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The stock market is essentially an ecosystem that’s teeming with crores of participants, most of whom are short term traders
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If there’s one thing that inexperienced investors love doing, it’s investing based on events – or ‘trading the news’. Policy outcomes, global events, RBI policy meets, the union budget, and most recently – geopolitical tensions – all assume excessive significance in the minds of investors, around which they build their investment decisions. The truth is that it’s an exercise in futility, and here’s a simple explanation of why this approach has a very low success rate.
The stock market is essentially an ecosystem that’s teeming with crores of participants, most of whom are short term traders (those out to reap quick profits). In the short term, it is the collective actions of these traders that move markets up or down. In the run up to any event, a sort of “consensus” begins to form about the outcome of that event, that in turn drives market participants to either collectively turn bullish or bearish. In other words, consensus drives prices up or down before the actual event – which means that the most probable outcome of any given event is already ‘priced into’ the market at the time that the event occurs.
After the actual event passes, these traders who got in begin to unwind their long or short positions as their work is essentially done – and this often pushes stock prices in the opposite direction. In the one-off case that the event outcome differs from the consensus, the event outcome does indeed lead to massive price swings – but in the direction opposite to the precluding build up!
Take for instance what happened last week. Wednesday night, the Fed not just announced a rate hike but also projected an aggressive stance going forward – something that markets had been fearing for long as it could impact FII flows and drag down equities in the medium term. What happened on Thursday? The SENSEX shot up more than 1000 points. Go figure!
And spare a moment for the poor retail investor who sat on the side-lines waiting for a correction during the post-pandemic rally 18 months back because they believed that the economic impact of COVID would be catastrophic. At first, they would have experienced a desperate FOMO (Fear of Missing Out) as the bellwether NIFTY surged past 10K, 12K and then 15K. Jumping in at that stage, they would now be sitting on losses as the index fell 1000 points. This cycle goes on and on. Trade, lose, repeat.
As an investor, what should you do? Stagger your equity investments using 3-6-month STP’s (Systematic Transfer Plans) if you’re a Mutual Fund investor. If you prefer direct equities, earmark a portfolio of solid businesses with a decent margin of safety and buy into them bit by bit each month, irrespective of short-term volatility. But whatever you do, don’t invest into equities just because you expect a positive outcome from a future event. That’s a strategy that’s doomed to fail.