V Pattabhi Ram
That was one hell a lot of money to lose. If the pink papers were to be believed the investing public had lost Rs 18 lakh crore in under a week’s time. The Sensex crashed from upwards of 21,000 to downwards of 16,000 points. Wafers the young CA did a quick count to realize that 18 lakh crore meant 18 by 12 zeroes. Phew. She had rushed to find a word for lakh crore; it was trillion. So the market had lost Rs 18 trillion in wealth that week. Now that was an easier number to mouth! India was in illustrious company as markets across the globe had tanked.
She got in touch with China, her engineering friend with an encyclopedic knowledge. He had a good chunk of his money parked in stocks and she wanted to have his views on why the Street went into a tail spin and what in his view was the way forward. “Clearly, the markets were overheated; they had risen too much too fast and there has been an overhang of liquidity” said China. “You speak like one of those stock market pundits who appear on television,” chided Wafers. “To an anchor’s question as to which way the market would be headed next week, the expert had blithely remarked, “The Sensex might either go up or come down.” China let the jibe pass.
Correction is welcome:
Wafers said, “The pundits are telling that this correction is welcome. Now what is correction? Does it mean that the prices are now correct? As it is in true and correct?” China smiled. “You see, in the stock market there is nothing like black or white; they are always shades of grey. When the market climbs too fast and people get into panic buying as though the stocks will not be available tomorrow, even the buyers get happy when the price falls. Such a steep fall is called a correction. It allows the buyers to take fresh positions at lower price. Similarly when the market falls like nine pins and people get into panic selling, even the sellers are happy when the price rises. Such a rise is called a correction. It allows the seller to take fresh positions at higher price”.
“I think this stock market is like a horserace; all speculation” remarked Wafers. China was aghast. “Hey, coming from a CA that’s a shocking statement. If there were no stock markets how will companies raise money? If companies didn’t raise money how will they fund new projects? If they didn’t fund new projects how will they grow? Stock markets have a very important economic role to play; but whether we should convert that into a gambling den or not is in our hands” said the enigmatic China
So are circuit breakers:
Wafers wasn’t through with picking a few other stock market insights. “Why was the trading halted when the stocks went into their tail spin on Tsunamic Tuesday? If bulls have a party when prices go up, bears should be allowed to have a party when prices fall. Isn’t it?” China again smiled. His 1000-watt smile was his biggest asset. “That’s well said. But remember markets are often driven by human sentiment. When prices fall sharply an avalanche of sale takes place pushing prices further down; seeing prices fall further down, still further sale takes place and before one knows what’s happening the prices have crashed”. Ha, the cascading effect thought Wafers.
“From shares and stocks the portfolio seem like stares and shocks. You stare at a stock price wondering how you picked them at higher prices! The opposite is also true when prices rise. So the exchange has a circuit breaker under which market trading is halted if the Index shoots up or crashes down by 10% points. Trading is halted for a one hour period to let sentiments cool. The same logic is true for individual stocks except in respect of those which are traded on the Futures and Options segment” closed out China.
The opportunity to average
Wafers accounting mind was quick at work. “Does this fall not provide me with the great opportunity to reduce the cost of holding?” China asked, “How?” Wafers was thrilled at getting into an explanation mode for the benefit of China. “Suppose I had bought 100 Infosys shares before the crash at Rs 1,800 apiece. Now post crash they are available at Rs 1,500/-. If I buy another 100 shares, my cost of purchase will effectively be only Rs 1,650/-. I have managed to reduce my cost from Rs 1,800 to Rs 1,650. It’s easier for a stock to move from Rs 1,500 to Rs1,650 and thus help me breakeven and make profits than for it to touch Rs 1,800 before it breaks even for me”.
China agreed. “The logic is good but you have to be careful. If the stock isn’t fundamentally good, averaging can turn out to be costly. If the stock sinks further down you will be throwing good money after bad money”. Wafers asked almost sarcastically, “So how do I place good money on good money?” China remarked, “You must add to investments when the stocks move up. True, you will be increasing the cost price but you will be sailing with the current. Averaging upwards is called pyramiding and is better than averaging downwards”.
“You aren’t suggesting that I should agree with you?” asked a belligerent Wafers. “No you don’t have to” said China. After all you have to have two views for a market to function. Remember every stock sold has a stock purchased. One man thinks the price is too high and sells, another man thinks the price is low and buys!
“In retrospect, what’s your view” asked Wafers. China responded, “I somehow am an optimist. I believe in the India growth story. I trust that the markets will touch 25,000 levels by March 2009. And would actually suggest people to take positions on the Index in addition to on specific stocks. That may be risky but it will help make some money on the side.” Wafers was surprised. “Aren’t you sticking your neck out?” she asked. “Yup” said China. “But you wanted me to do that isn’t it?”
The duo would have gone on and one, but China had a long night ahead of him to work. Wafers was happy that she now knew a trick or two and the markets and made up her mind to start investing.