scorecardresearchTwo ways to avoid stock market pitfalls

Two ways to avoid stock market pitfalls

Updated: 17 Jun 2022, 07:57 AM IST

One should not judge professionals by a short term performance of a few months or quarters. The short term performance in the stock market can be deceptive.

Different ways to keep market pitfalls at bay

Different ways to keep market pitfalls at bay

Whenever I meet with investors there are two common questions that I am asked. First, what do you think of the market and second, what are you buying currently?

Most investor attention is confined to the current macro environment and what is discussed and debated in the media, social media groups. It mostly includes financial or geopolitical risks. The investors try to project the future market outlook based on the recent past events. If interest rates are going up, rupee weakening, crude going up, what will happen, will the market correct further because there is a war going on. Such questions are relatively easy to handle as no one knows what will happen and mostly markets throw great opportunities during such turbulent and confusing times.

However, it is very difficult to comprehend the simple fact that macros have limited scope in the performance of the stock market. Macros adjust and readjust from time to time. They are cyclical as simple as that. However, investors spend a significant amount of time and give excessive attention to this topic. Simple things are not always easy to accept.

The second question related to what you are buying currently is a tricky one to handle. Each investor has his or her investment horizon and risk taking capabilities. Also, investors may end up changing their opinion when the facts change. The one working with tips has no idea what to do when facts are changing.

In such cases, what I find in most of the cases investors end-up buying junk or alternatively they book losses as they have no self-conviction during drawdowns. It happens in every bull to bear cycle or from upside to downside journey in the market. This question appears very simple to get tips but it has all the impacts on your performance in the market. Focusing on TIPs can take you to PITs (reverse of TIP).

Today, I am dealing with this second aspect that is TIPs and how to avoid a fall in the PITs.

Invest through professionals

There are multiple channels available. These include Mutual Funds, Services of Research Analyst and Registered Investment Advisors, Portfolio Management Services (PMS) to name a few.

There are different fee structures of these and depending upon one’s portfolio size and needs one can select them.

While going to a doctor we only go to the doctor who is qualified and experienced and not to any charlatan risking our life. Similarly one should strictly deal with the SEBI registered bodies and should not risk financial wellbeing by dealing with unscrupulous charlatans. SEBI has laid down important regulations on how these respective professional bodies conduct their business. These regulations are to protect investors’ interest. SEBI also ensures regulations are followed by means of various audits and constant vigil.

One should also check the background of the respective bodies, their past performance, qualification, experience and any references, if possible. All these may help in building trust. Trust is the most important aspect in the financial world. However, one should not judge professionals by a short term performance of a few months or quarters. The short term performance in the stock market can be deceptive. A 3-5 year performance is a better yardstick.

Direct investing

One can also consider direct investing. But if you are new and do not have the right skills and experience, it will be better to avoid big exposure through direct investment. One should keep it to the minimum and also remember that beginners' luck is at work when one starts. So initial success should not be extrapolated to future profits. One should take extra care with investments and build it for the long term while taking exposure in quality companies.

In our initial years when one is lacking experience, one should look at these simple parameters and as one develops experience and more skills additional parameters and sectors can be added

1. Prefer companies

  • Zero or low debt companies
  • Single digit PE (this can be deceptive in case of cyclical companies)
  • Businesses that you understand/can develop understanding
  • Strong Operating Cash Flow - I have covered this in detail in one of the videos. Check it here from 19min 10 sec onwards
  • Discipline to invest during the time of market corrections

2. Avoid large investments when there is all around euphoria

3. Before you invest make an excel sheet

  • Write the name of the script, buy price
  • Write briefly the reasons for investment: It could be your research finding or someone recommended you to buy.
  • Your expectations from the investment
  • Refer and update this excel sheet every time you want to take a decision regarding the stock.

Please remember that the stock market is not a quick money making machine. It requires significant patience and behavioural control. Those who are in a hurry to make money leave the market on a permanent basis. The market rewards those who are disciplined and patient in investments.

These are my two pence worth. I hope this is helpful. As always, I look forward to your feedback.

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 or Twitter handle @niteen_india

First Published: 17 Jun 2022, 07:57 AM IST