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ഇന്‍വെസ്റ്റ്‌മെന്റ് ഇന്‍ ഇക്വിറ്റി (ഭാഗം- 3: സുനില്‍ എം.എസ്)

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Investment in Equity (Part 3)

Before we go into anything else, let us repeat the theory, so that we may not forget it: Buy when price starts rising, and sell when price starts falling.

So far as we are active in the stock market, we need to chant this mantra all the time. The idea is to adhere to the theory, and to prevent us from digressing from it.

We decided in the preceding chapter that we shall consider 5% price movement as sufficient evidence of price’s having started to move either upward or downward. If the price has risen 5% from its recent bottom, we will decide that the price has started rising and it is time to buy. Conversely, if the price has fallen 5% from its recent top, we will decide that the price has started falling and that it is time to sell.

For a moment, we will switch to snowballs. It might sound ridiculous, but snowballs have some relevance in the movement of share prices at times. If you squeeze two handfuls of snow together, they will form a single mass, block or ball called snow ball. If you squeeze more snow into it, the ball might become larger. If you throw a snowball down a snow-clad slope, the snowball will roll down, and while sliding down the snow-covered slope, it might gather more snow and grow bigger and bigger. It is quite possible that the falling snowball becomes so large that it smashes every obstacle it crashes into.

When a scrip is rising, and is rising rather rapidly, people will rush to buy it. When people rush to buy an already rising scrip, it gathers momentum and rises faster. With every rise, the momentum increases. The reverse of the same thing happens when a scrip starts crashing, too. When a scrip crashes, people rush in to sell it away at whatever price becomes available. This makes it fall even faster. This snowballing effect becomes evident when price rapidly rises or falls.

When a scrip is rising, people may join the movement at different levels which they find comfortable. Even after the scrip has doubled in price in a matter of days or weeks, the momentum might remain intact and the upward movement might continue. Sometimes, the upward spiral might go on for years. Remember the example of Reliance Capital which had been at Rs. 134 in January 2005 and which had steeply risen to Rs. 2860 in the next three years. Just as people madly jumped in and pushed the price up between 2005 and 2008, they did just its opposite and made the scrip crash to Rs. 232 in the next four years.

The point is, when it becomes clear a scrip has been rising, more people jump in to buy it. Conversely, when it becomes clear that the scrip has been falling, more people jump in to sell it away. The momentum in the movement becomes noticeable when the movement touches 5%. A 5% movement is more noticeable than a 4%, 3% or 2% movement. The momentum becomes evident. It is assumed that a 5% rise has the potential to gather the momentum necessary for a further rise. It is this assumption or expectation that prompts people to join the upward movement by purchasing the scrip. Similarly, it is also assumed that when a scrip has fallen 5%, the downward movement has gathered momentum enough for a further downward movement of, maybe, 6%, 7%, 8% and so on.

Two conflicting stands are possible in stock market. At every level, one can think that (1) either the present movement will gather momentum and will continue (2) or the present movement will stop at this level and from here onwards the price will retrace its steps. If the price has been rising, some people will think that the upward movement will become stronger and will continue; at the same time, some others will think that since the price has already risen so much, it will now reverse and start falling. At every point, someone thinks that the price will hereafter rise, and he buys it. At the same time, the person from who he buys the scrip might be thinking that the price will now start falling, and this will be a good time to sell the scrip away. The purchase of a share by someone is the sale by someone else. Someone enters the scrip when someone else exits it.

Which of these two – whether the buyer or the seller – is doing the right thing? No one can have the right answer at that very moment. The subsequent price movement, over a period of time, alone will answer it. This makes it all uncertain at the time of the purchase or sale. One can decide to buy or not to buy. One can decide to sell or not to sell. Even the toss of a coin cannot come to your help. Because even then, there is 50% chance for you to go wrong. It is here the price movement comes to your rescue. It is here the 5% trigger shows you the direction. If you depend on the tossing of a coin, it is speculation. On the contrary, if you put in place a firm, well defined policy of acting in response to a trigger of a certain length, it will be wisdom and it will see you come out well even in times of disaster.

You have to choose from the various triggers: 1%, 2%, 3%, 4%, 5%, 6%...and so on. If the trigger is as short as 1%, it can cause you trouble. 1% fluctuation can happen every now and then, and it will increase the number of deals without any commensurate benefit. I have a natural inclination towards the 5% trigger. I do not have the patience to wait for a 10% movement. A 5% price movement triggers me into action. The length of the trigger depends on one’s patience. There may be people who are patient enough to find comfort in a 10% trigger.

Which is better, the 5% trigger or the 10% trigger? Frankly, I have no answer. Both have relative advantages and disadvantages. If you use the 5% trigger, by the time your scrip falls 5%, you will have sold it away. If the scrip crashes 20%, and then rises, the benefit you will derive from such a fall will be a clear 10%. If you are using a 10% trigger, your benefit from the 20% fall will be zero. While this can be seen as a relative advantage of 5% trigger over 10%, it could also become a disadvantage if the price fluctuates just 5% only and it does so frequently; every such time, the 5% trigger will cause you loss, while a 10% trigger will keep you undisturbed.

The point is, you need to make the choice yourself. To make the choice may not be easy. I will suggest you to go into the historical figures as deeply (four years, five years, six years, and so on…) and as extensively (in more than one scrip) as possible. You can work out using the past figures, find out the net results for both the 5% trigger and the 10% trigger, compare both and choose the one which would have provided the highest benefits in most scrips over the last four or five years. However, in stock market, the past is no guarantee for the future. Still, for formulating a firm policy, such research will be helpful and is indispensable. Whenever in doubt, research, and you will see the right direction.
Once a choice is made, you need to stick to it. Wavering can be disastrous in stock market. If you choose the 10% trigger, you shouldn’t switch to lower triggers. Stable policies will give you ample profits in the long run. There is no rule that you should select either 5% or 10%. 6%, 7%, 8%, 9% are also triggers which are as good as 5% or 10%. However, triggers lower than 5% and higher than 10% can be counterproductive.
I shall deal with other related topics such as scrip selection, trigger jumping, stop-loss orders, etc., in the next few chapters. Meanwhile, I shall conclude the current chapter with two edicts of mine: “Never buy when the scrip is crashing; never sell when the scrip is rallying.” I shall deal with these too, in one of the chapters which will follow.

(To continue)

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