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Thursday, June 28, 2012

Should small investors follow in the steps of well-known market players?

Many small investors believe that stock market investing is a zero-sum game. Some one buys and some one else sells. If a stock or index goes up after the transaction, the buyer wins and the seller loses. If the stock or index goes down, the buyer loses and the seller wins. Pretty simple, right?

Not quite. The commonly-held belief that ‘for every buyer there is a seller’ may be grammatically correct, but reality is entirely different. Here is an example: Today, the market was agog with the news that HSBC had sold major chunks of its holdings in Axis Bank and Yes Bank. Several hundred thousand shares changed hands.

Was there a single buyer who came forth to buy all the shares of Axis Bank and Yes Bank? No. How do I know that? From the price action. Axis Bank dropped 2.75% and Yes Bank dropped 2.25% after the news hit the market. There were several buyers for the Yes Bank offering. Fewer buyers for the Axis Bank offering.

Against one seller in both bank stocks, there were several buyers. If both stocks continue to fall in tomorrow’s trade, there will be one winner and several losers. A negative-sum game. If both stocks rise tomorrow, there will be one loser and several winners. A positive sum game. It is important to understand this – because it leads to the answer of the question.

Axis Bank and Yes Bank are well regarded and managed private sector banks. Buying their stocks and facing a temporary loss at current market price may not be a big deal because both companies are likely to perform well in future. Chances of making up the loss and moving into profit are high.

Now, replace HSBC in the above example by your favourite market player – RJ, RD, NK, etc. Imagine one of them is holding a large chunk of shares in companies like Bilcare, Delta Magnets, Bartronics. He first lets it be known that he has entered these companies. That attracts the attention of small investors. Then he keeps the market primed with all kinds of positive news – great acquisitions, fantastic prospects, brilliant technology tie-ups.

Small investors get sucked in, because every one loves to ride the gravy train. When the market price of the stock gets pumped up to a sufficiently high level, the selling begins. It’s a hugely negative-sum game. Only one winner, and thousands of losers.

If you want to be on the winning side in the stock market game, you have to work hard. Analyse companies fundamentally and technically, read newspapers and business magazines to keep updated on local and global economic issues, and trust your judgement but not your intuition.

Most important of all, do not try to follow in the footsteps of well-known market players. They are in the market to make money – from people like you and me.

That was the long answer. The short answer is: NO!

1 comment:

Jasi said...

Thanks for the very valuable lesson. Thats coming from someone whos been a sucker at times for all this! :)