How India turned into a trading nation

“Let me sleep yaar," she replied.

“Oh, get up and smell the coffee."

Mairaa took a few seconds to register the smell of freshly brewed coffee and then woke up: “That’s nice," she said, taking a sip. “And why are you glued to your phone at 7am?"

“I was reading this very interesting piece on livemint.com," said Vivaan, an engineer working with a software company.

“What does it say?" asked Mairaa, an economist by training and on a break to complete her PhD.

“It’s a sort of a mea culpa of a 32-year old."

“Mea culpa? Engineer sahab is speaking Latin early in the morning."

“Well," said Vivaan, ignoring his wife’s jibe. “This guy says that over the last eight to nine years he has lost ₹60 lakh by trading in financial derivatives."

“Oh. As time goes by, more such stories will come out," said Mairaa.

“Really?"

“Yes. In fact, as a recent consultation paper released by the Securities and Exchange Board of India (Sebi) pointed out, in 2023-24, 9.25 million unique individuals and proprietorship firms traded in the index derivatives segment of the National Stock Exchange (NSE) and cumulatively incurred a trading loss of ₹51,689 crore. Index derivatives are a kind of financial derivative."

“That’s a lot of money."

“Yes. And of these 9.25 million unique investors, 7.83 million investors, approximately 85 out of 100, lost money."

“Ouch."

“And once trading costs are taken into account, 90 out of 100 lost money trading financial derivatives."

“So, trading in financial derivatives is clearly a recipe for financial disaster for most." concluded Vivaan.

“True. But that doesn’t automatically imply that trading in stocks is safer."

“Oh."

“In fact, Sebi released a study in July, which said that around one-third of individuals who buy and sell stocks do so on an intraday basis, implying that if they buy a stock on a particular day, they also sell it on the same day."

“And what did this study find?"

“The number of individuals carrying out intraday trading has jumped from 1.5 million in 2018-19 to 6.9 million in 2022-23, with these figures being limited to the top ten stock brokers."

“And?" asked Vivaan.

“On average, 71 out of 100 intraday traders in stocks lose money. It stood at 65 out of 100 in 2018-19."

“Hmmm."

“Also, a bulk of those carrying out intraday trading are youngsters. In fact, in 2018-19, only 18% of those carrying out intraday trading were under 30 years of age. In 2022-23, this had jumped to 48%. Which means that a bulk of the newer intraday traders are under 30 years of age."

“Makes sense."

“Also, this is not just limited to intraday traders. In fact, data released by the National Stock Exchange in early August tells us that in March 2018, the unique registered investors under the age of 30 formed around 22.9% of the total unique registered investors. In July 2024, it stood at 39.9%, implying that nearly two in every five investors in the stock market are under thirty years of age. In fact, the share of those in the 30-39 age group has remained stable, whereas the share of those over 40 has come down."

“Interesting."

“This means that a bulk of those losing money—whether it means intraday trading in stocks or while trading in financial derivatives—are on the younger side."

Easy job

“So, how did it come to all this?" asked Vivaan.

“You want the short answer or the long answer?" asked Mairaa.

“First let me make us another cup of coffee," said Vivaan. He got up to boil some more water and was back in five minutes, with two cups of coffee: “You know this coffee might be instant but it’s good."

“You are the connoisseur here V, wanting to buy coffee sourced from this plantation and that plantation," said Mairaa. “When it comes to coffee, I have always been good with instant gratification."

“Okay, now tell me."

“The easy answer is that in the last few years, the rise of cheap smartphones, along with the fall in internet prices, and the launch of many apps with easy-to-use interfaces, has made trading in stocks and financial derivatives extremely easy."

“That makes sense," said Vivaan. “I had tried opening a trading and a demat account around ten years back and the process was so complicated. Plus, the user interfaces of these accounts were quite horrible."

“But there is more to it," replied Mairaa.

“Oh."

The sale

“In any economic transaction there are multiple parts. In this case, the existing and the prospective traders are one part, whereas the stock brokerages and stock exchanges who facilitate the process of trading, are another. And then there are financial influencers as well."

“Finfluencers?" asked Vivaan. “Where do they fit?"

“Have you ever heard of affiliate marketing?" asked Mairaa.

“No."

“So, it’s basically a marketing model where a company pays outsiders, referred to as affiliates, to generate leads for what it is selling. And for every sale that an affiliate helps make, they are paid a commission."

“That sounds like a legitimate business model to me."

“If done right it is."

“Hmmm."

“Now, in this case, the stock brokerage is the company, and the finfluencer is the affiliate. The finfluencer puts out a link to open a trading account with a particular stock brokerage. Many followers click on the link and open a trading account with the brokerage. Now, every time the followers trade using that account, they are likely to pay a commission to the stock brokerage, especially while trading financial derivatives. A good portion of this commission was being shared with the finfluencer."

“Sounds like a perfectly legitimate business model to me."

“Which is why you are an engineer and I am an economist," said Mairaa. “You can only see the seen and not the unseen."

“Sorry?"

“First, the referral link put out by the finfluencer is basically an advertisement. Second, when putting out the link, the finfluencer needs to clearly point this out to the followers, which wasn’t being done. Third, there was something else at work."

“What?"

“Well, through their content, the finfluencers promoted the idea that it was very easy to get rich off the stock market through trading, in particular trading financial derivatives."

“How did that help?"

“It led to people trading more. When they traded more, the stock brokerages earned a higher commission in absolute terms, helping the finfluencers earn more as well. In fact, the livemint.com piece I referred to earlier quoted a senior executive at a stock brokerage saying that brokerages shared 30-40% of their commissions with finfluencers."

“So, to summarise this, the stock brokerages incentivised finfluencers, who in turn nudged their followers to trade more, without telling them that they were being paid to do so."

“Exactly."

“Interesting."

Guess who?

“In fact, there is more to this. And it gets murkier. There is also a transaction fee, which the stock brokerage pays the stock exchange and in turn charges the individual trader," said Mairaa.

“Okay."

“So, the transaction fee that the brokerage pays the exchange is inversely proportional to the turnover that it is able to generate for the exchange. Given this, the higher the trading carried out by traders, the higher the turnover and the lower the transaction fee that the broker needs to pay the exchange."

“Okay."

“Now, stock brokerages incentivised finfluencers to promote the idea of how easy it is to make money of the stock market. The finfluencers did so through their videos, reels and other social media posts. This drove up the turnover. As the stock brokerage ICICI Direct pointed out in a recent note: “India’s monthly futures and options [financial derivatives] turnover reached a record… $1.1 trillion in March 2024." It was around $27 billion in March 2019. This led to two things."

“What?" asked Vivaan.

“First, as I have already explained, it helped drive up commissions earned by the stock brokerages, and in turn, finfluencers earned more money. Second, it also helped brokerages pay a lower transaction fee to the stock exchanges, given that the transaction fee is inversely proportional to turnover contributed," explained Mairaa.

“Okay."

“The stock brokerages did not pass on the benefit of this lower transaction fee charged by the exchanges to those trading through them. This difference is referred to as the rebate and stock brokerages made money from this as well."

“So, everyone other than the trader seems to have made money here."

“Yes. Kind of."

The end

“Now, what’s being done to stop this?"

“First, from 2 October, the stock brokerages will no longer be able to pocket the rebate and will have to charge the traders trading through them the same transaction fee as the stock exchange is charging them."

“Hmmm."

“Second, the entire affiliate marketing business, which operated under the shadows, will come to an end. In a recent interview to Moneycontrol, Manisha Kapoor, CEO and secretary general of the Advertising Standards Council of India, said that affiliate links that finfluencers host for brokerages will qualify as an advertisement. So, this will have to be stated up front. Finfluencers can no longer hide the fact that stock brokerages are paying them for this."

“Okay."

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“Third, the National Stock Exchange, in a recent circular, said: “With a view to safeguard the interest of investors, it is hereby clarified that any person referring a client to the Trading Member shall be appointed as an Authorised Person (AP) of the Trading Member after obtaining specific prior approval from the stock exchange for each such person.""

“What does this mean in simple English?" asked Vivaan.

“Every finfluencer who carries out affiliate marketing for a brokerage will have to be registered with the brokerage as an authorised person and this will need approval from the stock exchange. Basically, this at some level should take care of all the mis-selling that the finfluencers had been promoting."

“Okay."

“Also, this has led to several stock brokerages stopping payments made to finfluencers acting as affiliates, striking at the heart of the business model of finfluencers and new age low-cost brokerages," explained Mairaa.

The good story

“But why are individuals so attracted towards trading when the base rate of success while trading is quite low?" asked Vivaan.

“Good question," said Mairaa. “See, there is something called preference falsification at work."

“Ah, heavy duty jargon!"

“As Raghuram G. Rajan and Rohit Lamba write in Breaking the Mould—Reimagining India’s Economic Future: “Political scientist Timur Kuran coined the evocative phrase ‘preference falsification’, which is the act of misrepresenting what one believes, perceiving public pressure to do so. For instance, a substantial portion of the population of the Soviet Union was unhappy with the state, but many feared sharing their views openly."

Individuals are attracted to trade because of ‘preference falsification’. Everyone around them talks of the money they made, leading them to believe that their luck will soon change.

“How does this link up to the current state?"

“Something similar seems to be happening in India right now. So, individually, as Sebi data shows, many traders are losing money. But when they look at the world around them where finfluencers, fund managers, politicians and even regulators, sometimes, are talking about all the money being made, they end up thinking that they must be the only ones losing money. So, they believe that their luck will soon change. They can stop after a few losses. But they don’t," explained Mairaa.

“Basically, good stories end up drowning Sebi’s data on losses."

“Indeed," replied Mairaa. “Now, please can I have another cup of coffee."

“For sure. But first let me just call my boss and take a rainy day holiday."

(The example is hypothetical).

(Vivek Kaul is the author of Bad Money).