Market blues and investors agony – III 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: Professor, your classification of investors didn’t include algorithmic traders. Is there a specific reason why these groups of investors are left out?

Professor: Yes, I intentionally left them out. They are people who use technology and high speed computers to trade. But they are not interested in any specific stock because of its performance or for that matter to build a portfolio by their trade. They do influence the prices a lot and create all kinds of market distortions. Why they are allowed in the first place I don’t know? They can easily create 2 to 3 percent volatility in the stock prices in a short period of time which is enough to scare the retail investor. According to the latest data nearly 73% of all trades done in the Indian stock market is made by them which in my opinion is not market friend is and will kill the market eventually.

Student: Can you explain how they affect the price discovery process?

Professor: Every time they trade they will execute a very huge order by buying or selling stocks which will in turn push up or down the prices. The retail investor for example, if he is currently holding stock, he will rush to sell a call option which he may not have contemplated but for this volatility. The poor retail investor has no clear understanding of how the market and pricing mechanism works. He is shell shocked wondering how to survive the situation. Unfortunately this process repeats itself. Just look at the Sensex for the last one year and count the number of days the index moved up or down by say 300 to 400 points. You will understand what I am saying. It has been established that nearly 80% of the retail investors loose money primarily because of this volatility. It is not that they selected the wrong stock, but it is that they don’t understand what volatility can do or undo for him.

Student: Frightening. Are you then suggesting that the retail investor should stay away?

Professor: I am not saying that. What I am saying is that the retail investor should tell himself that once he has bought the stock based upon its expected performance, he should be willing to put up with the market fluctuation.

Student: Why does our government allow big fluctuations in the market place? Can they curb the volatility by appropriate action?

Professor: Are you asking whether the government should intervene in the market? This is the last thing they should be doing. Only in the case of extreme volatility they should intervene and that too only to bring stability and orderliness to the market.

Student: We learn so many methods to stock selection in our courses such as the equity analysis, valuation, and portfolio management. Do they mean anything at all?

Professor: It means everything. In the long run the fundamentals should work. But the retail investor’s patience runs out. He panics with every volatile price change and rushes for exit door. But unfortunately, such big changes are happening on a regular basis in the Indian market. He is not able to withstand it. Both pessimism and optimism are dangerous attitudes especially in the stock market. It leads to poorly executed decisions.

Student: Professor, I will come back to you with more questions. I always believed that I could create personal wealth in the stock market. You are telling me that I may not have the patience to survive the volatility. I will see you again tomorrow to talk about this.

Professor: OK.

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