The stock market is not a place where you can depend on luck though luck plays a critical role. It requires discipline and patience. It is easier to buy a stock but very difficult to hold. It tests human behaviour aspects to the core.
Only on some occasions do we have a stock we bought moves up only in one direction and we exit at a handsome profit. If anyone tells you that he does it repetitively, then he is either God or a Liar.
Similarly, people take adventure rides in the market. It gives them this massive adrenaline rush, a feeling like you're flying or on fire. But it does not take time to be back down on the floor or be completely burned. Such human errors often end up their stock market journey abruptly, permanently.
Today I am covering the story of my ex-colleague, Rakesh Joshi (name changed to protect identity). Rakesh, from a conservative Maharashtrian family, was an Engineer by qualification. He was smart and excellent in his work. His family never invested in the stock market. He was in his mid-30s.
It was back in 2004. The Sensex started moving up rapidly from April 2003 and was already up 100% in a year. As it happens, this movement of the market was getting celebrated in the media. Everywhere the talk was about how investors’ wealth has gone up. Rakesh got attracted to the market around the same time. He started investing small quantities and was making small but decent money. This helped him gain more confidence. Then he happened to learn about shorting a stock.
What is shorting a stock?
Shorting a stock means selling a stock that you do not have right now but you intend to buy it back later for a lesser price. Let’s suppose a stock ABC is trading at ₹100. You feel that it will trade today at a price lower than 100. So you sell this stock without having it. Once the stock comes to say 90, you decide to buy the same stock that you had sold some time ago at 100. You made ₹10 even without having this stock ABC in your Demat account. However, this has to be done on the same day in the cash market.
This looks like a very simple and easy money making tool. But it is not if we understand the risk involved. Also this sounds very strange for newcomers or those who are not familiar with the stock market. How can one sell if he/she does not have it? But this is completely legal and allowed in the market. If a stock is showing extreme volatility then there can be some investors/traders who may like to sell the stock without having it with them and expect to gain from it. Once they sell it and if stock comes down then they buy it back at a lower price.
Rakesh learnt about shorting from his broker & like a child to a new toy, he got attracted to it. Initially he was doing it on paper. It means he was not actually shorting in the market but only on paper without having actual financial liability.
He was sharp and systematic in his job. Similarly, in the market also he devised his “strategy” despite not having any formal understanding and training. His strategy worked and he was making paper money. So one day he decided to short an actual stock in the live market to make actual money and not just paper money. The stock that he decided to short was Shriram Industrial Enterprises Ltd. (SIEL Ltd.). He had no idea about this company, what it does, what is the revenue, profit and who is the management. He just shorted the stock because he was looking at its price and volume movements for several days and he could make out something. It was not even a technical analysis.
So what happened thereafter?
The stock came down as he expected. He made some INR 2200 intraday (within a day). This bolstered his confidence. So he did it again after a few days and made another INR 3000 intraday. This quick money continued during the next few days and so far he could make INR 10000. He did experience small losses in between. But overall the deal was very lucrative for him and turned out to be an easy money making machine.
He discussed his newfound love with me and other colleagues. He talked about his “strategy” and how he could identify by just viewing share price and volume during the time of the day whether the stock would come down or not. He was proved right again and again. He was almost getting a hero status by now. I warned him and asked him to leave it. I had seen in the past how it could come down heavily. But certain things cannot be taught but learned through experience.
He was getting bold by now with his “never say no” confidence. One day he shorted a very large quantity. This was beyond his capacity if the stock had moved in another direction.
However, after he shorted the stock, the price came down. He was making good money. The broker called him at around 12.45pm and asked him to recover the stock and book the profit. He declined. Shit hits the fan when you expect it the least. He said it is just down 7% & he expected it to touch the 20% lower circuit. So more money was being made.
He went out for lunch. At that time smartphones were yet to be common. It was through a desktop/laptop or broker that would help you see the price. By the time he came back from lunch, the stock was up in the upper circuit of 20%.
Now he was in a Catch-22 situation. He neither had the stock to deliver nor the money to compensate for the loss. The exchange would ask for the stock. Since he did not have a stock as he had shorted it, his trade went into the auction.
In an auction, the stock would be bought from the open market at whatever price it is available. Unfortunately, the stock remained in the upper circuit during the next two days. So he had to pay the highest price whenever the exchange could buy it from the market. Not only this, but the exchange also levied penalties on his trade.
His lunch that day cost him 2.50 Lacs. One single-day loss was multiple times more than what he had earned during the last several days. Not only monetary loss, but he lost his sleep too. He had no courage to tell about this to his wife. He was under immense stress.
Since he did not have money to pay, Rakesh was forced to sell his holdings in his Demat account at a throwaway price. So the total cost of that lunch was not just 2.50 lakh but much more than that.
Finally, the highest price Rakesh paid for his misadventure was that it permanently took him off the market. He could never muster the courage to invest in the market again.
What are the lessons for us to learn?
- The stock market is not a place to earn easy money. It requires skills and more than that, a lot of patience and behavioural control.
- One needs to understand the risk involved in everything they do in the market. Are the risk and the reward in line? More often than not the risk is much higher than the reward. If we understand that, then we will not be taking such actions.
- Improve your skills and do not act at random.
- The stock market could help you get decent returns over a long period if stocks of good companies backed by solid management are bought at a reasonable price and sold when they are moving away from their valuations.
- If you do not understand the stock market, then take the help of a qualified professional or invest through mutual funds or index funds.
- Be humble and learn to give credit to your luck rather than to your skills. Otherwise, it will not be far when the market makes you eat humble pie.
Niteen S Dharmawat is one of the founders of Aurum Capital, a SEBI-registered Investment Adviser and Research Analyst company. This article does not constitute personal recommendations and advice. Niteen can be reached at his email id firstname.lastname@example.org or Twitter handle @niteen_india