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This study is an exploration of the Indian stock market, focusing on the possible presence of momentum trading. One thing, however, should be noted. While it is true that momentum trading, which tends to generate speculative bubbles, may result in a financial market crash, its nature in contrast might depend on the nature of the economy itself. The study, while exploring the presence and nature of momentum trading on the Indian stock market in recent years, seeks to relate it to significant structural breaks in the Indian or global economy. To be precise, it outlines a potential correlation between the instability in the stock market and the speculative trading on the market, exploring the question of whether it is human psychology that drives financial markets. In the process, the choice of a significant structural break has been obvious: the global financial meltdown of 2007-2008 – a crisis that has often been referred to as the worst ever since the crash of 1929. While analyzing the nature of momentum trading on the Indian stock market with regard to the financial crisis of 2007-08, the study takes into account two major representatives of the market, the BSE (Bombay Stock Index) and NSE (National Stock Index), for the period 2005 to 2012. This study seeks to answer a few important questions. First of all, it tries to unveil the underlying structure of the market. In doing so, it examines the following issues: (i) What was the latent structure of the Indian stock market leading up to the crisis of 2007-08? Does the structure offer insights into designing profitable trading strategies? (ii) Is it possible to construct a profitable portfolio on the Indian stock market? (iii) Is there any profitable trading strategy on the Indian stock market? While exploring these issues, the study delves deeper, breaking the whole period down into two sub-periods, before the crisis of 2008 and after the crisis. The purpose of this division is to determine whether there has been any discernible change in the market structure since the shock.



Chapter 1. Introduction

Resolving issues like “how and why markets work? … and work well?” are often concerns of the so-called mainstream economists. The query dates back to Adam Smith who conjectured a self-regulating economic system that heads towards a stable equilibrium, as individual economic agents pursue their divergent, often conflicting self-interest.

Gagari Chakrabarti, Chitrakalpa Sen

Chapter 2. Trends in Indian Stock Market: Scope for Designing Profitable Trading Rule?

This chapter explores the latent structure in the Indian stock market, along with its sectors, around the financial crisis. To understand the market structure, the study makes use of exploratory factor analysis. It also tracks the factor scores along with the cycles in the respective indexes to scrutinize the underlying market behavior. Apart from looking for the latent structure, the chapter seeks to explore the following issues: How the market has behaved over the period of study? What are the trends at sectoral level? Are they similar, or otherwise to the market trends? Are the trends independent of the selection of the stock market exchanges and whether, and how financial crisis could affect such trends? The rationale behind such analyses is to see whether there has been any discernible change in the market structure before and after the shock. A clear behavioral pattern would hint toward an inefficient market and possible scope for designing profitable portfolio mix.

Gagari Chakrabarti, Chitrakalpa Sen

Chapter 3. Possible Investment Strategies in Indian Stock Market

This chapter explores the presence of possible and profitable investment strategies in the Indian stock market. The exploratory factor analysis used in Chap. 2 explored the presence of a distinct latent structure in the Indian stock market. Given the latent structures in the BSE and NSE, it is indeed possible for investors to design profitable investment strategies. Both risk-averse and risk-loving investors might find portfolios suitable for them based on different indicators such as return, risk-adjusted return, systematic, and unsystematic risk. The nature of such portfolios, however, has changed over time. The financial crisis of 2007–2008 has affected some sectors adversely, while some have been able to avoid the impact of the crisis. Some defensive sectors have emerged out of the crisis with an aggressive tenor. Portfolios in BSE and NSE moreover have some characteristics in common. Such discernable patterns in portfolio choice, however, will put Efficient Market Hypothesis on trial.

Gagari Chakrabarti, Chitrakalpa Sen

Chapter 4. Investigation into Optimal Trading Rules in Indian Stock Market

This chapter deals with momentum trading and possibility of a profitable trading strategy in the Indian stock market. It does so by examining the historical moving averages of the indexes. According to the trading rule, an investor should buy when price is above some moving average of historical prices and sell when price falls below some moving average. The study considers several moving averages, short run, medium run, and long run, and explores whether the general buy and sell strategies fare better than the holding strategy based on the moving average. Existence of a momentum strategy would reaffirm the doubt that the Indian stock market is not efficient. It will put a question mark to the invincibility of the market, as suggested by the efficient market hypothesis.

Gagari Chakrabarti, Chitrakalpa Sen
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