Auction system will help small investors

But price discovery will still be a problem. Small investors might as well avoid it

If you have stocks of a company for which there are no buyers, (the stock is illiquid), until now you had no option but to put a sell order through your broker or online trading account and hope someone would buy it. Chances were you were unable to sell it at all or even if you did, you did not get the price you hoped.

Now there is a mechanism by which you can sell your illiquid stocks. Following guidelines issued by the Securities and Exchange Board of India, a call auction mechanism has been introduced on the exchanges for buying and selling of illiquid stocks.

This window will provide an opportunity for retail investors holding illiquid securities to exit, says Sudip Bandyopadhyay, managing director and chief executive officer of Destimoney Securities. "Until now there was lot of uncertainty with regard to illiquid scrips. Neither buyers nor sellers knew if there were interested parties. This system could bring in some transparency and reduce uncertainty," he says.

Usually, only traders and operators buy illiquid stocks. That is why these are prone to price manipulation. The regulator hopes to end this through the call auction mechanism. The stocks transferred to the new mechanism that began on April 8 include 2,050 on the Bombay Stock Exchange and 262 on the National Stock Exchange. These will not be available for active trade.

A stock is classified as illiquid if the average daily volume of the scrip is less than 10,000 or the number of trades is less than 50 in a quarter. This list, mostly mid- and small-caps, will be revised periodically by the exchanges. If the trading volumes change, these will be moved into the active trade category.

This is how the mechanism works: During the day, there will be call auction periods of one hour each, where buyers and sellers can put in bids and match the prices. If the maximum bid price and the minimum sell price match, then the transaction is carried out.

There is a cap on the price. The cut-off bid should not be less than 20 per cent and more than 20 per cent of the last traded price. If the same client enters a sell price and a higher buy price, then a penalty will be levied. This can be verified by the exchange through the PAN number of the client. The penalty is one per cent of the trade value (0.5 per cent of the value for sale and 0.5 per cent of the value for buy) or Rs 5,000, whichever is higher. While the mechanism might address the issue of price manipulation, it may not necessarily lead to good price discovery, says Ashish Shankar, head-investment advisory, Motilal Oswal Private Wealth Management.

"Traditionally, in the case of small- and mid-cap scrips which are illiquid, investors never got a good price. But even under the mechanism, due to the limits on the bid and sell price, price discovery might not be possible," he says.