'Momentum selloff', margin calls singe mid- & small-caps

Mumbai: The latest equities rout in India has pulverised several mid- and small-cap stocks, among favourite 'momentum plays' with traders, as forced selling spawned by margin calls set off a domino effect that has now extended to other segments of risk assets.

Brokers slashed client positions to make up for the exchanges' margin requirements after steep share price declines. At the same time, stop losses triggered at various investment advisory firms, which have large retail client bases and give trading tips on stocks on the move, aggravated the slump.

The BSE's small-cap index tumbled 4.1% on Friday and the mid-cap index slumped 3.4% - their biggest single-day fall since February 24. The Sensex fell 1.6%. In the past two days, the small-cap index fell 5.9 %, and the mid-cap index 4.1%.

"Brokers have been forced to make some margin calls in various momentum stocks in mid-caps, small-caps and PSUs that have fallen sharply," said B Gopkumar, managing director, Axis Securities.

Margin calls become inevitable when there is a shortfall in the minimum deposit that traders must maintain with brokers in borrowed trades. Brokers, too, must maintain a minimum margin with exchanges and when there is a shortfall, they are forced to take back some of the loans extended to traders.

"In market declines as seen in the past two days, brokers have no option but to sell client leveraged positions to maintain this margin level to avoid penalty," said Gopkumar. He said retail traders creating fresh bets in the past week would have taken a hit in the latest slump.

Banks Cashed Out

The majority of the top mid-cap losers have been state-run banks, market darlings in the past few months. Union Bank of India, Indian Overseas Bank, Yes Bank, Bank of India and IDFC First have fallen 10-17% in the past two days. The biggest laggards among small-caps, such as Goodluck India, BLS International, Garden Reach, National Fertilizers and Mazagon Dock, have shed 15-27% since Wednesday.

Chirag Kabani, a professional trader and technical analyst, said the trigger for the crash in mid- and small-cap stocks was an unexpected selling in Bank Nifty on Wednesday that trapped a lot of options traders.

"Because of the MTM losses there, many retail traders have been forced to liquidate their other momentum trades," said Kabani. "That is why the market fell on Thursday despite FPIs and DIIs turning net buyers on that day, which is unusual."

On Thursday, the small-cap index slumped 1.8% and the mid-cap index fell 0.8%. The Sensex and Nifty ended almost 0.4% lower. Provisional data showed foreign portfolio investors net bought shares worth ₹928 crore and their domestic counterparts pumped ₹2,207 crore into stocks.

Market participants said unwinding of trading bets of several investment advisors, who have a huge retail client following, also caused a ripple effect. Many of their stock picks are based on stocks riding a bullish wave that are shortlisted by trading programmes and algorithms. When the tide reverses, the algorithms flash a sell signal, causing an army of retail traders to dump the stock. The impact of such selling tends to be widespread. "When a cycle is broken, there tends to be pressure on liquidity and the stocks that are most impacted are the less-liquid mid- and small-caps," said Hemang Jani, head, equity strategy, broking and distribution, Motilal Oswal.