Volatility in the Indian Stock Market By Dr. Bobby Srinivasan and Dr. Sudhakar Balachandran

December 22, 2014 | Posted by bobbysrinivasan << back to blog

Student: Professor, you left me in a state of confusion about the Indian stock market. Can you throw some light on it?

Professor: Yes of course! The other day I was talking about the FII participation. As far as I know, there are 1760 foreign institutions registered to trade with our securities exchange commission. Unlike citizens of India, they can take out their capital gains without paying any taxes. Most of their orders come through Mauritius. They enjoy a special privilege because of the double tax treaty arrangement with the country.

All kinds of money including money earned illegally can enter our market since the identity of the purchaser of shares is not necessary. In fact some also say that the black money stashed away is coming back as legal money through this system.

Believe it or not, the Sensex is definitely pro foreign institutions. Our former finance minister, Mr. P. Chidambaram is the chief architect behind this scheme called as Participatory Notes.

Student: I am confused. Is this fair to the Indian investors?

Professor: That is not the point! The foreign institutions have invested more than 200 billion USD in our markets and without their presence we will have poor participation. The price discovery will then be inefficient.

Student: Professor, tell me some of the challenges a retail investor faces.

Professor: First let us start with information symmetry, you would have read in your finance books that all investors are rational and they react to the released economic information in the same manner. Further, the textbook will tell you that the market is efficient. The fact of the matter is that the market has its own mind and behaves the way it wants and so is our retail investor who wakes up too late to every reality. Rich traders are always winning in our markets because they research profusely before they decide what stock to pick and when. They are always the first ones to enter and exit. Our retail investor on the other hand is the last to enter and the last to exit, thereby, burning his hard earned money.

Student: Prof., please tell one move. It sounds so unfair.

Professor: Of course it is! They say “caveat emptor” (buyers beware). There is a book written by the legendary currency trader, George Sores titled “Alchemy & Finance”. In the book he talks about the theory of reflexivity, what in simple terms means that the market affects the investor and the investor affects the market. For example, seeing the prices moving up in the market, the investors rush to buy the stocks. Just as the early bird gets the worm, the rich investors are ready to move in first while the retail investor is not in the scene at all. By the time retail investor understands and invests the money, the market has already moved up significantly.

Essentially what I am saying is that the retail investor is last to recognize the potential of a stock and puts his hard earned money to work only to realize that he had paid a very high price.

Student: Prof., it is often said in the class that in the long run, investing in the stock market is the best bet then why cant the retail investor stay invested until he realizes significant profit.

Professor: This is where the problem is. The price in the stock market can be quite volatile. The retail investor literally panics regardless of whether the market is going up or down. Let me give you some data for your understanding.

Sensex Index
Feb 6, 2006	10000
March 21, 2006	11000
April 10, 2006	12000
Oct 30, 2006	13000
Dec 5, 2006	14000
July 6, 2007	15000
Sept 15, 2007	16000
Sept 19, 2007	17000
Oct 5, 2007	18000
Oct 15, 2007	19000

You will see from the data that the Sensex Index literally doubled in 20 months. After reaching 21000, it dropped to 8000 in less than a year. Most of the retail investor lost the meager savings. In fact nearly 1/3^rd of them dropped out of the market forever.

Student: Prof., this is scary. Can this happen again?

Professor: It is a good question. Let us talk about it later.

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