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Grey Market Premium Explainer and How it Affects Investors

It’s raining IPOs in the Indian stock market. As investors had five companies — Flair Writing Industries Ltd, Tata Technologies, Ireda, and Gandhar Oil Refinery — to choose their initial public offering (IPO) from recently, one may have also discussed the grey market and grey market premium (GMP). If you are new to trading and unfamiliar with the stock market vocabulary, it will help to know about these and how they affect your investment decisions. Here’s a low-down on GMP, its advantages and disadvantages, and some tips to use it wisely.

What is grey market premium?

Before learning about the GMP, one must know the grey market. It’s a platform where investors can buy and sell shares of a company before its IPO or listing on the stock exchange. No authority regulates the grey market, and operates based on supply and demand. The GMP is the difference between the price of a share in the official stock market and this unofficial or grey market.

In the unofficial grey market, individuals buy and sell IPO shares before their official introduction to the stock exchange for trading. This market operates outside regulatory frameworks, allowing unrestricted over-the-counter transactions. Cash transactions occur directly between parties without involvement from entities like SEBI, SEBI registered investment advisory, the Stock Exchange, or brokers. This informal trading needs more official platforms or established rules, typically involving a limited group of individuals. ‘Grey market Premium’ and ‘Kostak’ are commonly used in the IPO grey market.

The GMP indicates the level of interest and demand for a particular share among the investors. A high GMP means the share is expected to perform well on the listing day and vice versa. For example, if a company’s IPO price is ₹100 per share and its GMP is ₹50, the IPO will list at approximately ₹150 on the first day of trading. Of course, it may not always be accurate, but the GMP is usually correct, and the IPO could list at that price.

What are the advantages and disadvantages of the GMP?

The GMP is a valuable tool for investors because it allows them to gauge the level of interest and demand for a share and gives them an idea of how it will perform on the listing day. It can help investors decide whether or not to apply for the IPO and how much to bid for the share. It also comes in handy in helping one plan their exit strategy after listing.

However, the GMP is not a reliable indicator of the share’s performance in the long run. Many factors, such as market sentiment, hype, speculation, peer performance, etc, influence it. It can change rapidly depending on the supply and demand situation in the grey market. Moreover, GMP is not an official or legal price, and there is no guarantee that it will reflect the actual listing price. Last but not least, it can expose investors to fraud, manipulation, default, and more risks.

How to use the GMP wisely?

Since the GMP has its pros and cons, if an investor wants to make use of it, they must use their discretion. Here are some tips to use the GMP effectively:

– Do not rely solely on the GMP to make your investment decisions. Do your research and analysis of the company’s fundamentals, financials, growth prospects, competitive edge, and so on.

– Do not get carried away by hype or speculation. Be realistic and rational about your expectations and goals.

– Do not invest what you can afford to lose. Beware of the risks in investing in the grey market, and be prepared for any outcome.

– Do not forget to diversify your portfolio. Invest in different sectors, companies, and asset classes to reduce risk exposure.

Conclusion

Understanding the GMP is essential in navigating the busy IPO market. While it can guide decisions regarding IPO applications and share bids, its reliability for long-term performance is debatable. Investors must tread cautiously, blending the GMP insights with thorough research, realistic expectations, risk awareness, and diversified portfolios. The GMP, while informative, is just one piece of the puzzle of informed investment strategies.

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