Retail traders on stock market incurred a whopping loss of ₹1.80 lakh crore. (₹1,80,000 crore) by trading in derivatives (futures and options) during three-year period of FY22-24. Nine out of 10 traders have lost money. FPIs and professional proprietary traders gained.

These are some of some of the startling facts revealed in a recent report by the Securities and Exchange Board of India (SEBI). SEBI needs to be complimented for such an analytical report and making it public.

Derivatives trading is a typical zero-sum game which doesn’t add value to the real economy.

Over 34 years back, the author (in an article published in financial newspaper) had cautioned small investors to rein in their greed. This was well before 1992 market crash which nosedived 40 per cent. The more things change, the more they remain the same.

Yet, over the last three decades, India has developed a whole new institutional ecosystem of SEBI, NSE, depositories, clearing corporations, among other systems. There are better disclosure requirements, transparency, standards, processes and practices and accountability. Today, India can boast of stock market and allied infrastructure on par with global standards, with a mature regulator.

Greed rules

Markets are far safer in terms of operational risks than a few decades ago. Yet, retail traders have lost heavily in derivatives. Greed seems to have taken over. Retail investors are sandwiched between safe but low interest yielding bank deposits and risky stock market instruments. They rushed into high-risk derivative trades, little understanding them. Nor did they understand the difference between direct investment and equity.

Derivates as directional bets and not investments: If an investor buys a Call Option (right but no obligation to buy) at, say, a strike price of ₹100, paying an option premium of ₹10 and if the price goes down even by just ten paise to ₹99.90 on the expiration date, he would lose entire investment. Such is the magnitude of the harm. It is a directional bet and not a view or bet on the economy.

On the contrary if the investment is directly on the scrip, he would have lost just ₹1 in a similar time window.

It is a deadly cocktail of leverage and volatility. Derivatives do not bestow ownership on the underlying asset. Retail traders are pitted against well informed and knowledgeable institutional and professional traders and it is no surprise the former lose.

Harmful betting culture: The SEBI report also reveals that over 50 per cent of these losing retail traders are first timers. Over 75 per cent of the traders continued trading in derivatives despite losses in the previous two years. Over one crore investors are engaged in these derivative trades. Investment culture needs a major makeover through education and awareness programmes.

Inverted wealth transfer: The most disturbing finding of this report reveals that over 75 per cent of these traders have reported an annual income of ₹5 lakh and this has been a massive wealth transfer from the bottom to the top. This derivative market is heavily tilted against small traders. All the stakeholders other than the retail investors appear to benefit at this game. Stock exchanges, brokers, intermediaries earn fees/commission, profits and the government gets taxes.

Keep small investors out of the ring: SEBI had proposed to raise the minimum ticket size to ₹15 lakh to discourage small investors from this dangerous game. SEBI should consider raising this threshold to even ₹50 lakh. Some critics liken it to closing the stable after the horse is bolted.

Ramp up investor education: Investor education needs to be stepped up further. All the market infrastructure companies contribute nearly 1-5 per cent toward investor protection fund. RBI has been organising one of the most aggressive and visible customer awareness campaigns/programmes to alert citizens.

Business models, sophisticated technology at stock exchanges and other intermediaries amplify rather than diminish greed. This has inflicted huge losses on unsuspecting retail traders... As a wag puts it “stock markets feed on greed and one needs a spiritual guru to dissipate greed”.

Investors need to make a distinction between investing in the real economy and investing in financial markets and manage their portfolios accordingly. Many experts recommend that the latter may be restricted to about 20-30 per cent of their investment corpus.

SEBI should further buffet guard rails. Insurance and banking industry regulators enforce rules to protect small investors.

Conditions shall be created to encourage at least 30-40 per cent of adult population (presently under 10 per cent) to participate in equity markets, away from derivative markets for retail, with prudence and long-term perspective.

Bull markets: Longer, Higher

According to Chat GPT, the history of last 20 years shows that bull markets last longer (around three or four years) than bear markets (around one year). Bull market returns can be high (around 200-300 per cent) and Bear markets losses much lower (around 40-50 per cent). These are averages.

Stay longer and be discerning in selecting companies and bet on the economy and not the markets. SEBI should lead a new investment movement for sustainable growth and shared prosperity.

The writer is former Chairman-NPCI and has served on the boards of financial market infrastructure organisations