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6 things a stock trader knows that you don't

November 10, 2015 12:01 IST
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The stock markets need not be an enigma - use resources at your disposal while investing in stocks

Stock market investors have always been fascinated by the aura stock brokers emanate and the fluency with which they spew out facts and trends about companies, financials, stocks, etc. For most investors, stock traders seem to work on gut instinct and hearsay rather than on any objective assessment. Things could not be further from the truth.

In this article, we will see some of the information that stock brokers have and rely on which an average investor does not have, or cannot gainfully interpret even if he has it.

Low price does not mean 'cheap'

Usually, a low price is equated to 'cheap'. Very low priced stocks are also known as penny stocks. Many investors buy such stocks in bulk, assuming that even an appreciation by fifty paisa will be enough to give huge returns. What goes abegging is that a stock’s price is a function of the underlying company and its financials as well as demand and supply. This myth has also been perpetuated by stock splits, where the stock looks cheaper after the split.

Obviously, this myth does not hold. The price can be low for many reasons, unhealthy financials of the company  being one of the prime ones. Prices could be low also because the company is new or a very small one. In any case, penny stocks or low priced stocks are risky propositions for investors.

The 'level' of the stock market

When the going is good, everybody jumps on the share-buying bandwagon, hoping to make a few bucks from the rally. However, the market rally depends on the stock market’s PE (price-earnings ratio), which indicates the level of the market - whether it is overheated or tepid. A market PE of 25 and more can be a dangerous time to buy. This is something stock traders are intrinsically aware of.

Though no number is sacrosanct when it comes to PE ratio, empirical evidence suggests that anything above the 22-25 range is a sign that the market is entering a dangerous phase and can tumble anytime. However, it is impossible to predict when the market would start falling. All investors can do is to be cautious and start systematic withdrawal when the market reaches these levels.

Impact of key drivers of a sector

These are the technical indicators pertaining to the sector the investor wants to invest in. These impact the prices of the stocks you invest in. For instance, a bank lowering its non-performing assets (NPA) in a financial quarter will have a positive impact on its stock prices. Lower prices of oil tend to have a favourable effect on the oil company’s stocks. A high interest rate regime is bad for auto sectors as well as real estate.

These are parameters that stock traders investing in specific classes of stocks tend to be privy to and keep their ears glued to. Though it is not impossible to gain these insights, it is a highly technical task requiring research and instinct.

Most IPOs lose money

Initial Public Offers (IPOs) priced at reasonable valuations have decent chances of going up once floated. However, most IPOs expect to raise as much as possible by pricing the issued stock to the maximum. In such cases, there are very little chances of the prices appreciating. Typically, IPOs that have done well after issue tend to be the only ones to be written about in the media and trade circles, while the bad ones do not make news. This brushes under the  carpet the fact that most IPOs lose money.

You may not find buyers of your stocks at the current market price

Many investors believe that you can sell or buy any stocks in the stock market instantaneously. Though this may be technically possible, it is not practical economically. For you to liquidate your stocks, you need buyers. Similarly, to buy stocks, you need sellers. This phenomenon manifests when investors, lured by superb returns, buy penny stocks. They get a jolt when they do not find any buyer later. This may also occur in the case of stocks that tumble due to unsurmountable problem faced by the company that has issued the stock.

Many investors buy these at a very low price hoping to sell them in future at a high price. However, in most such cases, stocks keep plunging, and investors do not even recover their original capital.

Mutual fund NFOs are equivalent to existing funds in the market

New fund offers (NFOs), to many investors, are synonymous to IPOs when it comes to how they approach the investment decision. This can be fatal for the investor. In the case of IPOs, the company is new and theoretically has the potential to fetch supernormal returns. However, NFOs are simply new mutual funds that are just schemes investing in a set of existing companies or assets. If the new fund schemes invest in the same set of firms or assets, the returns will be similar to having purchased all those firms’ stocks individually.

Keep the above parameters and insights in mind when you make an investment decision in the stock markets by buying a stock or a mutual fund. The stock markets need not be an enigma - use resources at your disposalor seek expert recommendations before you wet your hands in the bourses.

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