The first thing that attracts a newcomer to the stock market is the value of either the Nifty or the Sensex, flagship indices of the National Stock Exchange(NSE) and the Bombay Stock Exchange(BSE). Their rising and falling values are a mystery to the new enthusiast. We have demystified the Nifty 50 index, which might prove helpful before moving ahead.
Among the two indices, Nifty is the most widely followed and traded on the NSE. There are certain advantages in trading the nifty which will be discussed in this article.
Advantages of trading in the nifty
Nifty can be traded only via the futures option, the new reader is advised to read all about the nifty future, before progressing ahead.
The Nifty has the highest liquidity both in the futures and the options category. Rarely is the nifty’s volume crossed by an individual stock. This proves its popularity among traders and large institutional players, both local and foreign.
High liquidity ensures that the traders can enter and exit their positions easily. Stocks which do not have any derivatives traded against them have a circuit filter, the maximum such stocks can rise or fall in a day is fixed by the exchanges at 5, 10 or 20%, over the previous day’s close.
Investors of such stocks find it difficult to sell the stocks when the market crashes. The stock can continue in a freeze for days together and lose a considerable amount of value before liquidity resumes. Hence, large players prefer trading in the nifty.
Nifty can’t be manipulated
As various large players are involved taking both sides of the trades, it is difficult to manipulate the nifty. As the nifty level is determined based on the performance of 50 stocks, manipulating such large basket of stocks is not possible.
On the other hand, individual stocks are prone to manipulation if a large investor decides to do so. The K-10, the stocks favoured by Ketan Parekh, the ill-famed stock investor is an example how a single investor can take the stocks to the sky and when the manipulation stops, the stocks dump.
Nifty is safe from news based wild moves
Stocks can drop by 30 to 50% in a single day, as the F&O stocks don’t have any filters. If traders have positions in such stocks, they stand to lose a large amount of their trading capital in a day. On the other hand, rarely does the nifty fall more than 5% in a day.
Even the large capblue-chip, Infosys has seen around 10 to 20% up move or down move after its results.Hence, traders who have positions in the nifty are relatively at a lower risk compared to the stock traders.
No need to track individual balance sheets
For individual stocks, the investor has to track the company’s developments closely. A close eye has to be kept on the sector, because many times, due to technological advances, a whole sector suffers, an example can be the retail sector stocks, which after a stellar run went into oblivion with the advances in online trading.
However, to successfully trade the nifty, you just need to have a strong understanding of technical analysis, you don’t need to worry about anything else.
Nifty can be used as a superior hedge of the portfolio
The nifty is used to hedge against the portfolio by the investors. During market uncertainties or corrections, market participants sell the nifty to hedge for the losses in their portfolio. Barring direct hedges on individual stocks, studies have shown that the Nifty is a better hedge for most portfolios.
Disadvantages of trading in the nifty
Long-term view cannot be taken
As trading is allowed only in nifty F&O, taking a long-term view is difficult because only the near-month contracts are active. The far month contracts are illiquid, hence, the traders can trade only with a short-term approach.
Every successful investor, be it Warren Buffet, Rakesh Jhunjhunwala, or others have vouched for long-term investing. Nifty doesn’t give that advantage.
Individual stock pickers can earn more from stocks than nifty
Many times the nifty enters a trading range, but the individual stocks continue to rise. Even during bear markets, stocks rise. During bull markets, if the stock picker is able to identify good stocks, they can earn very handsome returns, much more than what the nifty offers, because nifty takes into account both the gainers and losers included in the index.
Stocks gives dividends, whereas the nifty doesn’t
Dividends are a great way to earn a steady flow of income from your stocks without selling them. You benefit both from price appreciation as well as steady dividends. Over the long-term, investors tend to earn a huge income.
However, if you only trade the nifty, you miss out on the opportunity to earn dividends.
With nifty you don’t get midcap and small cap exposure
The nifty 50 index, consists of only the large cap stocks. The midcap and small cap stocks offer excellent opportunities to the smart investor.
There are many who have identified the large cap stocks of today, when they were still mid-caps a few years ago. Only trading the nifty keeps you away from the midcap and small cap stocks.
It is difficult to trade the nifty when it is range-bound
There are many times in a year when the nifty enters a small range, trading becomes difficult because of lack of trading opportunities. Nonetheless, both small caps and large caps offer trading opportunities at that time because the traders divert their attention to trading them instead of the nifty.
Leverage trading is not suitable for all
Trading in the nifty is possible either via the ETFs or in F&O. The F&O route is the popular method of trading in the nifty, however, leverage trading is the main culprit for traders losing all their trading capital. The large broking houses of Lehmann brothers and Bear Stearns were also affected due to very high leverage on their books, which led to their bankruptcies. Therefore, only after the investor gains enough experience in money management should he attempt to trade the nifty F&O.
Tags: nifty50 index, nifty future, midcap, smallcap, bull markets, bear markets