Market blues and investors agony – I By Dr. Bobby Srinivasan and Dr. Sudhakar Balachandran

May 6, 2015 | Posted by bobbysrinivasan << back to blog

When P.M. Modi took over the mantle as the Prime Minister of India, the stock market gave him thumbs up for his expected pro-business policies. The Domestic Institutional Investors (DII), the Foreign Institutional Investors (FII) and the retail investors celebrated his grand success in the national election by driving up the Sensex by nearly 30 to 40% in the shortest period of 1 year. The market even sucked in occasional retail investors by promoting greed in them. The saying was “if you don’t act now, all is lost”. Exuberance which brought these players to the market is now witnessing their retract slowly but steadily. What really has gone wrong? Did the market run up was too fast and too soon? Currently the Sensex index and the Nifty have dropped by more than 10%. The FIIs seem locking in their profits and moving funds out of India. The rupee’s value is fluctuating between 63 and 64 to a dollar waiting for a breakout on the downside.

The question arises as to why this change of mind among the investors has taken place when there are no reasons to warrant it. Are they seeing a gloomier economy? Do they expect the global markets rally to loose ground? Then what will it take to keep the investors interest sustained? The answer is being searched in this conversation between a student and his professor.

Student: Professor, I am amazed to see that nearly 2000 point drop in the Sensex index in the last couple of weeks. Is there anything happening to create this negative sentiment?

Professor: Your question is very meaningful and at the same time very profound. I am going to give you a lecture on the markets behavior and explain to you as to why this is happening. OK.

Student: I am all ears, Professor.

Professor: First, bear in mind that all explanations about the market behavior are at best good guesses. Specifically, looking for the reason for such happening will demand continuous and sustained observations and it will take time. However we can still try. I am going to answer this question by a set of hypothesis and leave it to your judgment to find the answer. Here it goes.

Hypothesis 1: The players in all markets are subjected to greed and fear.

When for example, they see the market stagnant with no specific direction to go, investors come into the market to bring life. They come with the strong expectation that markets have to move one way or another

If the driving force is greed; the investors will come in a big way and buy stocks without any specific reason. This provides momentum for further purchases and the demand picks up as more investors seeing the trend become part of the investment band wagon.

The same way if the driving force is fear, you can see the investors bailing out rapidly. They sell without any specific reasons. Panic rules the roost and they will want to be out of the market at all cost.

Both greed and fear just look for a reason to happen and when it happens, the ensuing investors panic destroys the entire price discovery process. Imagine how can an investor explain his action which has no fundamentals to support. To justify you will need examples. Yes of course, after the sub-prime crisis, the entire global markets suffered huge losses. Indian market, namely Sensex, though in no way connected to the sub-prime crisis of the US dropped from 21,000 to 8,000 in 6 months. The people who spoke the rationale for entering the market in the first place are the same ones panicked and exited. Lesson to carry from this discussion is that much against commonsense and rationality investors could either get sucked in, because of greed or bail out because of fear. Another lesson to carry is that one should hold fort through such crisis to survive the market.

By the way it is time for my class. Please see me tomorrow.

Student: OK Professor.

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