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Money School

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Money School - Some Interesting Stuffs

How retail investors lose money

The reason is simple - a retail investor is driven by greed or fear. Never logic.

• Retail investors are always the last to enter a bull run
• "Smart money" enters markets long time back when markets are at its bottoms, there is frustration all around and no one wants to discuss markets
• When markets start booming and indices make new peaks, the retail investor "wakes" up. At this stage, he is still not sure and is a fence sitter.
• Lastly, there is optimism all around. Every one is bullish and talking markets. Stocks which were never traded in a year, suddenly start moving and start reaching "new highs"
• At this time, the retail investor starts buying as he does not want to miss out the "action"
• The retail investor will display a marked preference for "low priced" stocks because these are "cheap". He will stay clear of index stocks as these are "expensive"
• This is also the time when "smart money" starts moving out
• When a correction happens, it is usually quite severe
• The retail investor does one of two things. He either decides to wait (the optimism is still there) or he starts "averaging" his costs. Averaging is nothing but trying to "catch a falling knife"
• At some time or the other, panic sets in. The retail investor will then sell off all holdings as a distress sale.
• Sometimes the retail investor will do nothing but wait for the markets to rise
• When the markets do rise, he will sell off all his holdings at the first available opportunity and thus miss out on the new bull run

Other facts

• In a bull run, the retail investor is usually the first to sell off his holding. This investor seldom waits for the bull run to continue
• Those who have never participated when the rally started will invariably jump in towards the end of the bull run
• Retail investors rarely follow stoplosses. Circumstances eventually force them to take a bigger loss
• Lastly, retail investors spend an insignificant amount of time researching an investment as compared to buying a mobile or fridge.

Why trade the nifty

If you really want to earn money in the stock market, then don't deal in stocks - trade the nifty.

For all the technical analysis I do, I rarely trade in stocks...I trade the nifty.

Years of trading experience has taught me one simple thing...it is far easier to take a directional call on the broader market than individual stocks. If the economy is doing well, the market (nifty) will anyway do well (and vice versa).

Stock movements tend to cyclical, news driven or rangebound for considerable periods of time. Not only do you have to identify the sector correctly, you should also be able to pick the right stock. And then there is this possibility - everything else rallies except what you have bought.

From a fundamental perspective, this means you don't have to worry about crude oil, interest rates, FII inflows (or outflows), quarterly results, sectors, analysts talk and whatever you can think of.

Some advantages of trading the nifty:

• Index is the barometer of the stock market. If the market does well, Nifty will anyway rise (and vice versa)
• All FIIs and Mutual funds have an exposure on index and index stocks
• All good and bad news is reflected in index (nifty)
• You can play both sides of the market and profit from rallies as well as corrections
• You can daytrade in nifty (not recommended) or carry forward positions till expiry
• Low brokerage / nil demat costs
• Excellent liquidity: The daily turnover of nifty futures and options is 2-3 times that of ALL stocks traded on BSE.
• Low volatility: no wild swings. Because the nifty index is made of 50 stocks, it is always less volatile than the individual stocks. Check latest volatility statistics.
• Low investment: as nifty is least volatile, NSE margins are lowest. This reduces investment amount substantially.

Trading strategies

Is there any catch?

Nifty futures and options being derivatives, have an expiry period (the last Thursday of every month). You cannot take "delivery" and hold positions indefinitely the way one can do with stocks.

You can however exit a position any time you feel like...same day, same week, etc. So you can daytrade or carry forward positions till expiry date.

With stocks, you can take delivery and hold positions indefinitely. Very often, this is how traders become investors and short term investors become long term investors!

Futures trading is a leveraged transaction. In case of Nifty, every 1% change leads to 8% change in your profit (or loss). So while you can earn fantastic profits, you can also lose money.

Options trading is tricky. For buyers, investment is less and profits unlimited. But the real profit depends on the option bought, days left to expiry, implied volatility and how fast the underlying moves. The time decay can knock off your entire investment. But if you follow the trend and always buy in-the-money options, then you need not worry. Most retail investors lose money because (a) they trade against the trend and (b) they have absolutely no idea about option pricing.

One can earn 100% or sometimes even 200% return in a month (buying option). On the other hand, a wrong trade can reduce capital.

Transaction costs (brokerage) is not an issue as we are not looking at intraday trades. Since positions are carried forward for many days, this really does not matter.

Rangebound markets are a problem as technically there is no way to predetermine this situation. Unfortunately there is no solution here and one has to live with this. Fortunately nifty seldom trades in a range.

Summary: Irrespective of what you trade in - stocks, futures or options, you will earn money only if you follow the trend. If you trade against the trend, you are almost sure to lose money. So the problem is not with the instrument but with the trading style.

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