Simplest way to make money in stocks

June 16, 2007 11:33 IST

Though his salary may run into six digits, the average young executive would wait for that annual discount sale to buy his favourite brand of clothes, shoes and accessories.

A well-heeled housewife would probably squeeze the last paise out of the corner vegetable vendor, before deciding to buy her daily quota. You will proba

June 16, 2007 11:33 IST

Though his salary may run into six digits, the average young executive would wait for that annual discount sale to buy his favourite brand of clothes, shoes and accessories.

A well-heeled housewife would probably squeeze the last paise out of the corner vegetable vendor, before deciding to buy her daily quota. You will probably haggle for those ten rupees with the porter before handing over your luggage , even if you are traveling first-class by Rajdhani.

But when it comes to stocks, we prefer to buy the ones that are rising and shun those that are falling. A slight fall in value of stock reduces the number of investors who would want to invest.

We are not discussing the professional trader or a pock-marked technical analyst, who is seasoned enough to know when to run and when to bail out. We are discussing the common investor, who sells when a stock falls and buys when it rises. We are not discussing the trader who has no capital to take delivery and must square up in case stocks plummet.

Those who sit in front of the screen get carried away by the wild swings of the markets. Those who are glued to their TV sets and mobiles will also commit these mistakes.

The main reason for this behaviour is the lack of conviction in the stock, which stems from the fact that the stock has probably been bought in a jiffy on some hot flying tip.

A factor helping this phenomenon is the ease with you can buy and sell stocks. When have you seen someone booking a loss in his house, if the price falls from the levels which he has bought? But an investor will sell Rs 1 crore (Rs 10 million) worth of stocks at a loss if he sees the prices stumbling.

As investors, we should see market sell offs and corrections as an opportunity to buy rather than panic and sell. It is akin to a sale. When the stock is available at a massive discount to the recent prices, there are no takers.

Going back to our example of garment sale, the clothes in the sale may be export rejects, seconds or with other manufacturing defects, whereas in the stock sale, the stocks are the same class-1 shares. In fact, lower prices means locking of a higher dividend yield also.

If we have fundamentally liked the stock at a particular level, when the price drops 20 per cent lower, we should like the stock even more, if there has been no adverse fundamental change meanwhile. But investors tend to sell on weakness.

In order to see whether this theory holds true, I backtracked the Sensex for the last 17 years and studied its movements since January 1, 1990. In these 17.5 years there have been 43 instances when the Sensex has dipped 10 per cent or more, in terms of swings.

If an investor were to invest after all the 43 falls, he would have got positive returns in 34 of the instances, within three months. In nine instances there would have been negative returns.

On average, counting for the losses, his returns would have been 11 per cent in three months, non-annualised. And if you hold on for another three months in eight of those nine loss-making cases, the losses turn into profits.

But you don't have to wait for the Sensex to lose 10 per cent to start investing. Sometimes, individual stocks correct with in a broader market up-move. Unless there are fundamental reasons to believe that you should avoid the stock, dips are good opportunities to enter the stock.

Then there are other opportunities that come your way. When an analyst recommends a particular stock on television, you may find the stock doing an Indian Rope Trick. If you like the argument, do not run after the stock concerned. Give it some cooling time and it will be back at the same or even lower levels in a few weeks. That is the time when you close in on your prey.

The easiest and the simplest way to make money in the markets is to buy low and sell high. Keep that in mind for a sound sleep and a fatter wallet.

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