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

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

This is an ongoing conversation between a student and his professor.

Student: Your earlier hypothesis encourages me to ask more questions. Can you tell me your next hypothesis?

Professor: Hypothesis 2: There are different types of investors and their active presence creates the market volatility.

Student: Amazing, but what does it mean?

Professor: Many decades ago, the participants in the stock market were small and well informed people. They accepted annual dividend declared as their income and at the same time waited for long term capital gains which happens with the growth in net income of a company’s earnings. But to-day the players are different and they come to the market with different expectations. For your convenience I broadly classify them into different categories.

Category 1: The investor doesn’t know how the market works but still want to participate. Ask him why he bought and why he is now selling a particular share. The probable answer he will give will be either his broker or friend told him so. As long as he can get a decent return from the market he doesn’t mind taking his chances. He will probably ask the question, “do I need to know how the car works before I drive the car”.

Category 2: The investor knows how the market works and enjoys participating in it. For example, he may look to the expected GDP growth rate and then correlate the growth to the market performance. He will know what the profitable sector will be and will buy stocks in that sector. These are the types of people who buy TCS, Wipro, Infosys and Cognizant shares because he expects growth in this sector.

Category 3: Market Scooper

This investor is restless and waiting for an action. He is not bothered whether the market is going up or down. If the market looks up, he will rush to buy and similarly if the market trends down he will sell short the stock. He is not primarily worried about the economy and other related parameters. He knows where the liquidity is coming from and which stock it will chase. He is a front runner and with limited inside information about the FIIs involvement, he will take his position in the market. His action may borderline insider trading but in reality it is not the hard facts but the judgement that is driving him to act.

Category 4: Hedge funds

Where ever money is to be made these people come with huge amount of money and trade. They are like congregating vultures waiting to eat the dead carcass left behind. They will not hesitate to push the stock down or up with such a force which either will push up or correct the market prices significantly. The retail investor hates the sight of them, because they create volatility. In the end they reap enormous profits literally robbing the average investor of his investment money.

Category 5: The fund manager of a unit trust.

This guy has to show performance to survive in his job. He will close out his position, especially the profitable ones just in time in order to qualify for the bonus and he will let the losers stay longer in his portfolio. This guy will ultimately accumulate all the losers and hope for a turnaround in the market. Since he is playing with somebody elses money his only concern is how much commission he will get.

Category 6: Leveraged trader.

This investor wants to use the institution money as well as borrowed money to make more. These investors can sometimes be dangerous and will take big chances. After all he is using somebody elses money to speculate. There are enough number of such investors and when they take losses they are normally very huge. Sometimes they drive the institution for whom they trade into bankruptcy. For example: Nick lesson of Barrings lost all the equities of the bank which then was taken over by another bank.

So you see given that different investors with different mindset and varying risk approach they can create such volatility that an average small time investor cannot take the heat anymore and hence run for shelter.

Now I am done for the day. Let us talk about a different hypothesis tomorrow.

Student: Thanks, Professor.

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