The previous two articles have brought to light various myths that we must be carrying w.r.t markets, valuation of stocks and risk. There are some other myths related to analysts’ knowledge of the markets and active traders. All these myths need to be understood well to take rational decisions while investing in stock markets. More often than not, we follow these myths without realisation.
The Stock Market is an Exclusive Club for Brokers and Rich People
Market Advisers/Brokers claim to predict the market accurately. However, research shows that it is not true. Most market predictors are inaccurate and suffer from various biases (as discussed in the articles on behavioural finance). Also, with the advent of technology and internet, knowledge about the market and all the information related to it is more available to the public than ever before. All the data and research tools previously available only to brokerages are now also available to general public.
A Little Knowledge Is Better Than None
Usually we believe that knowing something about a topic is better than knowing absolutely nothing. However, this does not hold true in stock markets. In stock markets, it is crucial that individual investors have clear understanding of where they are investing their hard earned money. Investors who really research well and do their homework are usually the ones who succeed.
If you do not have the time to fully understand what to do with your money, it is better to have a financial advisor. The cost of investing in something that you do not fully understand far outweighs the cost of using an investment advisor.
In volatile markets, one must be an active trader
Before you believe in this blindly please know about brokerages and the various taxes. You might get a good bargain on brokerage but the taxes are quite wicked. Besides the STT, SEBI Fee, Stamp duty, etc on every transaction there is a 15% tax rate on short term capital gain (securities held less than 12 months) irrespective of the tax slab you fall in.
All these costs might make your profits less attractive.
Analysts are a good guide to picking stocks
Even though it’s an analysts’ job to recommend stocks and find the hidden gems and they are equipped with the relevant knowledge and resources they might not always standout at picking stocks. Despite knowing company’s managers better than most retail investors and working long hours, they themselves might be affected with the various myths and behavioural biases.
You Have To Be An Expert To Manage Money
You do not have to be an expert to know the entire market. There must be some industries you’re already interested in by virtue of your hobbies, passions, expertise, and work and shopping preferences. Just be an expert in that particular industry.
One might love motorcycles and know quite a lot about companies like Hero Motocorp, TVS Motors, etc. This interest can be easily extended to 4 wheelers and heavy vehicles. Similarly one might have a particular liking towards Britannia Industries over Nestle India. A little research can give them a vast knowledge about FMCG Industry.
By having deep knowledge about an industry, one can easily find out which are the companies with a bright future and buy them at attractive prices. Just focus on what you know and stick to it religiously.
Even Warren Buffett doesn’t pretend to be an expert in the whole market. For example, Warren’s portfolio is 67% invested in just four companies – Coke, IBM, American Express and Wells Fargo Bank.
Buy What’s In The News
Events such as an earnings release, a new product announcement or an analyst upgrade all affect stock prices. These stocks are discussed by the media and investment websites making headlines. People assume that most people either already own or are buying these stocks.
But by the time we hear this news, it has already been absorbed by the market and the pricing has been adjusted accordingly. Professional trading organizations react to the news immediately and will act accordingly before you can log into your trading account. This is why trying to react to the day’s headlines is a losing game. One cannot beat professional traders at their own game.
However, what one can do is analyse the stocks that are making headlines with good news and find a good entry price. If the study shows good long term returns, hold onto the stock for an extended period. But one should keep an eye on the valuations, financial statements and other factors that might affect the stock prices. The market and economic dynamics are constantly changing and hence one should keep revisiting their portfolio.
There is also another reason not to be reactive to the headlines. Stocks with relatively less trading volume tend to perform better. Primarily because, there is less focus on them and hence they are more likely to be mispriced and undervalued. So, one can also look at the stocks that aren’t making much headlines but are fundamentally strong.
Stocks bought by Foreign Institutional Investors (FIIs) or Domestic Institutional Investors (DIIs) must be very good
FIIs and DIIs deal with huge volumes of shares which can take a stock in any direction. FIIs increased their stake in 26 companies (in BSE 100 Index) since March 2013, nine of which gave negative returns between April 2013 and February 2014. Similarly, FIIs increased their stakes in 34 companies from March to December 2012, 13 of which negative returns in 2012-13.
Looking at specific examples, FIIs increased their stake in Tata Power Company from 24.54% in the quarter ended March 2013 to 24.78%, 25.05% and 26.03% in quarters ended June, September and December 2013. However the stock price fell 17% from Rs 95.8 on April 1, 2013 to Rs 79.45 on February 26, 2014 on account of poor cash flow.
While following the FIIs and DIIs strategy, retail investors overlook that FIIs and DIIs have their own parameters while taking investment decisions. If they are facing liquidity crunch they might sell even good stocks to raise money. If a retail investor follows and sells the stock, the miss out on the future gains. The risk appetite, the investment horizon as well as the holding power of retail investors are different from that of institutional investors. Hence, if an investor buys a stock that FIIs are buying and it falls in the near or medium term, retail investors without deep pockets will tend to exit, losing money.