. An example with which one may be familiar is the reluctance to
enter a restaurant that is empty; people generally prefer to have their
opinion validated by those of others in the group.
In one paper the authors draw an analogy with gambling.[37] In normal
times the market behaves like a game of roulette; the probabilities are
known and largely independent of the investment decisions of the
different players. In times of market stress, however, the game becomes
more like poker (herding behavior takes over). The players now must
give heavy weight to the psychology of other investors and how they are
likely to react psychologically.
The stock market, as with any other business, is quite unforgiving of
amateurs. Inexperienced investors rarely get the assistance and support
they need. In the period running up to the 1987 crash, less than 1 percent
of the analyst's recommendations had been to sell (and even during the
20002002 bear market, the average did not rise above 5%). In the run up
to 2000, the media amplified the general euphoria, with reports of rapidly
rising share prices and the notion that large sums of money could be
quickly earned in the so-called new economy stock market. (And later
amplified the gloom which descended during the 20002002 bear market,
so that by summer of 2002, predictions of a DOW average below 5000
were quite common)
18

On the other hand, Stock markets play an essential role in growing

industries that ultimately affect the economy through transferring
available funds from units that have excess funds (savings) to those who
are suffering from funds deficit (borrowings) (Padhi and Naik, 2012). In
other words, capital markets facilitate funds movement between the
above-mentioned units. This process leads to the enhancement of
available financial resources which in turn affects the economic growth
positively. Moreover, both of economic and financial theories argue that
stocks prices are affected by the performance of main macroeconomic
variables.
Many different academic researchers have stated companies with low P/E
ratios and smaller sized companies have a tendency to outperform the
market. Research carried out states mid-sized companies outperform
large cap companies and smaller companies have even higher returns
historically.
Irrational behavior
Sometimes, the market seems to react irrationally to economic or
financial news, even if that news is likely to have no real effect on the
fundamental value of securities itself.[38] But, this may be more apparent
than real, since often such news has been anticipated, and a
counterreaction may occur if the news is better (or worse) than expected.

19

Therefore, the stock market may be swayed in either direction by press

releases, rumors, euphoria and mass panic.
Over the short-term, stocks and other securities can be battered or buoyed
by any number of fast market-changing events, making the stock market
behavior difficult to predict. Emotions can drive prices up and down,
people are generally not as rational as they think, and the reasons for
buying and selling are generally obscure. Behaviorists argue that
investors often behave 'irrationally' when making investment decisions
thereby incorrectly pricing securities, which causes market inefficiencies,
which, in turn, are opportunities to make money.[39] However, the whole
notion of EMH is that these non-rational reactions to information cancel
out, leaving the prices of stocks rationally determined.
The Dow Jones Industrial Average biggest gain in one day was 936.42
points or 11 percent, this occurred on October 13, 2008.[40]
Robert Shiller's plot of the S&P Composite Real Price Index, Earnings,
Dividends, and Interest Rates, from Irrational Exuberance, 2d ed.[41] In
the preface to this edition, Shiller warns, "The stock market has not come
down to historical levels: the price-earnings ratio as I define it in this
book is still, at this writing [2005], in the mid-20s, far higher than the
historical average... People still place too much confidence in the markets
and have too strong a belief that paying attention to the gyrations in their

20

investments will someday make them rich, and so they do not make
conservative preparations for possible bad outcomes."
Price-Earnings ratios as a predictor of twenty-year returns based upon the
plot by Robert Shiller (Figure 10.1,[41] source). The horizontal axis
shows the real price-earnings ratio of the S&P Composite Stock Price
Index as computed in Irrational Exuberance (inflation adjusted price
divided by the prior ten-year mean of inflation-adjusted earnings). The
vertical axis shows the geometric average real annual return on investing
in the S&P Composite Stock Price Index, reinvesting dividends, and
selling twenty years later. Data from different twenty-year periods is
color-coded as shown in the key. See also ten-year returns. Shiller states
that this plot "confirms that long-term investorsinvestors who commit
their money to an investment for ten full yearsdid do well when prices
were low relative to earnings at the beginning of the ten years. Long-term
investors would be well advised, individually, to lower their exposure to
the stock market when it is high, as it has been recently, and get into the
market when it is low."[41]
A stock market crash is often defined as a sharp dip in share prices of
stocks listed on the stock exchanges. In parallel with various economic
factors, a reason for stock market crashes is also due to panic and
investing public's loss of confidence. Often, stock market crashes end
speculative economic bubbles.
21

There have been famous stock market crashes that have ended in the loss
of billions of dollars and wealth destruction on a massive scale. An
increasing number of people are involved in the stock market, especially
since the social security and retirement plans are being increasingly
privatized and linked to stocks and bonds and other elements of the
market. There have been a number of famous stock market crashes like
the Wall Street Crash of 1929, the stock market crash of 19734, the
Black Monday of 1987, the Dot-com bubble of 2000, and the Stock
Market Crash of 2008.
One of the most famous stock market crashes started October 24, 1929 on
Black Thursday. The Dow Jones Industrial Average lost 50% during this
stock market crash. It was the beginning of the Great Depression. Another
famous crash took place on October 19, 1987 Black Monday. The crash
began in Hong Kong and quickly spread around the world.
By the end of October, stock markets in Hong Kong had fallen 45.5%,
Australia 41.8%, Spain 31%, the United Kingdom 26.4%, the United
States 22.68%, and Canada 22.5%. Black Monday itself was the largest
one-day percentage decline in stock market history the Dow Jones fell
by 22.6% in a day. The names "Black Monday" and "Black Tuesday" are
also used for October 2829, 1929, which followed Terrible Thursday
the starting day of the stock market crash in 1929.

22

The crash in 1987 raised some puzzles main news and events did not
predict the catastrophe and visible reasons for the collapse were not
identified. This event raised questions about many important assumptions
of modern economics, namely, the theory of rational human conduct, the
theory of market equilibrium and the efficient-market hypothesis. For
some time after the crash, trading in stock exchanges worldwide was
halted, since the exchange computers did not perform well owing to
enormous quantity of trades being received at one time. This halt in
trading allowed the Federal Reserve System and central banks of other
countries to take measures to control the spreading of worldwide financial
crisis. In the United States the SEC introduced several new measures of
control into the stock market in an attempt to prevent a re-occurrence of
the events of Black Monday.
Since the early 1990s, many of the largest exchanges have adopted
electronic 'matching engines' to bring together buyers and sellers,
replacing the open outcry system. Electronic trading now accounts for the
majority of trading in many developed countries. Computer systems were
upgraded in the stock exchanges to handle larger trading volumes in a
more accurate and controlled manner. The SEC modified the margin
requirements in an attempt to lower the volatility of common stocks,
stock options and the futures market. The New York Stock Exchange and
the Chicago Mercantile Exchange introduced the concept of a circuit
23

breaker. The circuit breaker halts trading if the Dow declines a prescribed
number of points for a prescribed amount of time. In February 2012, the
Investment Industry Regulatory Organization of Canada (IIROC)
introduced single-stock circuit breakers.[42]
New York Stock Exchange (NYSE) circuit breakers[43]
% drop
time of drop close trading for
10
before 2 pm one hour halt
10
2 pm 2:30 pm half-hour halt
10
after 2:30 pm
market stays open
20
before 1 pm halt for two hours
20
1 pm 2 pmhalt for one hour
20
after 2 pm close for the day
30
any time during day
close for the day
Stock market prediction
Stock market prediction
Tobias Preis and his colleagues Helen Susannah Moat and H. Eugene
Stanley introduced a method to identify online precursors for stock
market moves, using trading strategies based on search volume data
provided by Google Trends.[44] Their analysis of Google search volume
for 98 terms of varying financial relevance, published in Scientific
Reports,[45] suggests that increases in search volume for financially
relevant search terms tend to precede large losses in financial markets.
[46][47][48][49][50][51]
Stock market index
Stock market index
The movements of the prices in a market or section of a market are
captured in price indices called stock market indices, of which there are
many, e.g., the S&P, the FTSE and the Euronext indices. Such indices are
24

usually market capitalization weighted, with the weights reflecting the

contribution of the stock to the index. The constituents of the index are
reviewed frequently to include/exclude stocks in order to reflect the
changing business environment.
Derivative instruments
Derivative (finance)
Financial innovation has brought many new financial instruments whose
pay-offs or values depend on the prices of stocks. Some examples are
exchange-traded funds (ETFs), stock index and stock options, equity
swaps, single-stock futures, and stock index futures. These last two may
be traded on futures exchanges (which are distinct from stock exchanges
their history traces back to commodity futures exchanges), or traded
over-the-counter. As all of these products are only derived from stocks,
they are sometimes considered to be traded in a (hypothetical) derivatives
market, rather than the (hypothetical) stock market.
Leveraged strategies
Stock that a trader does not actually own may be traded using short
selling; margin buying may be used to purchase stock with borrowed
funds; or, derivatives may be used to control large blocks of stocks for a
much smaller amount of money than would be required by outright
purchase or sales.
Short selling
Short selling

25

In short selling, the trader borrows stock (usually from his brokerage
which holds its clients' shares or its own shares on account to lend to
short sellers) then sells it on the market, betting that the price will fall.
The trader eventually buys back the stock, making money if the price fell
in the meantime and losing money if it rose. Exiting a short position by
buying back the stock is called "covering." This strategy may also be used
by unscrupulous traders in illiquid or thinly traded markets to artificially
lower the price of a stock. Hence most markets either prevent short
selling or place restrictions on when and how a short sale can occur. The
practice of naked shorting is illegal in most (but not all) stock markets.
Margin buying
In margin buying, the trader borrows money (at interest) to buy a stock
and hopes for it to rise. Most industrialized countries have regulations
that require that if the borrowing is based on collateral from other stocks
the trader owns outright, it can be a maximum of a certain percentage of
those other stocks' value. In the United States, the margin requirements
have been 50% for many years (that is, if you want to make a $1000
investment, you need to put up $500, and there is often a maintenance
margin below the $500).
A margin call is made if the total value of the investor's account cannot
support the loss of the trade. (Upon a decline in the value of the margined
securities additional funds may be required to maintain the account's
26

equity, and with or without notice the margined security or any others
within the account may be sold by the brokerage to protect its loan
position. The investor is responsible for any shortfall following such
forced sales.)
Regulation of margin requirements (by the Federal Reserve) was
implemented after the Crash of 1929. Before that, speculators typically
only needed to put up as little as 10 percent (or even less) of the total
investment represented by the stocks purchased. Other rules may include
the prohibition of free-riding: putting in an order to buy stocks without
paying initially (there is normally a three-day grace period for delivery of
the stock), but then selling them (before the three-days are up) and using
part of the proceeds to make the original payment (assuming that the
value of the stocks has not declined in the interim).
New issuance
Thomson Reuters league tables
Global issuance of equity and equity-related instruments totaled $505
billion in 2004, a 29.8% increase over the $389 billion raised in 2003.
Initial public offerings (IPOs) by US issuers increased 221% with 233
offerings that raised $45 billion, and IPOs in Europe, Middle East and
Africa (EMEA) increased by 333%, from $9 billion to $39 billion.
ASX Share Market Game
ASX Share Market Game is a platform for Australian school students and
beginners to learn about trading stocks. The game is a free service hosted
27

on ASX (Australian Securities Exchange) website.[52] Each year more

than 70,000 students enroll in the game. For the vast majority, this is an
introduction to stock market investing. Students once enrolled, are given
$50,000 virtual money and can buy and sell up to 20 times a day. The
game runs for 10 weeks. This time frame turns the game into a lottery,
encouraging people to take huge risks with their virtual $50,000, breaking
the laws of commonsense investing in the process.[53] Many similar
programs are found in secondary educational institutions across the
world.
Investment strategies
Investment strategy
This section's tone or style may not reflect the encyclopedic tone used on
Wikipedia. See Wikipedia's guide to writing better articles for
suggestions. (November 2011) (Learn how and when to remove this
template message)
One of the many things people always want to know about the stock
market is, "How do I make money investing?" There are many different
approaches; two basic methods are classified by either fundamental
analysis or technical analysis. Fundamental analysis refers to analyzing
companies by their financial statements found in SEC filings, business
trends, general economic conditions, etc. Technical analysis studies price
actions in markets through the use of charts and quantitative techniques to
attempt to forecast price trends regardless of the company's financial
28

prospects. One example of a technical strategy is the Trend following

method, used by John W. Henry and Ed Seykota, which uses price
patterns, utilizes strict money management and is also rooted in risk
control and diversification.
Additionally, many choose to invest via the index method. In this method,
one holds a weighted or unweighted portfolio consisting of the entire
stock market or some segment of the stock market (such as the S&P 500
or Wilshire 5000). The principal aim of this strategy is to maximize
diversification, minimize taxes from too frequent trading, and ride the
general trend of the stock market (which, in the U.S., has averaged nearly
10% per year, compounded annually, since World War II).
Taxation
Capital gains tax
According to much national or state legislation, a large array of fiscal
obligations are taxed for capital gains. Taxes are charged by the state over
the transactions, dividends and capital gains on the stock market, in
particular in the stock exchanges. However, these fiscal obligations may
vary from jurisdictions to jurisdictions because, among other reasons, it
could be assumed that taxation is already incorporated into the stock price
through the different taxes companies pay to the state, or that tax free
stock market operations are useful to boost economic growth.
A second transformation is the move to electronic trading to replace
human trading of listed securities.
29

Beginning in the early 1970`s, the Efficient Market Hypothesis (EMH

henceforth) became dominant in academic circles trying to understand the
rules of return in the equity market. After a long period of successes, faith
in this hypothesis was gradually eroded by the discovery of several
anomalies. The last decades showed immense research efforts to find new
models accurately predicting market behavior. These efforts build the
foundation for what is called Behavioral Finance. During all this time
researchers have identified two major reasons why the EMH fails to
deliver correct results in so many cases. While the first is called Limits
to arbitrage and it shows why even well informed, completely rational
investors can be limited in their ability to use market options; the second
relates to an application of behavioral psychology on individual investors,
cataloguing the kinds of deviations from full rationality in investment
decisions. Behavioral finance began as an attempt to understand why
financial markets react inefficiently to public information. One stream of
behavioral finance examines how psychological forces induce traders and
managers to make suboptimal decisions, and how these decisions affect
market behavior. Another stream examines how economic forces might
keep rational traders from exploiting apparent opportunities for profit.
Behavioral finance remains controversial, but will become more widely
accepted if it can predict deviations from traditional financial models
30

without relying on too many ad hoc assumptions. Approaches based on

perfect predictions, completely flexible prices, and complete knowledge
of investment decisions of other players in the market, are increasingly
unrealistic in todays global financial markets. Behavioral finance is a
new paradigm of finance theory, which seeks to understand and predict
systematic financial market implications of psychological decisionmaking (Olsen, 1988). By understanding the human behavior and
psychological mechanisms involved in financial decision making,
standard finance models may be improved to better reflect and explain
the reality in todays evolving markets. Different investors behave
differently in different market situation before investing like return,
flexibility and etc but the markets will face a question mark in knowing
the pulse of an investor. So a study must be made on the demographics
and psychographics of the investor such that the market can know the
pulse of an investor and can act upon it. Investor behavior analysis deals
with analyzing the behavior of an investor based on his demographic and
psychographic factors like age, gender and income groups. This states
what would be a preferred portfolio of an investor at a particular age. This
will be helpful to the stock brokers and portfolio managers so that they
can offer better portfolios to their investors. This needs better insight, and
understanding of human nature in the existing global perspective, plus
development of fine skills and ability to get best out of investments. In
31

addition, investors have to develop positive vision, foresight,

perseverance and drive. Every investor differ from others in all aspects
due to various demographic factors like socio-economic background,
educational attainment level, age, race and sex. The most crucial
challenge faced by the investors is in the area of investment decisions. An
optimum investment decision plays an active role and is a significant
consideration. This analysis will show the mentality of an investor and his
preferences clearly and concisely. In order to study a review of literature
was conducted to develop the concept and idea behind the study.

32

2. Review of Literature
Investment property portfolio management and financial derivatives by
Patrick McAllister, John R. Mansfield. His study on Derivatives has been
an expanding and controversial feature of the financial markets since the
late 1980s. They are used by a wide range of manufacturers and investors
to manage risk. This paper analyses the role and potential of financial
derivatives investment property portfolio management. The limitations
and problems of direct investment in commercial property are briefly
discussed and the main principles and types of derivatives are analysed
and explained. The potential of financial derivatives to mitigate many of
the problems associated with direct property investment is examined.
Derivatives, risk and regulation: chaos or confidence? by R. Dixon,
R.K. Bhandari said that there has been an extraordinary increase in the
use of financial derivatives in the capital markets. Consequently
derivative instruments can have a significant impact on financial
institutions, individual investors and even national economies. This
relatively recent change in the status of derivatives has led to calls for
regulation. Using derivatives to hedge against risk carries in itself a new
risk was brought sharply into focus by the collapse of Barings Bank in
1995. The principal concerns of regulators about how legislation may
meet those concerns are the subject of current debate between the finance
industry and the regulators. Recommendations have been made and
33

reviewed by some of the key players in the capital markets at national and
global levels. There is a clear call for international harmonization and its
recognition by both traders and regulators. There are calls also for a new
international body to be set up to ensure that derivatives, while remaining
an effective tool of risk management, carry a minimum risk to investors,
institutions and national/global economies. Having reviewed derivatives
and how they work, proceeds to examine regulation. Finds that calls for
regulation through increased legislation are not universally welcome,
whereas the regulators main concern is that the stability of international
markets could be severely undermined without greater regulation.
Considers the expanding role of banks and securities houses in the light
of their sharp reactions to increases in interest rates and the effect their
presence in the derivatives market may have on market volatility.
Includes the reaction of some 30 dealers and users to the
recommendations of the G-30 report and looks at some key factors in
overcoming potential market volatility. Managements disc losure o f
hedging activ ity: An empirica l investigation of analysts and investors
reactions by JenniferReynolds-Moehrle. This study aims to examine
how market participants changed the way they process earnings
information after learning of the implementation of hedging activities.
Design/methodology/approach Using a sample of derivative user and
non-user firms, this study empirically compares earnings predictability,
34

forecast revision behavior, and the earnings response coefficients before

and after the disclosure of hedging activity. Findings The findings
indicate that analysts forecast accuracy increased and that unexpected
earnings were incorporated into subsequent earnings forecasts to a greater
extent subsequent to disclosure of sustained hedging activity.
Additionally, the findings indicate an increase in the earnings-return
relation in the hedging activity period. Research limitations/implications
This evidence empirically supports the claim that, when a company
communicates that hedging activities have been started, market
participants are better able to forecast earnings and view subsequent
earnings announcements as providing greater information about future
earnings. The results may be understated due to the minimal disclosures
required during the sample period. Future research could
Narayana (1976)1 found that the most important forms of urban financial
investment were bank deposits, shares and securities. Mudra - SAMIRS
(1992)2 work brings that the fact that the working women in urban India
put aside one-fifth of their earnings as savings. According to Jawaharlal,
(1995)3 investors with be provided with adequate and reliable
information so that they can make sound investment decisions. Bandgar
P.K (1999)4 opines that most of the investors do not know about safety of
new issues of company shares, debentures and shares bought stock
exchanges. Abhijit Dutta (2000)5 observes that the individual investors
35

have high confidence in themselves and are not guided by the market
discounted asymmetric information. Maruthupandian.P(2001)6 says that
investors should remember that their active participation in the activities
of the investor forum is a must. The Indian Household Investors Survey,
(2004)7 registers the fact that a developing economy like India needs a
growing amount of household savings to flow to corporate enterprises.
Kirshnudu.Ch, B. Krishna Reddy and G. Rama Krishna Reddy(2005)8
have found out that the Investors are mostly influenced by family
members while taking decisions on investment. Sridhar.R (2008)9 records
that the majority of the respondents have invested less than one lakh.
SunatanKhurana (2008)10 observe that protection is the main purpose for
taking an insurance policy. Darshana.P (2008)11 the visual and print
media and training programs will help investors make well informed
decisions. Vikram.S (2008)12 records that major percentage of
respondents have moderate knowledge and have less exposure towards
the financial market. Kasilingam. R and Jayabal.G (2009)13 observe that
the funds invested in small savings schemes will yield good results, not
only to individual investors but also to the nation. Selvatharangini P.S
(2009)14 concludes that generally people differ in their taste and
preference. Kaboor.A (2010)15 finds that financial literacy is not uniform
among different groups of investors. Mathivannan.S and Selvakumar.M
(2011)16 observe that the teachers are saving their money for the purpose
36

of their childrens education, marriage and other welfare expenses.

Manish Sitlani, Geeta Sharma &BhoomiSitlani (2011)17 observe that
there is no relationship between demographic variables and investment
choices of occupants of financial services industry. Suman and
Warne.D.P. (2012)18 ascertain that the market movements affect the
investment patterns of
In order to study the behaviour a review of literature was done to develop
the concept and understand what had been done earlier. Stock markets
performance is not simply the result of intelligible characteristics but also
due to the emotions that are still baffling to the analysts. Despite loads of
information bombarding from all directions, it is not the cold calculations
of financial wizards, or companys performance or widely accepted
criterion of stock performance but the investors irrational emotions like
overconfidence, fear, risk aversion, etc., seem to decisively drive and
dictate the fortunes of the market. Rajarajan (2000) in his study revealed
that there was an association between the lifestyle clusters and investment
related characteristics. K.Santi Swarup (2003) studied on the decisions
taken by the investors while investing in the primary markets. In her
study she indicated that investors give importance to their own analysis as
compared to their brokers advice. Louhichi Wael (2004) examined the
market behavior around the times of annual earnings announcements
made in the Paris Bourse to study both the informational role of
37

accounting numbers and the intraday speed of adjustment of stock prices

to new information. Yash Pal Davar and Suveera, Gill (2007) in their
paper on investment decision making revealed that the class of investors
(undoubtedly) with growing age develop maturity and experience for
making decisions about the usage of their surplus and available funds in
the light of overall economic needs of family.
Szyszka Adam (2008) in his study on efficient market hypothesis to
behavioral finance analyzed how investors psychology changes the vision
of financial markets. He found that investors are not always able to
correctly value the utility of decision alternatives, cannot update and
estimate probability and events and do not diversify properly. Dr. Vanita
Tripathi (2008) examines the perceptions, preferences and various
investment strategies in Indian stock market. Study reveals that investors
use both fundamental as well as technical analysis while investing in
Indian stock market. Most of the respondents strongly agree that various
company fundamentals (such as size, book to market equity, price
earnings ratio, leverage etc.) significantly influence stock prices and
hence addition of these factors in asset pricing model can better explain
cross sectional variations in equity returns in India. Gaurav Kabra,
Prashant Kumar, Mishra, Manoj Kumar Dash (2010) from the study
concluded that modern investor is a mature and adequately groomed
person. In spite of phenomenal growth in the security market and quality
38

Initial Public Offerings (IPOs) in the market, the individual investors

prefer investments according to their risk preference. A majority of
investors are found to be using some source and reference groups for
taking decisions. Though they are in the trap of some kind of cognitive
illusions such as overconfidence and narrow farming, they consider
multiple factors and seek diversified information before executing some
kind of investment transaction. Syed Tabassum Sultana (2010) concludes
that the individual investor still prefers to invest in financial products
which give risk free returns. This confirms that Indian investors even if
they are of high income, well educated, salaried, independent are
conservative investors prefer to play safe. The investment product
designers can design products which can cater to the investors who are
low risk tolerant and use TV as a marketing media as they seem to spend
long time watching TVs. E. Bennet, Dr. M. Selvam, Eva Ebenezer, V.
Karpagam, S. Vanitha (2011) concluded that the average value of the five
factors, namely, Return on Equity, Quality of Management, Return on
Investment, Price to Earnings Ratio and various ratios of the company
influenced the decision makers. Further, other five factors, namely,
recommendation by analysts, Broker and Research Reports,
Recommended by Friend, Family and Peer, Geographical Location of the
Company and Social Responsibility were given the lowest priority or
which had low influence on the stock selection decision by the retail
39

investors. Azwadi Ali (2011) in his study showed interest in examining

the relationships between individual investors perceived financial
performance of companies and their trading intentions, and the mediating
effect of companies images on the relationships. Giridhari Mohanta & Dr.
Sathya Swaroop Debasish (2011) studied that investors invest in different
investment avenues for fulfilling financial, social and psychological need.
While selecting any financial avenue they also expect other type of
benefits like, safety and security, getting periodic return or dividends,
high capital gain, secured future, liquidity, easy purchase, tax benefit,
meeting future contingency etc.

40

3. Research Methodology
4.
4.1 Research Objectives
5. On the basis of the above study we framed the main objectives of
our study which are as under:
6. 1. To study the influence of age on the investment pattern.
7. 2. To study the impact of income level on investment decisions.
8. 3. To analyze the investment pattern of investors to various capital
market information.
9. 4. To study the impact of announcement of annual result on
investment pattern.
10.
5. To study the impact of declaration of dividend & bonus
announcements on investment pattern.
11.
11.1 HYPOTHESIS OF THE STUDY:
12.
H01 : There is no association between the age of the
investors and their investment behavior .
13.
H02 : There is no association between the age of the
investors and their behavior when dividends of listed companies are
announced .
14.
H03 : There is no association between the age of the
investors and their behavior during bonuses are announcements.
15.
15.1 SOURCES OF DATA:
16.
The research design for the study is descriptive in nature.
The researchers depended heavily on primary data. The required data
were collected from the retail investors living in Udaipur during the
period between September 2011 and January 2012 through a
Structured Questionnaire.
17.
17.1 SAMPLING SIZE AND PROCEDURE:
41

18.

The questionnaire approach was used for the collection of

data. In this study, the primary data was collected from 110 investors
in Udaipur city. Questionnaire was distributed through online
platform through social networking websites and offline platform
through individual brokers. Questionnaires were hand delivered to
many investors while personal interviews have also been taken to
ensure a degree of objectivity in the survey data, selected investors
were personally interviewed to verify the accuracy of the selfreported data. The responses were received from those investors who
wished to contribute to research willingly.
19.
19.1 Sampling Design
20.
The questionnaire was divided into three parts: In the first
part, the demographic factors of the investors were recorded primarily
for their classification. The second part of the questionnaire was
related to the investment details of the investor. The various avenues
the investor had invested in and details regarding investment in
capital market viz. primary, secondary or both were recorded. The
final part of the questionnaire was related to the behavioral details,
which recorded the investors reaction to the various capital market
information. ANOVA test has been used to test the relationship
between age and decision making process and between average
income and investment portfolio. CHI SQUARE test was also used
42

for testing the relationship between age and behavior of investors to

the various information announcements.
21.
22.
23.
3.6 Statement of Problem
24.
25.
The development of any economy depends on healthy
savings and proper allocation of capital for the developmental
activities of any country. The reduction of disposable income or
increase in per-capita income will contribute to savings. The avenues
of investment and the investors opinion based on their preferences
vary from person to person. Liquidity and safety play a major role in
the investment decision; tax exemption and other factors are also
taken into consideration. Apart from the above factors, there are
demographic factors which influence the decision on investment. This
article discusses the factors which affect the investment behavior of
individuals in the city of Coimbatore.
26.
26.1 Research Limitations
27.
28.
Understanding the nature of the risk is not adequate unless
the investor or analyst is capable of expressing it in some quantitative
terms. Expressing the risk of a stock in quantitative terms makes it
comparable with other stocks.
29.
Measurement cannot be assured of cent percent accuracy
because risk is caused by numerous factors such as social, political,
economic and managerial efficiency.
43

30.

Time was a limiting factor. Only those investors who deal

in capital markets are considered.

31.
32.

44

33.Indian Commodity Market

34.
35.A commodity market is a market that trades in primary economic sector
rather than manufactured products. Soft commodities are agricultural
products such as wheat, coffee, cocoa and sugar. Hard commodities are
mined, such as gold and oil.[1] Investors access about 50 major commodity
markets worldwide with purely financial transactions increasingly
outnumbering physical trades in which goods are delivered. Futures
contracts are the oldest way of investing in commodities. Futures are secured
by physical assets.[2] Commodity markets can include physical trading and
derivatives trading using spot prices, forwards, futures, and options on
futures. Farmers have used a simple form of derivative trading in the
commodity market for centuries for price risk management.[3]
36.
37.A financial derivative is a financial instrument whose value is derived
from a commodity termed an underlier.[2] Derivatives are either exchangetraded or over-the-counter (OTC). An increasing number of derivatives are
traded via clearing houses some with Central Counterparty Clearing, which
provide clearing and settlement services on a futures exchange, as well as
off-exchange in the OTC market.[4]

45

38.
39.Derivatives such as futures contracts, Swaps (1970s-), Exchange-traded
Commodities (ETC) (2003-), forward contracts have become the primary
trading instruments in commodity markets. Futures are traded on regulated
commodities exchanges. Over-the-counter (OTC) contracts are "privately
negotiated bilateral contracts entered into between the contracting parties
directly".[5] [6]
40.
41.Exchange-traded funds (ETFs) began to feature commodities in 2003.
Gold ETFs are based on "electronic gold" that does not entail the ownership
of physical bullion, with its added costs of insurance and storage in
repositories such as the London bullion market. According to the World Gold
Council, ETFs allow investors to be exposed to the gold market without the
risk of price volatility associated with gold as a physical commodity.
42.Commodity-based money and commodity markets in a crude early form
are believed to have originated in Sumer between 4500 BC and 4000 BC.
Sumerians first used clay tokens sealed in a clay vessel, then clay writing
tablets to represent the amountfor example, the number of goats, to be
delivered.[9][10] These promises of time and date of delivery resemble
futures contract.

46

43.
44.Early civilizations variously used pigs, rare seashells, or other items as
commodity money. Since that time traders have sought ways to simplify and
standardize trade contracts.
45.
46.Gold and silver markets evolved in classical civilizations. At first the
precious metals were valued for their beauty and intrinsic worth and were
associated with royalty. In time, they were used for trading and were
exchanged for other goods and commodities, or for payments of labor.[11]
Gold, measured out, then became money. Gold's scarcity, unique density and
the way it could be easily melted, shaped, and measured made it a natural
trading asset.[12]
47.
48.Beginning in the late 10th century, commodity markets grew as a
mechanism for allocating goods, labor, land and capital across Europe.
Between the late 11th and the late 13th century, English urbanization,
regional specialization, expanded and improved infrastructure, the increased
use of coinage and the proliferation of markets and fairs were evidence of
commercialization.[13] The spread of markets is illustrated by the 1466
installation of reliable scales in the villages of Sloten and Osdorp so villagers

47

no longer had to travel to Haarlem or Amsterdam to weigh their locally

produced cheese and butter.[13]
49.
50.Indeed, the Amsterdam Stock Exchange, often cited as the first stock
exchange, originated as a market for the exchange of commodities. Early
trading on the Amsterdam Stock Exchange often involved the use of very
sophisticated contracts, including short sales, forward contracts, and options.
"Trading took place at the Amsterdam Bourse, an open aired venue, which
was created as a commodity exchange in 1530 and rebuilt in 1608.
Commodity exchanges themselves were a relatively recent invention,
existing in only a handful of cities."[14]
51.
52.In 1864, in the United States, wheat, corn, cattle, and pigs were widely
traded using standard instruments on the Chicago Board of Trade (CBOT),
the world's oldest futures and options exchange. Other food commodities
were added to the Commodity Exchange Act and traded through CBOT in
the 1930s and 1940s, expanding the list from grains to include rice, mill
feeds, butter, eggs, Irish potatoes and soybeans.[15] Successful commodity
markets require broad consensus on product variations to make each
commodity acceptable for trading, such as the purity of gold in bullion.[16]
Classical civilizations built complex global markets trading gold or silver for
48

spices, cloth, wood and weapons, most of which had standards of quality and
timeliness.
53.
54.Through the 19th century "the exchanges became effective spokesmen
for, and innovators of, improvements in transportation, warehousing, and
financing, which paved the way to expanded interstate and international
trade."[17]
55.
56.Reputation and clearing became central concerns, and states that could
handle them most effectively developed powerful financial centers.
57.
58.Commodity price index
59.In 1934, the US Bureau of Labor Statistics began the computation of a
daily Commodity price index that became available to the public in 1940. By
1952, the Bureau of Labor Statistics issued a Spot Market Price Index that
measured the price movements of "22 sensitive basic commodities whose
markets are presumed to be among the first to be influenced by changes in
economic conditions. As such, it serves as one early indication of impending
changes in business activity."[19]
60.
49

61.Commodity index fund

62.A commodity index fund is a fund whose assets are invested in financial
instruments based on or linked to a commodity index. In just about every
case the index is in fact a Commodity practically investable commodity
futures index was the Goldman Sachs Commodity Index, created in 1991,
[20] and known as the "GSCI". The next was the Dow Jones AIG
Commodity Index. It differed
63.
64.Cash commodity
65.Cash commodities or "actuals" refer to the physical goodse.g., wheat,
corn, soybeans, crude oil, gold, silverthat someone is
buying/selling/trading as distinguished from derivatives.[3]
66.
67.Call options
68.In a call option counterparties enter into a financial contract option where
the buyer purchases the right but not the obligation to buy an agreed quantity
of a particular commodity or financial instrument (the underlying) from the
seller of the option at a certain time (the expiration date) for a certain price
(the strike price). The seller (or "writer") is obligated to sell the commodity

50

or financial instrument should the buyer so decide. The buyer pays a fee
(called a premium) for this right.[21]
69.
70.Electronic commodities trading
71.In traditional stock market exchanges such as the New York Stock
Exchange (NYSE), most trading activity took place in the trading pits in
face-to-face interactions between brokers and dealers in open outcry trading.
[22] In 1992 the Financial Information eXchange (FIX) protocol was
introduced, allowing international real-time exchange of information
regarding market transactions. The U.S. Securities and Exchange
Commission ordered U.S. stock markets to convert from the fractional
system to a decimal system by April 2001. Metrification, conversion from
the imperial system of measurement to the metrical, increased throughout the
20th century.[23] Eventually FIX-compliant interfaces were adopted globally
by commodity exchanges using the FIX Protocol.[24] In 2001 the Chicago
Board of Trade and the Chicago Mercantile Exchange (later merged into the
CME group, the world's largest futures exchange company)[23] launched
their FIX-compliant interface.
72.

51

73.By 2011, the alternative trading system (ATS) of electronic trading

featured computers buying and selling without human dealer intermediation.
High-frequency trading (HFT) algorithmic trading, had almost phased out
"dinosaur floor-traders".[22][notes 2]
74.
75.Increased complexity of financial instruments and interconnectedness of
global market
76.The robust growth of emerging market economies (EMEs), (such as
Brazil, Russia, India, and China) in the 1990s, "propelled commodity
markets into a supercycle". The size and diversity of commodity markets
expanded internationally.[25]
77.
78.In 2012, as emerging-market economies slowed down, commodity prices
declined. From 2005-13 energy and metals' real prices remained well above
their long-term averages. In 2012 real food prices were at their highest level
since 1982.[25]
79.
80.The price of gold bullion fell dramatically on 12 April 2013 and analysts
frantically sought explanations. Rumors spread that the European Central
Bank (ECB) would force Cyprus to sell its gold reserves in response to its
52

financial crisis. Major banks such as Goldman Sachs began immediately to

short gold bullion. Investors scrambled to liquidate their exchange-traded
funds (ETFs)[notes 3] and margin call selling accelerated. George Gero,
precious metals commodities expert at the Royal Bank of Canada (RBC)
Wealth Management section reported that he had not seen selling of gold
bullion as panicked as this in his forty years in commodity markets.[26]
81.
82.The earliest commodity exchange-traded fund (ETFs), such as SPDR
Gold Shares NYSE Arca: GLD and iShares Silver Trust NYSE Arca: SLV,
actually owned the physical commodities. Similar to these are NYSE Arca:
PALL (palladium) and NYSE Arca: PPLT (platinum). However, most
Exchange Traded Commodities (ETCs) implement a futures trading strategy.
At the time Russian Prime Minister Dmitry Medvedev warned that Russia
could sink into recession. He argued that "We live in a dynamic, fastdeveloping world. It is so global and so complex that we sometimes cannot
keep up with the changes". Analysts have claimed that Russia's economy is
overly dependent on commodities. [27]
83.
84.Contracts in the commodity market

53

85.A Spot contract is an agreement where delivery and payment either takes
place immediately, or with a short lag. Physical trading normally involves a
visual inspection and is carried out in physical markets such as a farmers
market. Derivatives markets, on the other hand, require the existence of
agreed standards so that trades can be made without visual inspection.
86.
87.Standardization
88.US soybean futures, for something else, are of not being standard grade if
they are "GMO or a mixture of GMO and Non-GMO No. 2 yellow soybeans
of Indiana, Ohio and Michigan origin produced in the U.S.A. (Non-screened,
stored in silo)". They are of "deliverable grade" if they are "GMO or a
mixture of GMO and Non-GMO No. 2 yellow soybeans of Iowa, Illinois and
Wisconsin origin produced in the U.S.A. (Non-screened, stored in silo)".
Note the distinction between states, and the need to clearly mention their
status as GMO (genetically modified organism) which makes them
unacceptable to most organic food buyers.
89.
90.Similar specifications apply for cotton, orange juice, cocoa, sugar, wheat,
corn, barley, pork bellies, milk, feed,stuffs, fruits, vegetables, other grains,

54

other beans, hay, other livestock, meats, poultry, eggs, or any other
commodity which is so traded.
91.
92.Standardization has also occurred technologically, as the use of the FIX
Protocol by commodities exchanges has allowed trade messages to be sent,
received and processed in the same format as stocks or equities. This process
began in 2001 when the Chicago Mercantile Exchange launched a FIXcompliant interface that was adopted by commodity exchanges around the
world.
93.
94.Derivatives
95.Derivatives evolved from simple commodity future contracts into a
diverse group of financial instruments that apply to every kind of asset,
including mortgages, insurance and many more. Futures contracts, Swaps
(1970s-), Exchange-traded Commodities (ETC) (2003-), forward contracts,
etc. are examples. They can be traded through formal exchanges or through
Over-the-counter (OTC). Commodity market derivatives unlike credit
default derivatives for example, are secured by the physical assets or
commodities.
96.
55

97.Forward contracts
98.A forward contract is an agreement between two parties to exchange at
some fixed future date a given quantity of a commodity for a price defined
when the contract is finalized. The fixed price is known as the forward price.
Such forward contracts began as a way of reducing pricing risk in food and
agricultural product markets, because farmers knew what price they would
receive for their output.
99.
100.

Forward contracts for example, were used for rice in seventeenth

century Japan.
101.
102.

Futures contract

103.

Futures contracts are standardized forward contracts that are

transacted through an exchange. In futures contracts the buyer and the seller
stipulate product, grade, quantity and location and leaving price as the only
variable.[28]
104.
105.

Agricultural futures contracts are the oldest, in use in the United

States for more than 170 years.[29] Modern futures agreements, began in
Chicago in the 1840s, with the appearance of the railroads. Chicago,
56

centrally located, emerged as the hub between Midwestern farmers and east
coast consumer population centers.
106.
107.

Swaps

108.

A Swap is a derivative in which counterparties exchange the cash

flows of one party's financial instrument for those of the other party's
financial instrument. They were introduced in the 1970s.[30][31]
109.
110.

Exchange-traded commodities (ETCs)

111.

Exchange-traded commodity is a term used for commodity

exchange-traded funds (which are funds) or commodity exchange-traded

notes (which are notes). These track the performance of an underlying
commodity index including total return indices based on a single commodity.
They are similar to ETFs and traded and settled exactly like stock funds.
ETCs have market maker support with guaranteed liquidity, enabling
investors to easily invest in commodities.
112.
113.

They were introduced in 2003.

57

114.

At first only professional institutional investors had access, but

online exchanges opened some ETC markets to almost anyone. ETCs were
introduced partly in response to the tight supply of commodities in 2000,
combined with record low inventories and increasing demand from emerging
markets such as China and India.[32]
115.
116.

Prior to the introduction of ETCs, by the 1990s ETFs pioneered by

Barclays Global Investors (BGI) revolutionized the mutual funds industry.

[32] By the end of December 2009 BGI assets hit an all-time high of $1
trillion.[33]
117.
118.

Gold was the first commodity to be securitised through an

Exchange Traded Fund (ETF) in the early 1990s, but it was not available for
trade until 2003.[32] The idea of a Gold ETF was first officially
conceptualised by Benchmark Asset Management Company Private Ltd in
India, when they filed a proposal with the Securities and Exchange Board of
India in May 2002.[34] The first gold exchange-traded fund was Gold
Bullion Securities launched on the ASX in 2003, and the first silver
exchange-traded fund was iShares Silver Trust launched on the NYSE in
2006. As of November 2010 a commodity ETF, namely SPDR Gold Shares,
was the second-largest ETF by market capitalization.[35]
58

119.
120.

Generally, commodity ETFs are index funds tracking non-security

indices. Because they do not invest in securities, commodity ETFs are not
regulated as investment companies under the Investment Company Act of
1940 in the United States, although their public offering is subject to SEC
review and they need an SEC no-action letter under the Securities Exchange
Act of 1934. They may, however, be subject to regulation by the Commodity
Futures Trading Commission.[36][37]
121.
122.

The earliest commodity ETFs, such as SPDR Gold Shares NYSE

Arca: GLD and i Shares Silver Trust NYSE Arca: SLV, actually owned the
physical commodity (e.g., gold and silver bars). Similar to these are NYSE
Arca: PALL (palladium) and NYSE Arca: PPLT (platinum). However, most
ETCs implement a futures trading strategy, which may produce quite
different results from owning the commodity.
123.
124.

Commodity ETFs trade provide exposure to an increasing range of

commodities and commodity indices, including energy, metals, softs and

agriculture. Many commodity funds, such as oil roll so-called front-month
futures contracts from month to month. This provides exposure to the

59

commodity, but subjects the investor to risks involved in different prices

along the term structure, such as a high cost to roll.[7][8]
125.
126.

ETCs in China and India gained in importance due to those

countries' emergence as commodities consumers and producers. China

accounted for more than 60% of exchange-traded commodities in 2009, up
from 40% the previous year. The global volume of ETCs increased by a 20%
in 2010, and 50% since 2008, to around 2.5 billion million contracts.
127.
128.

Over-the-counter (OTC) commodities derivatives

129.

Over-the-counter (OTC) commodities derivatives trading originally

involved two parties, without an exchange. Exchange trading offers greater

transparency and regulatory protections. In an OTC trade, the price is not
generally made public. OTC are higher risk but may also lead to higher
profits.[38]
130.
131.

Between 2007 and 2010, global physical exports of commodities

fell by 2%, while the outstanding value of OTC commodities derivatives

declined by two-thirds as investors reduced risk following a five-fold
increase in the previous three years.
60

132.
133.

Money under management more than doubled between 2008 and

2010 to nearly $380 billion. Inflows into the sector totaled over $60 billion
in 2010, the second highest year on record, down from $72bn the previous
year. The bulk of funds went into precious metals and energy products. The
growth in prices of many commodities in 2010 contributed to the increase in
the value of commodities funds under management.
134.
135.

Commodities exchange

136.

A commodities exchange is an exchange where various

commodities and derivatives are traded. Most commodity markets across the
world trade in agricultural products and other raw materials (like wheat,
barley, sugar, maize, cotton, cocoa, coffee, milk products, pork bellies, oil,
metals, etc.) and contracts based on them. These contracts can include spot
prices, forwards, futures and options on futures. Other sophisticated products
may include interest rates, environmental instruments, swaps, or freight
contracts.

61

137.

Stock Market Cycles

138.

Description[edit]

139.

There are many types of business cycles including those that

impact the stock market.[1]

140.

In his book The Next Great Bubble Boom, Guna, a Harvard

graduate and Fortune 100 consultant, outlines several cycles that have
specific relevance to the stock market.[2]Some of these cycles have been
quantitatively examined for statistical significance.
141.

The major cycles of the stock market include:

The four-year presidential cycle in the US.

Annual seasonality, also known as Sell in May or the Halloween
indicator[3]
The "January effect"[4]
The lunar cycle[5]
The 17.6 Year Stock Market Cycle[6]
142.

Investment advisor Mark Hulbert has tracked the long-term

performance of Norman Fosbacks a Seasonality Timing System that

combines month-end and holiday-based buy/sell rules. According to Hulbert,

62

this system has been able to outperform the market with significantly less
risk.[7]
143.

According to Stan Weinstein there are four stages in a major cycle

of stocks, stock sectors or the stock market as a whole. These four stages are
(1) consolidation or base building (2) upward advancement (3) culmination
(4) decline.[8]
144.

Longer term cycles: Cyclical, Secular and Kondratiev[edit]

145.

Cyclical cycles generally last 4 years, with bull and bear market

phases lasting 13 years, while Secular cycles last about 30 years with bull
and bear market phases lasting 1020 years. It is generally accepted[citation
needed]

that in early 2011 the US stock market is in a cyclical bull phase as it

has been moving up for a number of years. It is also generally accepted[citation

needed]

that it is in a secular bear phase as it has been stagnant since the stock

market peak in 2000. The longer term Kondratiev cycles are two Secular
cycles in length and last roughly 60 years. The end of the Kondratiev cycle is
accompanied by economic troubles, such as the original Great Depression of
the 1870s, the Great Depression of the 1930s and the current Great
Recession.
146.

Theory[edit]

63

147.

The four-year U.S. presidential cycle is attributed to politics and its

impact on America's economic policies and market sentiment. Either or both

of these factors could be the cause for the stock market's statistically
improved performance during most of the third and fourth years of a
president's four-year term.[9]
148.

The month-end seasonality cycle is attributed to the automatic

purchases associated with retirement accounts.

149.

The secular stock market cycles that last about 30 years move in

lockstep with corresponding secular economic, social, and political cycles in

the US.[10]
150.

Compound cycles[edit]

151.

The presence of multiple cycles of different periods and

magnitudes in conjunction with linear trends, can give rise to complex

patterns, that are mathematically generated through Fourier analysis.
152.

In order for an investor to more easily visualise a longer term cycle

(or a trend), he sometimes will superimpose a shorter term cycle such as

a moving average on top of it.
153.

A common view of a stock market pattern is one that involves a

specific time-frame (for example a 6-month chart with daily price intervals).

64

In this kind of a chart one may create and observe any of the following
trends or trend relationships:
A long-term trend, which may appear as linear
Intermediate term trends and their relationship to the long-term trend
Random price movements or consolidation (sometimes referred to as
'noise') and its relationship to one of the above
154.

For example, if one looks at a longer time-frame (perhaps a 2-year

chart with weekly price intervals), the current trend may appear as a part of a
larger cycle (primary trend). Switching to a shorter time-frame (such as a 10day chart using 60-minute price intervals), may reveal price movements that
appear as shorter-term trends in contrast to the primary trend on the sixmonth, daily time period, chart.
155.

Concept of Dynamic Cycles[edit]

156.

Real cyclic motions are not perfectly even; the period varies

slightly from one cycle to the next because of changing physical

environmental factors. This dynamic behavior is also valid for financial
market cycles. It requires an awareness of the active dominant cycle
parameter and requires the ability to verify and track the real current status
and dynamic variations that facilitate projection of the next significant event.
Cycles morph over time because of the nature of inner parameters of length
65

and phase. Active Dominant Cycles in financial markets do not abruptly

jump from one length (e.g., 50) to another (e.g., 120). Typically, one
dominant cycle will remain active for a longer period and vary around the
core parameters. The genes of the cycle in terms of length, phase, and
amplitude are not fixed and will morph around the dominant mean
parameters.
157.

Steve Puetz calles this "Period variability": Period variability

Many natural cycles exhibit considerable variation between repetitions. For

instance, the sunspot cycle has an average period of 10.75-yr. However,
over the past 300 years, individual cycles varied from 9-yr to 14-yr. Many
other natural cycles exhibit similar variation around mean periods.[11][12]
158.

These periodic motions abound both in nature and the man-made

world. Examples include a heartbeat or the cyclic movements of planets.

Although many real motions are intrinsically repeated, few are perfectly
periodic. For example, a walkers stride frequency may vary, and a heart may
beat slower or faster. Once an individual is in a dominant state, the heartbeat
cycle will stabilize at an approximate rate of 85 bpm. However, the exact
cycle will not stay static at 85 bpm but will vary +/- 10%. The variance is not
considered a new heartbeat cycle.
159.

To arrive at more reliable and robust information on the dominant

cycle for financial markets, the following steps should be performed:[13]

66

160.

Step 1: A cycle detection algorithm should have a dynamic filter

for detrending, which is included for pre-processing. This ensures that the
data is not affected by trending information.
161.

Step 2: Subsequently, a cycles engine performs a spectral analysis

based on an optimized Discrete Fourier Transform and then isolates those

cycles that are repetitive and have the largest amplitudes. Research results
have shown that an adapted Goertzel algorithm is most suitable when it
comes to detecting cycles in financial time series.
162.
163.

Step 3: In a third step, the statistic reliability of each cycle is

evaluated. The goal of this procedure is to exclude cycles that have been
influenced by one-time random events (e.g. news). One of the algorithms
used for this is a more sophisticated Bartels Test. The test builds on detailed
mathematics (statistics) which measures the stability of the amplitude and
phase of each cycle. Bartels statistical test for periodicity, published at the
Carnegie Institution of Washington in 1932, was embraced by the
Foundation for the Study of Cycles decades ago as the best single test for a
given cycle's projected reliability, robustness, and consequently, usefulness.
The method provides a direct measurement of the likelihood that a given
cycle is genuine. The higher the Bartels score is (above 70%, up to 100%),

67

the higher the likelihood that the cycle is genuine and has not been
influenced by one-time events.[14]
164.

Step 4: An important final step in making sense of the cyclic

information is to establish a measurement for the strength of a cycle. Once

the third step is completed, cycles that are dominant (based on their
amplitude) and genuine with reference to their driving force in the financial
market are detected. But for trading purposes, this does not suffice. The price
influence of a cycle per bar on the trading chart is the most crucial
information.
165.

Step 5: Sort the outcome according to the calculated cycle strength

score.
166.

After a cycles engine has completed all five steps, the cycle at the

top of the list (with the highest cycle strength score) will give information on
the dominant dynamic cycle in the analyzed market. In fact, the wavelength
of this cycle is the dominant dynamic cycle, which is useful for trading
financial markets.
167.

Use of multiple screens[edit]

168.

A stock market trader will often use several "screens" or charts on

their computer with different time frames and price intervals in order to gain

68

valuable information for making profitable buying and selling (trading)

decisions.
169.

Often expert traders will emphasize the use of multiple time frames

for successful trading. For example, Alexander Elder suggests a Triple

Screen approach.[15][16]
Longer-term screen: To identify the long-term trend and opportunities
Middle screen: To identify the best day(s) on which to locate a buy or sell
opportunity
Finer screen: To identify the optimum intra-day price at which to buy or
sell a given security
170.

Technical indicators[edit]

171.

The 'technical analysis' approach to investing is based on cycles or

repeating price patterns. Some of the technical indicators used to measure

and project patterns include oscillators, moving averages, and candlestick
charts.
Oscillators: These illustrate the price and volume cycles thereby allowing
the investor/trader to identify relevant peaks and valleys within the trend
itself.

69

 Moving Averages: There are many types of moving average indicators;

for example, the exponential moving average shows a slightly different
version of the price trends by smoothing out the short-term fluctuations.
Candlestick charts: This is a specialized type of price chart that provides
different information about price activity than the standard "mountain"
style chart.
172.

Federal Reserve Bank of Chicago

173.

Chicago Fed National Activity Index (CFNAI) Diffusion Index

174.

The Chicago Fed National Activity Index (CFNAI) Diffusion Index

is a macroeconomic model of Business Cycle Models. [When passing thru a

value of -0.35, the] CFNAI Diffusion Index signals the beginnings and ends
of [ NBER ] recessions on average one month earlier than the CFNAIMA3. the crossing of a -0.35 threshold by the CFNAI Diffusion Index
signaled an increased likelihood of the beginning (from above) and end of a
recession (from below).,.[17][18]
175.

Chicago Fed National Activity Index, Moving Average of 3

months (CFNAI-MA3)[edit]
176.

When the CFNAI-MA3 index falls below (0.7) historically

indicating the economy has entered a recession.

70

177.

THE CFNAI-MA3 TRACKS ECONOMIC EXPANSIONS AND

CONTRACTIONS
178.

The CFNAI is a coincident indicator of economic expansions and

contractions. To highlight this fact, it is best to focus on the CFNAI-MA3.

179.

In each of the seven recessions, the CFNAI-MA3 fell below -0.7

180.

near the onset of the recession.

181.

after the onset of a recession, when the index first crosses +0.2,

the likelihood that the recession has ended according to the NBER business
cycle measures is significant.
182.

we have found the crossing of the -0.7 threshold at least six

months after a recession's trough to be a more reliable indicator of an

increasing likelihood of an end of a recession.
183.

the crossing of a -0.35 threshold by the CFNAI Diffusion Index

signaled an increased likelihood of the beginning (from above) and end of a

recession (from below).
184.

Federal Reserve Bank of Philadelphia[edit]

185.

Aruoba-Diebold-Scotti Business Conditions Index (ADS Index)

[edit]

71

186.

Aruoba-Diebold-Scotti Business Conditions Index (ADS Index) is

published by the The Federal Reserve Bank of Philadelphia. The average

value of the ADS index is zero. Progressively bigger positive values indicate
progressively better-than-average conditions, whereas progressively more
negative values indicate progressively worse-than-average conditions. ,[19][20]
187.

BofA Merrill Lynch Global Research, GLOBALcycle[edit]

188.

The GLOBALcycle is a real-time indicator of economic activity.

The indicator optimally extracts a common factor across data frequencies.

Weekly asset-price information, as well as monthly and quarterly hard data
feed the indicator. It is based on the ADS index developed at the Federal
Reserve Bank of Philadelphia.
189.

Federal Reserve Bank of New York[edit]

190.

Consumer Confidence, Conference Boards Present Situation

Index
191.

Major turns in the Conference Boards Present Situation Index tend

to precede corresponding turns in the unemployment rateparticularly at

business cycle peaks (that is, going into recessions). Major upturns in the
index also tend to foreshadow cyclical peaks in the unemployment rate,
which often occur well after the end of a recession. Another useful feature of
the index that can be gleaned from the charts is its ability to signal sustained

72

downturns in payroll employment. Whenever the year-over-year change in

this index has turned negative by more than 15 points, the economy has
entered into a recession.

73

193.

192.
Market Trends
A market trend is a perceived tendency of financial markets to

move in a particular direction over time.[1] These trends are classified as

secular for long time frames, primary for medium time frames, and
secondary for short time frames.[2] Traders identify market trends using
technical analysis, a framework which characterizes market trends as
predictable price tendencies within the market when price reaches support
and resistance levels, varying over time.
194.
195.
A trend can only be determined in hindsight, since at any time
prices in the future are not known.
196.
197.
Market nomenclature[edit]
198.
For more details on this topic, see Bull (stock market speculator).
199.
The terms "bull market" and "bear market" describe upward and
downward market trends, respectively,[3] and can be used to describe
either the market as a whole or specific sectors and securities.[2] The
names perhaps correspond to the fact that a bull attacks by lifting its
horns upward, while a bear strikes with its claws in a downward motion.
[1][4]
200.
201.
Etymology[edit]
202.
The fighting styles of both animals may have a major impact on the
names.[4]
203.
204.
One hypothetical etymology points to London bearskin "jobbers"
(market makers),[5] who would sell bearskins before the bears had
actually been caught in contradiction of the proverb ne vendez pas la peau
74

de l'ours avant de lavoir tu ("don't sell the bearskin before you've killed
the bear")an admonition against over-optimism.[5] By the time of the
South Sea Bubble of 1721, the bear was also associated with short
selling; jobbers would sell bearskins they did not own in anticipation of
falling prices, which would enable them to buy them later for an
additional profit.
205.
206.
Some analogies that have been used as mnemonic devices:
207.
208.
Bull is short for "bully", in its now somewhat dated meaning of
"excellent".
209.
It relates to the speed of the animals: Bulls usually charge at very
high speed, whereas bears normally are thought of as lazy and cautious
moversa misconception, because a bear, under the right conditions, can
outrun a horse.[6]
210.
They were originally used in reference to two old merchant
banking families, the Barings and the Bulstrodes.
211.
The word "bull" plays off the market's returns being "full", whereas
"bear" alludes to the market's returns being "bare".
212.
"Bull" symbolizes charging ahead with excessive confidence,
whereas "bear" symbolizes preparing for winter and hibernation in doubt.
213.
Secular trends[edit]
214.
A secular market trend is a long-term trend that lasts 5 to 25 years
and consists of a series of primary trends. A secular bear market consists
of smaller bull markets and larger bear markets; a secular bull market
consists of larger bull markets and smaller bear markets.
215.
75

216.

In a secular bull market the prevailing trend is "bullish" or upward-

moving. The United States stock market was described as being in a

secular bull market from about 1983 to 2000 (or 2007), with brief upsets
including the crash of 1987 and the market collapse of 2000-2002
triggered by the dot-com bubble.
217.
218.
In a secular bear market, the prevailing trend is "bearish" or
downward-moving. An example of a secular bear market occurred in gold
between January 1980 to June 1999, culminating with the Brown Bottom.
During this period the nominal gold price fell from a high of $850/oz
($30/g) to a low of $253/oz ($9/g),[7] and became part of the Great
Commodities Depression.
219.
220.
Primary trends[edit]
221.
222.
Statues of the two symbolic beasts of finance, the bear and the bull,
in front of the Frankfurt Stock Exchange.
223.
A primary trend has broad support throughout the entire market
(most sectors) and lasts for a year or more.
224.
225.
Bull market[edit]
226.
227.
A 1901 cartoon depicting financier J. P. Morgan as a bull with
eager investors
228.
A bull market is a period of generally rising prices. The start of a
bull market is marked by widespread pessimism. This point is when the
"crowd" is the most "bearish".[8] The feeling of despondency changes to
hope, "optimism", and eventually euphoria, as the bull runs its course.[9]
76

This often leads the economic cycle, for example in a full recession, or
earlier.
229.
230.
An analysis of Morningstar, Inc. stock market data from 1926 to
2014 found that a typical bull market "lasted 8.5 years with an average
cumulative total return of 458%", while annualized gains for bull markets
range from 14.9% to 34.1%.[10]
231.
232.
Examples[edit]
233.
India's Bombay Stock Exchange Index, BSE SENSEX, was in a
bull market trend for about five years from April 2003 to January 2008 as
it increased from 2,900 points to 21,000 points. Notable bull markets
marked the 1925-1929, 19531957 and the 1993-1997 periods when the
U.S. and many other stock markets rose; while the first period ended
abruptly with the start of the Great Depression, the end of the later time
periods were mostly periods of soft landing, which became large bear
markets. (see: Recession of 196061 and the dot-com bubble in 20002001)
234.
Bear market[edit]
235.
A bear market is a general decline in the stock market over a period
of time.[11] It is a transition from high investor optimism to widespread
investor fear and pessimism. According to The Vanguard Group, "While
theres no agreed-upon definition of a bear market, one generally
accepted measure is a price decline of 20% or more over at least a twomonth period."[12]
236.
77

237.

An analysis of Morningstar, Inc. stock market data from 1926 to

2014 found that a typical bear market "lasted 1.3 years with an average
cumulative loss of -41%", while annualized declines for bear markets
range from -19.7% to -47%.[13]
238.
239.
Examples[edit]
240.
A bear market followed the Wall Street Crash of 1929 and erased
89% (from 386 to 40) of the Dow Jones Industrial Average's market
capitalization by July 1932, marking the start of the Great Depression.
After regaining nearly 50% of its losses, a longer bear market from 1937
to 1942 occurred in which the market was again cut in half. Another longterm bear market occurred from about 1973 to 1982, encompassing the
1970s energy crisis and the high unemployment of the early 1980s. Yet
another bear market occurred between March 2000 and October 2002.
Recent examples occurred between October 2007 and March 2009, as a
result of the financial crisis of 200708. See also 2015 Chinese stock
market crash.
241.
Market top[edit]
242.
A market top (or market high) is usually not a dramatic event. The
market has simply reached the highest point that it will, for some time
(usually a few years). It is retroactively defined as market participants are
not aware of it as it happens. A decline then follows, usually gradually at
first and later with more rapidity. William J. O'Neil and company report
that since the 1950s a market top is characterized by three to five
78

distribution days in a major market index occurring within a relatively

short period of time. Distribution is a decline in price with higher volume
than the preceding session.
243.
244.
Examples[edit]
245.
The peak of the dot-com bubble (as measured by the NASDAQ100) occurred on March 24, 2000. The index closed at 4,704.73. The
Nasdaq peaked at 5,132.50 and the S&P 500 at 1525.20.
246.
A recent peak for the broad U.S. market was October 9, 2007. The
S&P 500 index closed at 1,565 and the Nasdaq at 2861.50.
247.
248.
Market bottom[edit]
249.
A market bottom is a trend reversal, the end of a market downturn,
and the beginning of an upward moving trend (bull market).
250.
251.
It is very difficult to identify a bottom (referred to by investors as
"bottom picking") while it is occurring. The upturn following a decline is
often short-lived and prices might resume their decline. This would bring
a loss for the investor who purchased stock(s) during a misperceived or
"false" market bottom.
252.
253.
Baron Rothschild is said to have advised that the best time to buy is
when there is "blood in the streets", i.e., when the markets have fallen
drastically and investor sentiment is extremely negative.[14]
254.
255.
Examples[edit]
256.
Some examples of market bottoms, in terms of the closing values
of the Dow Jones Industrial Average (DJIA) include:

79

257.

The Dow Jones Industrial Average hit a bottom at 1738.74 on 19

October 1987, as a result of the decline from 2722.41 on 25 August 1987.

This day was called Black Monday (chart[15]).
258.
A bottom of 7286.27 was reached on the DJIA on 9 October 2002
as a result of the decline from 11722.98 on 14 January 2000. This
included an intermediate bottom of 8235.81 on 21 September 2001 (a
14% change from 10 September) which led to an intermediate top of
10635.25 on 19 March 2002 (chart[16]). The "tech-heavy" Nasdaq fell a
more precipitous 79% from its 5132 peak (10 March 2000) to its 1108
bottom (10 October 2002).
259.
A bottom of 6,440.08 (DJIA) on 9 March 2009 was reached after a
decline associated with the subprime mortgage crisis starting at 14164.41
on 9 October 2007 (chart[17]).
260.
Secondary trends[edit]
261.
Secondary trends are short-term changes in price direction within a
primary trend. The duration is a few weeks or a few months.
262.
263.
One type of secondary market trend is called a market correction. A
correction is a short term price decline of 5% to 20% or so.[18] An
example occurred from April to June 2010, when the S&P 500 went from
above 1200 to near 1000; this was hailed as the end of the bull market
and start of a bear market, but it was not, and the market turned back up.
A correction is a downward movement that is not large enough to be a
bear market (ex post).
264.
80

265.

Another type of secondary trend is called a bear market rally

(sometimes called "sucker's rally" or "dead cat bounce") which consist of

a market price increase of only 10% or 20% and then the prevailing, bear
market trend resumes.[19] Bear market rallies occurred in the Dow Jones
index after the 1929 stock market crash leading down to the market
bottom in 1932, and throughout the late 1960s and early 1970s. The
Japanese Nikkei 225 has been typified by a number of bear market rallies
since the late 1980s while experiencing an overall long-term downward
trend.
266.
267.
The Australian market in the beginning of 2015 has been described
as a "meerkat market", being timid with low consumer and business
sentiment.[20]
268.
269.
Causes[edit]
270.
The price of assets such as stocks is set by supply and demand. By
definition, the market balances buyers and sellers, so it's impossible to
literally have 'more buyers than sellers' or vice versa, although that is a
common expression. For a surge in demand, the buyers will increase the
price they are willing to pay, while the sellers will increase the price they
wish to receive. For a surge in supply, the opposite happens.
271.
272.
Supply and demand are created when investors shift allocation of
investment between asset types. For example, at one time, investors may
move money from government bonds to "tech" stocks; at another time,
81

they may move money from "tech" stocks to government bonds. In each
case, this will affect the price of both types of assets.
273.
274.
Generally, investors try to follow a buy-low, sell-high strategy but
often mistakenly end up buying high and selling low.[21] Contrarian
investors and traders attempt to "fade" the investors' actions (buy when
they are selling, sell when they are buying). A time when most investors
are selling stocks is known as distribution, while a time when most
investors are buying stocks is known as accumulation.
275.
276.
According to standard theory, a decrease in price will result in less
supply and more demand, while an increase in price will do the opposite.
This works well for most assets but it often works in reverse for stocks
due to the mistake many investors make of buying high in a state of
euphoria and selling low in a state of fear or panic as a result of the
herding instinct. In case an increase in price causes an increase in
demand, or a decrease in price causes an increase in supply, this destroys
the expected negative feedback loop and prices will be unstable.[22] This
can be seen in a bubble or crash.
277.
278.
Investor sentiment[edit]
279.
Investor sentiment is a contrarian stock market indicator.
280.
281.
When a high proportion of investors express a bearish (negative)
sentiment, some analysts consider it to be a strong signal that a market
bottom may be near. The predictive capability of such a signal (see also
82

market sentiment) is thought to be highest when investor sentiment

reaches extreme values.[23] Indicators that measure investor sentiment
may include:[citation needed]
282.
283.
David Hirshleifer sees in the trend phenomenon a path starting
with underreaction and ending in overreaction by investors / traders.
284.
285.
Investor Intelligence Sentiment Index: If the Bull-Bear spread (%
of Bulls - % of Bears) is close to a historic low, it may signal a bottom.
Typically, the number of bears surveyed would exceed the number of
bulls. However, if the number of bulls is at an extreme high and the
number of bears is at an extreme low, historically, a market top may have
occurred or is close to occurring. This contrarian measure is more reliable
for its coincidental timing at market lows than tops.
286.
American Association of Individual Investors (AAII) sentiment
indicator: Many feel that the majority of the decline has already occurred
once this indicator gives a reading of minus 15% or below.
287.
Other sentiment indicators include the Nova-Ursa ratio, the Short
Interest/Total Market Float, and the put/call ratio.

83

289.
290.

288.
Stock Market Data System
History[edit]
The earliest stock exchanges were in France in the 12th century

and in Bruges and Italy in the 13th. Presumably data about trades in those
times was written down by scribes and traveled by courier. In the early
19th century Reuters sent data by carrier pigeons between Germany and
Belgium[1] In London early exchanges were located near coffee
houses[2] which may have played a part in trading.
291.
292.
Chalk boards[edit]
293.
In the late 1860s, in New York, young men called runners carried
prices between the exchange and brokers offices, and often these prices
were posted by hand on large chalk boards in the offices.[3] Updating a
chalk board was an entry point for many traders getting into financial
markets and as mentioned in the book Reminiscences of a Stock Operator
those updating the boards would wear fur sleeves so they wouldn't
accidentally erase prices.
294.
295.
The New York Stock Exchange is known as the "Big Board",
perhaps because of these large chalk boards. Until recently, in some
countries such chalkboards continued in use. Morse code was used in
Chicago until 1967 for traders to send data to clerks called "board
markers".[4]
296.
297.
Newspapers[edit]

84

298.

From 1797 to 1811 in the United States, the New York Price

Current was first published. It was apparently the first newspaper to

publish stock prices, and also showed prices of various commodities.
299.
300.
In 1884 the Dow Jones company published the first stock market
averages, and in 1889 the first issue of the Wall Street Journal appeared.
As time passed, other newspapers added market pages.[5] The New York
Times was first published in 1851, and added stock market tables at a
later date.
301.
302.
Electronic systems[edit]
303.
Ticker tape[edit]
304.
See the main article: Ticker tape
305.
306.
In 1863 Edward A. Calahan of the American Telegraph Company
invented a stock telegraph printing instrument which allowed data on
stocks, bonds, and commodities to be sent directly from exchanges to
broker offices around the country. It printed the data on 0.75 inches (1.9
cm) wide paper tape wound on large reels. The sound it made while
printing earned it the name "stock ticker". Other inventors improved on
this device, and ultimately Thomas Edison patented a "universal stock
ticker", selling over 5,000 in the late 19th century.[3]
307.
308.
In the early 20th century Western Union acquired rights to an
improved ticker which could deal with the increasing volume of stocks
sold per day.[3]
309.
85

310.

At the time of the stock market crash in October, 1929, trading

volumes were so high that the tickers fell behind, contributing to the
panic. In the 1930s the New York Quotation Stock Ticker became widely
used. A further improvement was in place in 1960.[3]
311.
312.
In 1923 Trans Lux Corporation delivered a rear projection system
which projected the moving ticker onto a screen where all in a brokerage
office could see it. It was a great success, and by 1949 there were more
than 1400 stock-ticker projectors in the U.S. and another 200 in Canada.
In 1959 they started shipping a Trans-Video system called CCTV which
gave a customer a small video desk monitor where he could monitor the
tickers.[6]
313.
314.
In August 1963 Ultronics introduced Lectrascan, the first wall
mounted all electronic ticker display system. By 1964 there were over
1100 units in operation in stock broker offices in the U.S. and Canada.[7]
315.
316.
Competition, including Ultronics' Lectrscan electron wall system,
led Trans-Lux to introduce the Trans-Lux Jet. Jets of air controlled
lighted disks which moved on a belt on the broker's wall. Brokers ordered
over 1000 units in the first six months, and by the middle of 1969 more
than 3000 were in use in the U.S. and Canada.[6]
317.
318.
Automatic quotation boards[edit]
319.
A quotation board is a large vertical electronic display located in a
brokerage office, which automatically gives current data on stocks chosen
86

by the local broker. In 1929 the Teleregister Corporation installed the first
such display, and by 1964 over 650 brokerage offices had them.
320.
321.
The information included the previous days closing price, opening
price, high for the day, low for the day, and current price. Teleregister
offered data from the New York, American, Midwest, Chicago
Mercantile, Commodity, New York Cocoa, New York coffee and sugar,
New York Mercantile, New York Produce, New York Cotton, and New
Orleans Cotton exchanges, along with the Chicago Board of Trade.[8]
322.
323.
Some firms had a battery of telephone operators seated in front of a
Teleregister board to supply commission houses with price and volume
data. In 1962 two such batteries handled over 39,000 calls per day.[9]
324.
325.
In 1955 Scantlin Electronics, Inc. introduced a competitive display
system very similar in appearance but with digits twice the size of
Teleregisters, fitting into the same board area. It was less expensive and
soon was installed in many broker offices.
326.
327.
Stock market quotation systems[edit]
328.
In the late 1950s brokers had become accustomed to several
problems doing business with their customers. To make a trade, an
investor had to know the current price for the stock. The investor got this
from a broker who could find it on his board. If the last trade (or the stock
itself) hadn't made it to the board (or there was no board) the broker
telegraphed a request for the price to that firm's "wire room" in New
87

York. There, such requests would be forwarded to the floor of the

appropriate exchange, where messengers could copy down prices at the
locations where those stocks were traded, and telephone answers back to
the wire room. Typical elapsed times were between 15 and 30 minutes
just to inform the broker.[10]
329.
330.
Quotron[edit]
331.
Jack Scantlin of Scantlin Electronics, Inc. (SEI) developed the
Quotron I system, consisting of a magnetic tape storage unit that could be
sited at a brokerage and Desk Units with a keyboard and printer. The
storage unit recorded the data from the ticker line. Brokers could enter the
stock symbol on a desk unit. This triggered a backward search on the
magnetic tape (which continued recording incoming ticker data). When a
transaction was located, the price was sent to the desk unit, which printed
it on a tape.
332.
333.
The first Quotron units were installed in 1960, and were an
immediate success. By the end of 1961 brokers were leasing Quotrons in
some 800 offices, serving some 2,500 desk units across the United States.
[10]
334.
335.
Ultronics vs. Quotron[edit]
336.
Quotrons success attracted the attention of Robert S. Sinn, who
observed its disadvantages: it could only give a last price. The opening
price, high and low for the day, and share volume were not available. His
system received the ticker transmissions from the various stock and
88

commodity exchanges. These were then automatically interpreted by a

hard wired digital computer updating a drum memory with the last sale
prices and at the same time computing and updating highs and lows and
total volume for each stock. As these items were updated a data packet
would be generated for transmission by AT&T Dataphone at 1000
bits/second to identical magnetic drum storage devices in each major city
in the United States. These slave drum memory units located in the
metropolitan centers in the US could then be accessed by desk units in
local stock brokerage offices again using Dataphone transmission. The
desk units would set up the ticker symbol code for the desired stock by
mechanical means actuating micro switches. The local control box would
continuously interrogate each desk unit in sequence and send a request
data packet by Dataphone to the local drum memory which would then
send return data packets back to the local brokerage office. Each packet
both for request and answer would contain the request stock alphabetic
symbols plus a desk unit identifier. Because the desk units set up the
requested stock code statically the desk unit would automatically update
the stock price, volume, and highs and lows without any operator
intervention because the control unit could complete the interrogation of
all desk units in the office in about every one or two seconds, This is the
first use of data packet transmission with the senders identification
imbedded in the data packet in order to avoid switching- a forerunner of
89

the internet? There was no switching in the entire system; all was done
with data packets containing sender identifiers.
337.
338.
Sinn formed Ultronic Systems Corp. in December 1960, and was
president and CEO from then until he left the company in 1970. By the
fall of 1961 Ultronics had installed its first desk units (Stockmaster) in
New York and Philadelphia, followed by San Francisco and Los Angeles.
The Stockmaster desk units offered the user quick access and continuous
monitoring of last sale, bid, ask, high, low, total volume, open, close,
earnings, and dividends for each stock on the NYSE and the AMEX plus
commodities from the various U.S. commodity exchanges. Ultimately
Ultronics and General Telephone (which bought Ultronics in 1967)
installed some 10,000 units world-wide. In June 1964 Ultronics and the
British news company Reuters signed a joint venture agreement to market
Stockmaster worldwide outside of North America. This venture lasted for
10 years and was very successful, capturing the worldwide market for
U.S. stock and commodity price information. Ultronics invented time
division multiplex equipment to utilize Reuters voice grade lines to
Europe and the Far East to transmit U.S. stock and commodity
information plus Reuters teletype news channels.[11][12]
339.
340.
In the early 1960s when these first desk top quotation units were
developed the only real time information available from the various stock
and commodity exchanges were the last sale and the bid and ask ticker
90

lines. The last sale ticker contained every trade with both price and
volume for each trade. The bid-ask ticker contained only the two prices
and no size. The volume of data on the last sale ticker was therefore much
greater than on the bid-ask ticker. Because of this, on high volume days
the last sale ticker would run as much as fifteen minutes behind the bidask ticker. This time difference made having the bid-ask on their desk top
unit extremely important to a stockbroker even though there was an extra
charge to the exchange for this information.[13]
341.
342.
343.
Quotron II Desk Unit.
344.
Scantlin Electronics reacted immediately to the Ultronic threat. In
early 1962 they began work on their own computer-based system and put
it into service in December, 1962. It used four Control Data CDC 160A
computers in New York which recorded trading data in magnetic core
memory. Major cities hosted Central Office equipment connected to
newly designed Quotron II desk units in brokerage offices on which a
broker could request, for any stock, price and net change from the
opening, or a summary which included highs, lows, and volumes (later
SEI added other features like dividends and earnings). The requests went
to a Central Office, which condensed and forwarded them to the New
York computer. Replies followed the sequence in reverse. The data was
transmitted on AT&T's Dataphone high-speed telephone service. In 1963

91

the new system was accepted by many brokers, and was installed in
hundreds of their offices.[10]
345.
346.
At the end of each day, this same system transmitted stock market
pages to United Press International, which in turn sold them to its
newspaper customers all over the world.
347.
348.
When Ultronics introduced their Stockmaster desk units in 1961
they priced the service at approximately the same price as the Quotron
desk units. They did not want a price competition only a performance
competition. All of these stock quote devices were sold on leases with
monthly rental charges. The cost of the system, desk units and installation
was therefore born solely by the vendor not the customer (broker). The
pricing at that time made the units quite profitable and allowed the
companies to finance the cost and use rapid accounting depreciation of
the equipment. In 1964 Teleregister introduced their Telequote desk units
at prices significantly less than Stockmaster or Quotron. This forced
Ultronics and Scantlin to reduce the prices of their Stockmaster and
Quotron systems. The Telequote desk units never did gain a significant
share of the desk top quotation business, but their price cutting did
seriously reduce the overall profitability of this business in the U.S..
Ultronics was fortunate to have made the joint venture arrangement with
Reuters for the stock quotation business outside of North America where
this price cutting was not a factor.[14]
92

349.
350.

The 1962 Cuban Missile Crisis blocked Ultronics from winning a

historic first. In July 1962 AT&T launched the first commercial satellite
(Telstar) to transmit television and telephone voice channels between the
U.S. and England and France. This was a non-synchronous satellite
which circled the earth in an elliptical orbit of about 2.5 hours, such that it
gave only about 20 minutes of communication between the U.S. and
Europe on each pass. Ultronics arranged with AT&T to use one of its
voice channels to transmit U.S. stock prices to Paris in October 1962. All
of the arrangements were made-a Stockmaster unit was installed in the
Bache brokerage office on Rue Royale and all of the American
Stockbrokers and the press and television were ready for this historic
event. About two hours before the pass the stock transmission was
cancelled because U.S. president John Kennedy was going to use the pass
to send his speech to France concerning the Cuban missile crisis.[14]
351.
352.
Am-Quote[edit]
353.
In 1964 Teleregister introduced the Am-Quote system[15] with
which a broker could enter code numbers into a standard telephone; a
second later a pleasant (prerecorded) voice repeated the code numbers
and provided the required price information. This system, like Ultronics,
made use of magnetic drums.
354.
Computerized quoting
355.
NASDAQ, originally founded in 1972 was the first electronic stock
market. It was originally designed only as an electronic quotation system,
93

with no ability to perform electronic trades.[16] Other systems soon

followed and by the turn of the century, every exchange was using this
model.

94

356.

Portfolio Risk Management in

Commodities Investments

357.
358.

Commodity futures investing has only

recently entered the mainstream. As recently as 2001, there was only $10
billion invested in commodity indexes whereas during the fall of 2005
this figure had increased to over $70 billion, according to Rodger (2005).
Once an institution has obtained its core commodity exposure through a
commodity index investment, the next logical step is to include active
commodity managers for further added value. This is analogous to the
evolving nature of institutional equity management whereby active
management is being unbundled from passive index investments. A
number of institutions are now getting core equity exposure through
equity index funds, exchange-traded funds, and/or futures and then
investing in long/short equity hedge funds for further added value. The
risk management expectations for an investors passive exposure to
commodities differ greatly from what is expected of active managers.
When an investor elects to invest in a commodity index product, that
investor realizes that he or she will earn the inherent return of the asset
class and will be able to do so cheaply, but will not be provided with any
downside risk protection. It will be the responsibility of the investor
either to time the investments in commodity indices, or to create a
properly balanced overall portfolio, so as to avoid downside risk. Instead,
95

when an investor chooses to invest in an actively managed commodity

program for further added value, then that investor expects the potential
downside of the active investment to be carefully managed. This chapter
will cover the crucial elements of an active commodity managers risk
measurement process. We will specifically discuss what should be
included at both the strategy and portfolio level. 2. RISK
MEASUREMENT AT THE STRATEGY LEVEL 2.1. VaR If a portfolio
of instruments is normally distributed, one can come up with the 95%
confidence interval for the portfolios change in monthly value by
multiplying the portfolios recent monthly volatility by two (or 1.96, to be
exact.) The portfolios volatility is calculated from the recent volatilities
and correlations of the portfolios instruments. This is the standard Valueat-Risk approach. Now, this approach alone is obviously inadequate for a
commodity portfolio, which consists of instruments that have a tendency
towards extreme positive skewness. That commodity price distributions
are positively skewed has been observed by a number of researchers,
including Deaton and Laroque (1992). They attribute this empirical
feature to the impossibility of the market as a whole to carry negative
inventories. When there is too much supply of a commodity, there are
two levers that can balance supply and demand: the price can decrease
and some of the commodity can be held in storage. When there is not
enough of a commodity, only price can adjust to balance supply and
96

demand, leading to the asymmetry in commodity price distributions.

Exhibit 1, for example, illustrates how the price of corn rises
exponentially as the amount of inventories (normalized for recent
consumption) decreases. We would conclude that while the Value-at-Risk
measure is useful, it has to be used jointly with other measures and
actions, given the potential for violent price explosions in the
commodities markets. Nonetheless, VaR is useful since one wants to
ensure that under normal conditions, a commodity position has not been
sized too large that one cannot sustain the random fluctuations in profits
and losses that would be expected to occur, even without a dramatic event
occurring. 2.2. Worst-Mark Evaluation Using long-term data, one can
directly examine the worst performance of a commodity trade under
similar 3 4 circumstances in the past. In practice, we have found that such
a measure will sometimes be larger than a Valueat-Risk measure based on
recent volatility. If the loss on a particular commodity futures trade
exceeds the historical worst case, this can be an indication of a new
regime that is not reflected in the data. This should trigger an exit from a
trade since one no longer has a handle on the worst-case scenario. This
may be counterintuitive advice for investment professionals who have
been schooled in the financial markets of the past 18 years. Since 1987,
market professionals have been rewarded either for staying with
investments or even for increasing the size of their investments in the face
97

of financial market dislocations. But in the commodity market it is

different. Akey (2005) explains why this is the case: When a currency
weakens, the Federal Reserve has a variety of tools available to
manage valuation and promote stability. Similarly, central banks can
massage interest rates to address economic concerns like inflation and
deflation. Companies, also, can address many near-term over- or underperformance matters through a variety of corporate actions. When a
drought damages a grain crop on a large-scale basis or a hurricane
destroys a key energy distribution channel, however, governments, banks,
and companies often have limited options to encourage short-term
stability in commodity markets. Even Alan Greenspan cant make more
corn. There are two reasons that previously historically reliable
commodity strategies can fail. One reason is that fundamental structural
changes may occur in a commodity markets supply or demand situation.
Another reason is that one may have inadequate historical data to
understand the full range of possible outcomes for a market. Examples of
each of these scenarios are given below. 2.2.1.Structural Break
Monitoring During the summer of 2005, a very good example of a market
undergoing fundamental changes was the petroleum complex. A
historically reliable strategy had been to enter into the gasoline versus
heating oil spread. Until this year, traders had expected gasoline to
outperform heating oil coming into the U.S. summer driving season. The
98

market historically provided large monetary incentives to refiners to

maximize the production of gasoline at the expense of heating oil to
sufficiently service summer gasoline demand. This year was different.
Fusaro (2005) reveals that in the summer of 2005, the big Wall Street
houses and some other hedge funds lost many hundreds of millions [of
dollars] on gasoline/heating oil spreads. They could not imagine that
heating oil would go higher than gasoline in June. It just never happened
before. Exhibit 2 shows the gasoline versus heating oil spread
differential as of the beginning of June since 1985. Indeed, heating oil
had never before been priced at a premium to gasoline at that time of
year. What happened? One hypothesis is that Chinese demand patterns
are creating structural changes in the commodity markets. According to
Stein (2005), This is the first business cycle where Chinese demand is
having a global effect on prices, notably of energy and other raw
materials. In the specific case of petroleum products, Farivar (2005)
states that in China, diesel demand has been rising rapidly, because
power shortages have forced many companies to use stand-alone
generators. Diesel accounts for a significant portion of the overall rise in
Chinese oil demand over the past year. Because diesel and heating oil
have similar compositions, heating oil futures are frequently used as a
proxy hedge for diesel inventories, which means that a rise in diesel
prices tends to lead to a rise in the value of heating oil futures. It appears
99

that the Chinese demand for diesel trumped the American consumers
demand for gasoline, a historically unprecedented scenario. This unusual
demand for diesel also led to the breakdown of other historical petroleum
complex relationships. For example, one reasonably reliable strategy had
been to expect that deferred-month crude oil futures would outperform
deferred-month heating oil futures from the beginning of the year through
the summer. A reason for this strategys historical consistency is as
follows. At the beginning of the year, there had been a historical tendency
for airlines or their intermediaries to buy heating oil futures as a proxy
hedge for their future jet fuel needs. There would also be no natural
commercial sellers of heating oil in the deferred (six to nine months out)
sector of the futures curve in similar magnitude to the purchases by the
airlines. This then caused deferred heating oil prices to be bid up relative
to other petroleum complex products. Specifically, the deferred heating
oil crack spread (long heating oil/short crude oil) would be bid to a level
that was higher than what it would likely converge to six to nine months
forward, given refinery economics. With the crack spread sufficiently
wide, marginal providers of liquidity would enter the market, selling
deferred heating oil and buying crude oil against this sale. By holding this
spread at levels beyond what one would expect the spread to converge to,
spread traders had historically earned a liquidity premium. Exhibit 3
shows the historical results of entering into a spread position of selling
100

deferred-delivery heating oil versus buying deferred-delivery crude oil.

Exhibit 4 shows the worst within-period loss that a commodity futures
investor would have sustained historically. The largest loss over the
period had been -$1,385 per spread. Exhibit 5 shows how this spread
fared during 2005. Given the unprecedented demand for heating oil, the
crudeoil-versus-heating oil spread performed very poorly, ultimately
losing -$7,549 per spread. The conclusion from this discussion is that a
commodity program will not experience the full brunt of a structural
break if one exits a trading strategy after experiencing losses that are
greater than have been the case in the past. In our example, once the
spread had lost more than the previous worst-case loss of -$1,385, one
had an indication that there may have been structural changes in heating
oil demand, which would have led to an early exit from this strategy, thus
substantially reducing the ultimate losses experienced with this strategy.
2.2.2. Inadequate Historical Data The summer of 2005 provides another
good example of the need to monitor worst-case scenarios. Some
commodity futures contracts do not have long-term historical data in
which to evaluate the range of possible outcomes of a trading strategy.
For example, the natural gas futures contract only started trading in 1990.
This becomes a problem when one needs very long-term data to
understand the potential severity of hurricane risk. A news bulletin of the
time stated that as of September 2005, [Hurricane] Rita is the 17th
101

named storm of the Atlantic hurricane season. That makes this season
already the fourth busiest since record-keeping began in 1851, according
to Sullivan and Piotrowski (2005). Fusaro (2005) discusses some of the
investment consequences of incompletely understanding hurricane risk:
The new energy hedge fund phenomenon has also been slammed
recently as several very big funds lost $100 to $150 million apiece on
natural gas prices. They thought natural gas would [decline] in the
fall [contract months] when gas usage [typically] drops. They were
wrong due to the event risk of Hurricane Katrina. Exhibit 6 shows the
unprecedented rise in natural gas prices, as of September 2005. This
example again shows the need to monitor the worst-case historical loss.
Once this loss is exceeded, this could indicate that ones historical data
does not incorporate the full range of possible negative outcomes. In that
case, it is advisable either to exit or to scale down the sizing of the losing
strategy. 3. RISK MEASUREMENT AT THE PORTFOLIO LEVEL The
previous section focused on risk measurement at the strategy level. We
had recommended that the investor use two metrics: Value-at-Risk and
Worst-Mark Evaluation. We discussed the Worst-Mark recommendation
in 5 6 depth because this recommendation may seem unusual to investors
whose previous experience is in the financial markets alone. Risk
measurement at the portfolio level is fundamentally different from risk
measurement at the strategy level. At the portfolio level, an investor is
102

concerned with how dynamic correlations among strategies may affect

portfolio-level risk. An investor is further concerned with how
commodity portfolios may perform during financial shocks since
commodity products are frequently marketed as being uncorrelated to the
dominant financial asset classes. This section will describe appropriate
portfolio-level metrics that address these concerns. 3.1. Diversified
Portfolio Goal As discussed by Erb and Harvey (2005), To a large
degree, commodity futures are uncorrelated with one another. Using data
from December 1982 to May 2004, the authors study the
interrelationships of the following commodity futures contracts: heating
oil, live cattle, lean hogs, wheat, corn, soybeans, sugar, coffee, cotton,
gold, silver, and copper. Erb and Harvey write that The average
correlation of individual commodities with one another is only 0.09 [with
the average absolute correlation being 0.11]. For instance, heating oils
average correlation with the other eleven commodities is 0.03, its highest
correlation of 0.15 is with gold and its lowest correlation of -0.07 is with
coffee. A commodity portfolio manager will use this property of
commodity futures contracts to attempt to create a portfolio of diversified
commodity strategies with dampened risk. Commodity hedge fund
manager Paul Touradji affirms this view: One of the best things about
being a commodity manager is the natural internal diversification.
While even unrelated equities have a beta to the overall market, many
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commodities, such as sugar and aluminum, traditionally have no

correlation at all, according to Teague (2004) in his interview with the
hedge fund manager. Exhibit 7 illustrates a commodity futures portfolio
from June 2000, which combined seven unrelated commodity trades. The
exhibit demonstrates the effect of incrementally adding unrelated trades
on portfolio volatility. One difficulty with using historical correlations to
evaluate portfolio risk is that correlations amongst commodities vary both
seasonally and during eventful periods. There are times when a common
factor can impact seemingly unrelated positions, causing a seemingly
diversified portfolio to have inadvertent concentration risk to the common
factor. Therefore, a commodity investor needs to include scenario
analyses, which show a portfolios sensitivity to meaningful events, in his
or her risk-measurement toolkit. Example scenario analyses are provided
below. 3.2. Extreme Weather Events Normally, natural gas and corn
prices are unrelated. But during the summer, they can be highly
correlated. During a three-week period in July 1999, for example, natural
gas and corn prices were +85% correlated. Both corn and natural gas
trades are heavily dependent on the outcome of weather in the U.S.
Midwest. And in July, 1999, the Midwest had blistering temperatures
(which even led to some power outages.) During that time, both corn and
natural gas futures prices responded in nearly identical fashions to
weather forecasts and realizations, as seen in exhibit 8. More recently,
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exhibit 9 shows how corn and natural gas prices waxed and waned in
concert during the summer of 2005 due to their common reactions to the
possibility of extreme Midwest heat. What this means for commodity
managers is that they should measure how much sensitivity their portfolio
has to extreme summer weather in the Midwest. The manager would want
to ensure that in the event of a heat-wave in the U.S. Midwest that his or
her portfolio would not perform exceptionally poorly. Other potentially
extreme weather shocks to include in ongoing scenario analyses include
the chance of an end-of-February cold shock on energy positions as well
as the possibility of a damaging hurricane season, as discussed earlier.
359.
360.
Futures products are typically marketed
as equity investment diversifiers. Therefore, one job of risk management
is to attempt to ensure that a futures investment will not be too correlated
to the equity market during periods of dramatic equity losses. Although a
commodity futures portfolio may contain no financial futures contracts,
the portfolio can still have systematic risk to the stock market. For
example, Bessembinder (1992) found that live cattle, soybeans, silver and
platinum futures contracts had statistically significant betas to the U.S.
stock market using data from January 1967 to December 1989. (The data
for platinum started in January 1968.) Erb and Harvey (2005) state that
the non-energy sector has a statistically significant, but small equity risk
premia beta. (Using data from December 1982 to May 2004.) Exhibits
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10 and 11, for example, illustrate how live cattle futures positions
performed poorly along with the stock market during the October 1987
stock market crash and during the aftermath of the September 11th, 2001
terrorist attacks. Given the potential of a commodity portfolio to perform
poorly during financial shocks, a manager should therefore examine what
the portfolios performance would have been during the October 1987
stock market crash, the 1990 Gulf War, the Fall 1998 bond debacle, and
during the immediate aftermath of September 11, 2001. If the commodity
portfolio would have done poorly during these events, the manager may
consider either deleveraging his or her portfolio or buying option
protection against one of the damaging scenarios. Rajagopal (2004) notes
that a commodity-index investment provides tail protection for fixed
income. In other words, during those quarters where bonds had negative
performance, commodities cumulatively performed well over the period
from 1992 to 2004. For a portfolio that has a long commodity bias, one
can also state the converse: long fixed-income positions can potentially
provide event-risk protection for a commodity portfolio. This is
illustrated in exhibit 12, which is discussed in the next section on
summary risk metrics. Summary Risk Metrics Exhibit 12 provides an
example risk report, which shows the Value-at-Risk and Worst-Case
scenarios at both the strategy and portfolio level. The events used in
exhibit 12s risk report are defined above in the Sharp Shocks to Business
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Confidence section of this article. Note that a deferred long position in

Eurodollar (short-term U.S. interest-rate) futures contracts reduces the
commodity portfolios risk to extreme financial events. On a per-strategy
basis, it is useful to examine each strategys: Value-at-Risk based on
recent volatilities and correlations; Worst-case loss during normal times;
Worst-case loss during well-defined eventful periods; Incremental
contribution to Portfolio Value-at-Risk; and Incremental contribution to
Worst-Case Portfolio Event Risk. The latter two measures indicate
whether the strategy is a risk reducer or risk enhancer. On a portfoliowide basis, it is useful to examine the portfolios: Value-at-Risk based
on recent volatilities and correlations; Worst-case loss during normal
times; and Worst-case loss during well-defined eventful periods. Each
measure should be compared to a limit, based on the risk tolerance of
ones investors. If the product should not perform too poorly during
financial shocks, then the worst-case loss during well-defined eventful
periods should be constrained to a relatively small number. If that worstcase loss exceeds the limit, then one can devise macro portfolio hedges
accordingly. 7 8 Obviously the danger with these recommended
approaches is that one is relying on historical data for guidance. But
completely unprecedented events do happen, as discussed previously.
That is why we recommend exiting any futures trades in which the losses
exceed those known in history since one is then in uncharted territory.
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Exhibit 12 displays the recommended risk measures for an example

portfolio. Note again the properties of the Eurodollar (short-term interest
rate) futures. The interest-rate position is a portfolio event-risk reducer, as
discussed previously, but it also adds to the volatility of the portfolio
under normal conditions. Therefore, an incremental-contribution-to-risk
measure based solely on recent volatilities and correlations does not give
complete enough information about whether a trade is a risk reducer or
risk enhancer. 3.4. Final Caveat on Dynamic Correlations: The
Relationship Between Commodities and Interest Rates 3.4.1. Correlations
During the Aftermath of the 9/11/01 Attacks A number of commodity
futures strategies have a long commodity bias since they rely on taking
on inventory risk that commercial participants wish to lay off. One
consequence is that these strategies are at risk to sharp shocks to business
confidence. And during sharp shocks to business confidence as occurred
in the aftermath of September 11th, 2001, not only did the stock market
perform quite poorly, but economically sensitive commodities also
performed poorly. The Greenspan Federal Reserve Board has responded
to financial shocks by cutting interest rates, which has resulted in the
stock market stabilizing. As long as this type of policy continues, one
way to hedge a portfolio that has exposure to shocks to business
confidence or shocks to the availability of credit is to include a fixed
income hedge. The hedge could take the form of either a Eurodollar
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futures contract overlay or purchases of out-of-the-money fixed-income

calls. The post-9/11/01 experience shows that a long fixed-income
position is an effective hedge for a portfolio that is primarily long
economically sensitive commodities. Exhibit 13 reviews the performance
of gasoline futures contracts and short-term interest rate contracts in the
aftermath of the 9/11/01 attacks. While gasoline prices plummeted due to
the expectation of an economic slowdown, short-term interest rate
contracts rallied as the Federal Reserve Board (Fed) cut interest rates to
calm the financial markets. 3.4.2. Correlations During the Aftermath of
Hurricane Katrina One caveat to this lesson is that the relationship
between commodities and interest rates varies according to the type of
meaningful event. For example, during the aftermath of Hurricane
Katrina in late August through the middle of September, 2005, gasoline
and short-term interest rates reacted similarly to the prospect of scarce
gasoline supplies, as shown in exhibit 14. During the initial explosive rise
in gasoline prices, due to the shutdown of crucial Gulf Coast refineries,
interest-rate-market participants concluded that the Fed would pause in its
interest-rate tightening cycle, which then caused deferred month interestrate contracts to rally. According to a Dow Jones Newswire report (2005)
of the time, [Hurricane] Katrina shut in nearly all of oil and gas
production in the Gulf of Mexico The large scale supply disruption
and fear of an economic shock triggered a massive government response.
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The outages prompted the Bush administration to release Strategic

Petroleum Reserve oil, waive air-pollution rules on fuels, and ease
restrictions on use of foreign-flagged vessels to carry fuel in U.S. waters.
Further, Members of the Organization of Economic Cooperation and
Development agreed to [release] 2 million barrels a day of crude oil
and petroleum products from their strategic stocks for 30 days. This
unprecedented government response caused gasoline prices to decline
from their post-Katrina peak, and with that response, fears of an
economic slump diminished, which in turn caused deferred interest-rate
contracts to also decline, as the market resumed pricing in the expectation
that the Fed would continue tightening interest rates. In the scenario just
described, changes in daily gasoline prices and short-term interest rates
became +75% correlated during the aftermath of Hurricane Katrina. This
is in sharp contrast to the negative relationship 9 between changes in
gasoline prices and short-term interest rates that occurred in the aftermath
of Twin Tower attacks. In the aftermath of Hurricane Katrina, long
positions in interest rates did not serve as an event hedge for long
positions in gasoline; instead, these two positions became the same trade,
both on the upside and the downside. The lesson from this section is that
risk measurement at the portfolio level is a constant and dynamic process.
4. FINAL NOTE According to an equity hedge fund manager who
specializes in options trading, There is a lumpiness to returns with
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volatility trading. You take the returns when they are there, and the rest is
risk management, wrote Gallo (2005) in his interview with the manager.
A commodity futures investor, who relies on the stability of historical
relationships, could say much the same thing. There are pockets of
predictability within the commodity futures markets that managers can
potentially take advantage of in disciplined futures trading strategies. As a
matter of fact, Till and Eagleeye (2005a) summarize the academic and
practitioner literature, which provides evidence of numerous empirical
regularities in these markets. That said, fundamental structural changes
occur constantly in the commodity markets. Therefore, the measurement
and management of risk are absolutely crucial to the ongoing viability of
an active commodity futures program. 5. ACKNOWLEDGEMENTS The
author would like to note that the ideas in this chapter were jointly
developed with Joseph Eagleeye, co-founder of Premia Capital
Management, LLC. As such, we have previously discussed some of this
chapters concepts in Till and Eagleeye (2004) and in Till and Eagleeye
(2005a) as well as in Till (2002). The author would like to express thanks
to John Hill of the Intercontinental Exchange for helpful comments. That
said, the content of this article is the opinion of the author alone.

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361.
362.

Conclusion
Commodities as an asset class has gone

from relative darkness and have come into the limelight in recent times.
There are two main reasons for increased focus on commodities; firstly,
we have seen a bull market in commodities and that has attracted the
attention of investors. Secondly, past studies and literature have
unanimously shown that commodities have a low correlation with stocks
and bonds, making it an attractive portfolio component. The price of
commodities is a function of demand, which has increased due to the
rising economic activity in many emerging markets such as China, India
and Latin America, and supply, which often is limited and difficult to
adjust in the short run. Over the years, investors became more active on
the commodity market as a result of passive indices and the findings of
researches. Small changes in production output may have great marginal
effects on price, thereof the disreputable volatility of commodities (Akey,
2005). Higher prices of commodities resulted that food companies had to
increase their product prices or had to accept lower margins (Wolzak,
2010). Prices of gold and oil for example have broken price records.
Currently the price of gold is still going up, while the price of oil is
descending as a result of using tactical oil reserves (Verheggen, 2011).
Moreover, considerable research has been done regarding the reasons for
investing in commodities and how to gain exposure to the commodity
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sector. However, there has been little research regarding the optimal size
of an allocation to commodities. Historically, Ibbotson 2006 found that
commodities have provided high returns, diversification, a hedge against
inflation and an improved risk/return profile in strategic asset allocation.
Our thesis have given more or less similar results, but not as robust as the
result of past studies. We have found positive correlation instead of
negative and zero correlation between stock and commodities. Also, the
inflation hedging properties of commodity in Indian markets is significant
only with Comdex and Energy. And, its very amazing to find out
negative correlation with inflation and Agri which was expected to be
positive. But the important conclusion is that this study shows the
advantage of including commodities in strategic asset allocation. 152 The
contradiction is, however, that though in itself being a relatively risky
asset, commodities may reduce the overall risk of a portfolio due to its
relatively low correlation to traditional asset classes like stocks and
bonds. Empirical studies have concluded that passive commodity futures
indexes show not only good stand-alone performance but also substantial
portfolio diversification benefits (Abanomey and Mathur [2001], Ankrim
and Hensel [1993], Anson [1999], Becker and Finnerty [1994], Georgiev
[2001], Gorton and Rouwenhorst [2004], Kaplan and Lummer [1998],
Johnson and Jensen [2001], and Jensen, Johnson and Mercer [2002]).
These studies are done using Markowitzs mean-variance theory, and
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conclude that adding commodity futures into the portfolio should

improve the portfolio performance by reducing the total risk without
sacrificing expected return. Moreover, commodities have been suggested
as a hedge against inflation, i.e. having a positive correlation. The
primary purpose of this thesis is to examine commodity futures and its
characteristics from an Indian perspective and to investigate whether the
potential benefits of commodity futures investments suggested by
previous research is applicable in this part of the world as most of these
studies are done in U.S. This study takes the perspective of an Indian
investor, with significant exposure to its local stock and commodity
market and whose returns will ultimately be measured in the local
currency. The objective of this work was to explain the investment
possibilities in the commodity markets, and to examine whether
commodities as an asset class are able to contribute to enhance of the
risk-return-ratio of a portfolio. This study has managed to create optimal
portfolios for investors with known and unknown risk preferences and
conclude that our investment strategy have been efficient and profitable if
look forward to see the portfolio diversification effect of these lowcorrelated commodities. Commodities futures had sources of risk and
return that were distinct from traditional assets such as stocks and bonds,
making commodity futures an effective portfolio diversifier. The analysis
of diversification benefits of investing in commodities over the period of
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our study i.e. June 2005- Dec 2011 has shown that expanding the
investable universe with commodities improves the risk/return trade-off
of optimal portfolios for any given risk tolerance coefficient. 153
Therefore it can be said that adding commodities to a portfolio of stocks
increases the Sharpe ratio of optimal portfolios. These conclusions are in
line with other findings in international literature. The goal of this thesis
was to examine the impact of adding commodities to a traditional
financial portfolio and determine which one adds the most value to the
risk-return relation of a financial portfolio. In order to realize this goal we
examined the equity sector (Nifty) and MCX commodity futures indices
as asset class in the India. Previous researches have shown that alternative
asset classes have been used to enhance the risk-return characteristics of a
portfolio. The search for high return always was, and still is, the main
theme for investors. In order to gain higher yields in a more globalized
market, investors started to search beyond the area of the traditional stock
and bond markets. This opened the door to alternative investments such
as precious metals, energy, and Agriculture etc. in short we can call it
commodities, which have several attractive characteristics as we have
seen in this thesis. Based on the general evidence from the data, we find
that commodity serves as an investment asset with positive expected
returns for institutional investors that may also function as a hedge
against inflation. This study has explained the modern portfolio theory
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which formed the basic framework of this thesis. Furthermore, topics

such as portfolio theory, benefits of traditional and new alternative assets,
inflation hedging benefits using alternative investments, and using
commodities as a portfolio investment were discussed. And our findings
are more or less in line with the international literature and thus, it can be
concluded that if commodity indices trading is started in India then it will
give way to a new asset class in Indian scenario. Commodities have
relatively high returns which make them interesting to consider in the
traditional portfolio. Of course, the study not only considers the returns
but also the associated risk. In addition to this, the relationship between
the various asset classes was positive. Furthermore, the excess return per
unit of risk was calculated by the 154 Sharpe ratio, which showed that
commodities provide the most return for their risk in comparison with the
remaining asset classes. In order to assess the impact of adding
commodities the efficient frontiers were constructed and optimal risky
portfolio and optimal complete portfolio were constructed which shows
that adding commodities to the traditional all equity portfolio had a
positive influence on the efficient frontier. The results are of course to
some extent data dependent and may not apply in all circumstances. This
thesis provides more evidence for the desirability of including
commodities in portfolios. This study provides alternative ways to
examine diversification benefits and risk-return results by employing the
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mean-variance optimization model. Moreover, the Sharpe ratios of the

tangent optimal portfolios which lie on CAL are larger than those of the
traditional benchmark portfolios. Lastly as given by Eling (2007)
different conclusion can be attributed to the use of different databases,
sample periods, performance measures, and statistical methodologies.
Finally from this empirical research we are able to draw the following
end conclusion of the study; which is that that compare to the previous
studies done to investigate the role of commodities under the meanvariance (MV) static asset allocation setting, we have found commodities
is having diversification benefits in Indian markets. Even though not as
much benefit as provided by GSCI and DJAIJ in US, there is scope of
further development in Indian commodities markets as the investors need
to gain more confidence in the markets and get more knowledge in the
market. Also, the rules and regulations of commodity market are not as
transparent as equity and Indian commodity markets require a strong
regulatory body like SEBI for protection of investors, which can lead to
excellent development in the commodities market that can benefit
hedgers and speculators alike. This can lead to opening of a complete
new investment avenue and give the investor a new asset class to invest
in.

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363.
364.

Suggestions
First of all one important suggestion is

that Indian markets should not be deprived of index investment in

commodities. It is an excellent tool for diversification and investors
confidence in commodity market will increase if trading in commodity
index futures are introduced in India. An optimally diversified portfolio
should be one that is invested across as many asset classes and markets as
possible. If the commodity derivatives products offer risk and return
trade-offs that cannot be easily replicated through other investment
alternatives, or provide risk diversification opportunities for investors in
other market segments, then it can be expected that the investment in
commodity derivatives markets will benefit the institutional investors
who are up till now prohibited from operating in these markets. The
particular benefits of including commodity futures in an otherwise welldiversified portfolio vary (Fortenberry and Hauser, 1990; Becker and
Finnerty, 1997), but in the long-run they tend to improve its financial
performance (Bodie and Rosansky, 1980; Jensen et al., 2000). A Recent
study by Gorton and Rowenhorst 2005 has shown benefits of commodity
futures investment in US markets after which investors got lot of
confidence in the market. India, needs such kind of study to be done by
firms like E&Y, KPMG, Merill Lynch, Lehman bros. etc. As a whole
research team is required to prepare a comprehensive report which cover
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Indian commodity futures markets and its diversification benefits. It can

be said that a commodity investment in isolation will be as volatile as
equities. If you think equities are volatile, then yes, commodities are
volatile-in isolation. But I'll emphasize that commodities should be
viewed not in isolation, but based on their impact on your overall
portfolio. From a portfolio perspective, it is believed that commodities
have a strategic role to play, and investors need to be thinking
strategically in deciding to implement them. They might be concerned
tactically about 160 how much to implement, but the key decision is to
think about a longer time frame. We can therefore recommend to
investors that they view commodities not as a tactical allocation, based on
an expectation that commodities will go up or down, but rather that they
view it as a strategic allocation with the acknowledgment that they're not
sure that commodities, or stocks or bonds will go up or down. Once we
recognize the inability to accurately predict with certainty the returns of
any asset class in any portfolio, it forces one to the conclusion that one
should diversify (Bekkers Niels, Ronald Q. and Trevin W., 2009). And
historically commodities have provided very strong diversification from
stocks and bonds. It's easy for investors to look at what's happened in
commodities in the last six months and say, "I want commodities because
they're going up in price," or look at what's happened in the last week and
say "Oooh, I don't want commodities because they're going down in
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price." The lesson to investors is "invest for the right reason"-and the
right reason is diversification, not because in the short term you think
they're going up or down. That's not a good reason to invest in
commodities. Commodities are to be considered as an asset class
approach. So much of the work on commodities has been looking at longonly strategies, and that generally is the way the asset class is described.
For someone who offers a long-short strategy, you might ask them, "If
you pick up the newspaper six months from now and read that the price
of steel has gone up, can you assure me that that will be good for my
portfolio?" If someone truly has a long/short strategy, then they might not
know that they'll always have a positive exposure to steel, and in that
case, they've lost exposure to the asset class of commodities. Further, we
suggest that if one considers macro-economic point of view then time to
invest in commodities shall be in phases with a high expected and
unexpected inflation rate. Also, the time to invest in commodities is
during times of low inventories and when their futures curves are in
backwardation, but this can be valid for the long-only strategy, typical for
most commodity funds. Taking into consideration the current macroeconomic scenario and effects of factors such as the continued growth of
the 161 global economy, a constant demand for commodities from Asia,
China, and other developing economies; the US dollar depreciation and
resulting rising interest rates during the recent months in the USA as well
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as in the EU, the strengthening of the monetary policy, government

budget deficit, the energy shortage and business cycle phases, it can be
reasonably assumed that commodities can offer benefit opportunities for
the next years. In recent years, investable commodity indices and
commodity linked assets have increased the number of available
commodity-based products. For the next years two further developments
in the commodity market are expected specially introduction of MCX
futures indices trading can be the next step in developing the commodity
markets in India. There can be an improvement of the future contracts
liquidity because of their increasing usage among producers forced to
hedge their products against commodity price changes. Lastly, we will be
seeing growing popularity of commodities amongst institutional asset
managers, because of excess capital which has to be invested.

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