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What is Basket Trade?

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A basket trade is an order that allows us to buy or sell a group of securities at the same time. This strategy is commonly used by large investors, such as investment funds and institutional investors, who hold a significant number of securities in certain proportions. Essentially speaking, when an investor executes a basket trade, he does not buy or sell a single security; instead, he buys or sells a mini portfolio.

Understand the Meaning of Basket Trade

Let us understand the meaning of basket trade in detail:

  1. A basket trade is a type of order that enables us to purchase or sell a basket of various securities in one go. In other words, we trade in many securities simultaneously.

  2. In basket trade, we do not trade in individual securities. Instead, we trade in many securities at the same time.

  3. Such trades are mostly executed by large investors (e.g., investment funds and institutional investors) who intend to hold many assets in certain percentages.

  4. In basket trade, large investors end up trading a mini portfolio, as they purchase or sell a group of securities at the same time.

  5. As such large investors buy/sell a high number of securities, they have to ensure that they trade these securities at a price that does not change the allocation of their portfolio.

How Basket Trade Works in the Stock Market

Let us understand how basket trade works in the stock market:

  1. Assume that you are the manager of a large portfolio. You intend to create a portfolio that mirrors Sensex, which is an index of the 30 largest and most liquid stocks in the Indian stock market.

  2. You set up a basket comprising all these 30 stocks from Sensex. You ensure that the proportion of each stock in your basket is equal to its proportion in Sensex. These proportions are publicly available. Hence, you can access data easily.

  3. Now, you should select a stockbroker that has a trading platform that allows basket trading.

  4. On this platform, you have to set up an order that allows you to buy 30 stocks simultaneously.

  5. Suppose after a month, Sensex is up by 7%, your portfolio will be up by 7% minus the transaction cost incurred on buying the 30 stocks.

Types of Basket Trade

Find below the prominent types of basket trade:

  1. Equity basket: Here, you can make a basket of several equity stocks. Let us say that you create a basket of pharma stocks. Hence, you are not exposed to the risk of an individual pharma stock. Moreover, your portfolio will go up and down basis the stock prices of multiple pharma stocks. Similarly, you can even make an equity basket of stocks comprising a benchmark index like Nifty or Sensex.

  2. Fixed-income basket: You can create a basket of bonds, debentures, and other fixed-income securities. This will help you earn fixed interest on the securities. Besides, when the market price of fixed-income securities goes up, you can sell your basket to cash in some profit.

  3. Commodity basket: You can create a basket of commodities publicly traded. This will help you gain when the prices of commodities in your basket move up.

Characteristics of Basket Trade

The main characteristics of basket trade are discussed below:

  1. Multiple securities are bought or sold: In a basket trade, multiple securities are bought or sold at the same time. A single security is never purchased or sold in this case.

  2. Institutional investors prefer this strategy: Typically, large investors like investment funds and institutional investors prefer this strategy, especially those who want to hold many securities in certain proportions.

  3. Baskets of shares, bonds, & commodities can be made: An investor can make a basket of several shares, several fixed-income securities, or many commodities. Hence, this strategy does not limit an investor to only shares.

  4. Flexible weighting criteria: Two investors do not need to have the same weighting criteria while creating a basket of assets, as they are free to have different criteria for weighting based on their investment objective.

Benefits of Basket Trade

Basket trades offer several benefits listed below:

  • Flexibility: You can create a basket of securities based on your investment objective. For example, if your investment objective is high growth, then you can create a basket of stocks that have a high growth potential. They can belong to one sector or multiple sectors. However, if your objective is value, then you can create a basket of stocks with high dividend yield.

  • Control: You can add or remove an asset from your basket easily, as you have full control over it. If your objective is only diversification, then you can invest in a mutual fund (MF) as well. However, in an MF, a manager decides which stocks to buy and sell and investors have no control over it.

  • Diversification: Basket trades can help you diversify your portfolio, reducing your exposure to the unsystematic risk in the market. Let us say that you want to invest in an FMCG stock; however, you are anxious because its price may or may not move up. Instead, you can invest in a basket of FMCG stocks. In this basket, if one stock does not move up, other stocks may move up, thereby reducing your overall risk.

Challenges Faced in Basket Trade

Trading in baskets is not without challenges. Imagine you have made a basket of stocks after hours of crunching numbers. You place an order to buy all those stocks. All orders are executed but one. It can totally change your entire basket and can have an adverse impact on your returns. This is possible especially in a volatile market when the prices change rapidly.

Apart from price, there can be other reasons for not being able to execute a trade. If a stock in your portfolio has low liquidity, it can also make it difficult for you to buy or sell it.

Remember that you have to execute multiple orders at the same time in basket trading. Therefore, you need to be extremely sure of transaction costs, quality of trading software, and other issues. If you face a problem with one of these factors, you may not be able to successfully execute your basket trade.

Conclusion

Basket trade has its benefits; however, it is mostly meant for large investors. Most retail investors find it difficult to research multiple stocks, fixed-income securities, or any other assets. So, if you are a retail investor, you should consider basket trading only if you have a deep knowledge of all the securities you want to buy. Besides, you should keep the benefits and limitations of basket trade in mind while executing such trades.

Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing. This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.

For All Disclaimers Click Here: https://bit.ly/3Tcsfuc

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Frequently Asked Questions

What is the meaning of basket trade?

Answer Field

When we buy or sell a group of securities together and at the same time, it is known as basket trade.

How does a basket trade work?

Answer Field

For a basket trade, an investor places an order to buy or sell a large number of securities simultaneously. While placing such an order, investors have to ensure that they trade these securities at a price without altering their portfolio’s allocation.

What are the benefits of investing in basket trade?

Answer Field

You have total control over the allocation of your portfolio in basket trades. You can decide how much to invest in which security. Besides, you can diversify your risk by investing in multiple securities.

What types of basket trade are available?

Answer Field

Investors can invest in a basket of stocks, bonds, and commodities. However, basket trades are most popular for stocks.

How can basket trade be used for hedging purposes?

Answer Field

Basket trade allows people to buy or sell many securities simultaneously. So, if a security’s price does not move in the desired direction, the prices of other securities may move in a manner that an investor wants, thereby diversifying or hedging his risk.

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