Written By: Roshni Bhatia on May 28, 2011 No Comment

If you wonder how people in the market make so much money, If you wonder if some make millions why do others end up losing more than millions then you must understand the basic functioning of the markets. Pondering over various ideas, an interesting way of putting forward the mechanism of Stock markets popped up in my mind. I believe this is the easiest possible way in which I can communicate the functioning of a Stock Market. I shall explain with the help of this anecdote.

Once there was a man who happened to visit a village. He declared to the farmers that he shall pay Rs. 10 per banana. The farmers knew that bananas are available in plenty and soon rushed to get them and fetch some easy money. For once also they dint bother to check the credibility of the man and his statement. The man purchased about lakhs of bananas at Rs.10 each and gradually the supply fell. As a consequence, now the farmers did not take the pain of searching more bananas. Considering that, he broke the news that he will now buy not at Rs. 10, but double the price: Rs. 20! This brought about a new enthusiasm amongst the farmers and once again the farmers started finding bananas and provided to the man; but this time at Rs. 20! Due to this, supply further went down and farmers were about to return to their work. Again the man quoted a new price: Rs. 25. By now supply had reduced so drastically that it was a daunting task to find a banana. A further declaration was made of buying at Rs. 50 but that shall be done by his secretary on his behalf as he had to return to city. Now the secretary was no less smart. He knew that the farmers knew little about business and trading, so informed then that he is willing to sell all the bananas collected at Rs. 35 to them and they can sell it back to his boss at Rs.50! Poor farmers….Little did they know the implications of this, gathered all their earnings so far in order to buy those bananas. What happens next? Need I say? The man, his secretary and the farmers’ money nothing returned again!

Welcome to the Stock Market!

People dream to become wealthy and land up in Stock Market. It is a known fact that day by day the no. of people who actively participate in markets is increasing. People set aside their core business and invest money into stocks to become millionaires. Is it that simple? Definitely not! While we put in so much effort to scale our core business to new highs, we don’t even put 50% of efforts when it comes to investing in markets. In other words, we work so hard to earn money and while it comes to investing this hard earned money, we are very casual. This is one of the basic reasons for Investor’s repentance. I would draw attention to few mistakes an investor commits and how to overcome them.

Understand Your Risk Taking Abilities/Don’t over leverage

When you know that all you can afford to lose is Rs. 1000, then please do not bet for Rs. 10000. Had the farmers realized that buying those bananas for Rs. 35 was not under their capacity as it ate up all their earnings, they would have never lost money. Not that you must not take risk, but to the extent that you can bear, else suffer losses.

The not so good G for “GREED”

One must be contempt with what one gets. Being greedy in markets heeds you nowhere, in fact, puts you in losses. Just as in case of the farmers, they were not contempt in Rs. 25; wanted to gain more and more and the end result was “LOSS”.

If all are buying that stock, Why not me?

A strict no! We come to know that there is some news in stock “abc” and as a result, all people are buying the stock. Convinced that it might be a good opportunity to make money, you as well allocate your money without knowing anything about the stock. Such actions only create bubble in the stock that results into trapping and leaves common man into losses.

 Wait for a while

One really needs to be very patient and disciplined while dealing in markets or one shall go for a toss. This can be understood clearly in the next point.



Exit during Profits and Wait during Losses

In simple words, in order to gain from market volatility, one aims to buy at low prices and sells at higher prices. In this process, one must not make an early exit if the stock is fetching good returns in fear of losing money in stock goes down. Nonetheless, one should be careful not to wait too long and stick to the stock if it goes down in the hope that it shall come up again, which could result into losses. It is crucial to identify exit points and stop losses.

 Timing the Market/Power of Averaging

Suppose that you invested in a stock and it’s going down. What must you do? Book a stop-loss! But you don’t! Instead you wait further until you learn that stock price has further crashed. Now that you are in a state of agony and fear, you try to make for the loss. You buy more stock at this low price to bring down your average price considering that stock will again take an upward swing. Unfortunately, many people have lost lot of money due to this.



Markets follow a Random Walk?

Markets are very volatile and cannot be predicted. One cannot take a decision solely based on past. In fact, markets reflect the current scenario overall. So one must be capable enough to understand current conditions and take decisions accordingly.



Diversification

If you have a low risk profile, Diversification is most important for you. Don’t put all eggs in one basket. One must invest into various classes like stocks, mutual funds, bonds, etc. Within that as well, try to allocate funds into various segments. For instance, Instead of investing all money into Reliance Industries, I would invest into Infosys, DLF, Educomp etc. That is because if one stock or a particular sector goes down due to any reason you don’t suffer high losses.

The most neglected fact while taking investment decisions is planning. In order to avoid losses and make profits, one must plan well in advance one’s risk appetite, how much capital can he allocate, where he wants to allocate, where will the capital be diversified, and so on.