I had done this piece for rediff in 2006. It is relevant today also 🙂

read on…

The most important animal in the markets is the pig. It gets slaughtered whether the bulls have a party or the bears have a party. That pig is your lay investor.

I am not a doomsday specialist or a day trader, but surely if one reads the papers one can see some gloom. Here are just some of the typical reactions on the street. (Taken from Mumbai based newspaper, DNA, dated Tuesday, May 23, 2006)

Narayandas Bajaj (75), a retail trader from south Mumbai, is on the phone, talking to his family, attempting to gently break the news of his Rs 600,000 loss over the past few days.

Forty-five year old Santhosh Balachandran, who works for a telecom-related business, is scribbling furiously on a paper to gauge his losses. The recent market volatility has shaved Rs 70,000 off his Rs 500,000 invested funds.

Entrepreneur Ramesh Mirchandani (40), an Ulhasnagar resident, is another investor grievously hurt in market crash. He lost Rs 80,000 last week, and more than Rs 250,000 on Monday.

Read carefully – these are all classic ‘market players’ (no these are not traders) masquerading as investors. God bless them. They will compound their mistakes. If they bought high, they will sell low. Then wait for the market to go up. Once the market goes to 15000, they will enter and expect the markets to defy gravity. But that will never happen.

There is only one thing certain about the markets – asset prices fluctuate. There is never a one-way journey. Economics never goes out of fashion. We just forget it from time to time. Here’s a reminder.

In stock market parlance, a ‘correction’ is usually taken to mean a downward swing of 25 per cent or more. As I type, the Sensex is off roughly 20 per cent from the high it touched earlier this month, which means we may still have a way to go before hitting correction territory.

Volatility is a nice word to hide bigger words like ‘melt down’. The markets are down, and may perhaps stay there. What one needs to understand, mathematically speaking is that for a 50 per cent fall in your portfolio to be recovered, the market has to go up 100 per cent. This is difficult. What it means is if you invested Rs 100 in the market, and the market fell 50 per cent from there, your investment will now be at Rs 50. For this Rs 50 to come back to Rs 100, the market has to double. To accept that is not easy.

Nonetheless, last week’s swoon propelled by this weeks’ crash has me wondering if the folks at the predictions shop are onto something.

Surely some of the data mavens think there’s a possibility that ‘a significant economic slowdown, or possibly a recession, could become increasingly obvious by the second half of 2006.’

Also keep in mind for 3 years we have believed that markets cannot come down, and interest rates cannot go up. That might be about to change. We believed that a 2-day fall would be followed by a rise. We believed that the market is fairly valued at 3000, 5000, 8000, 10000 and 12000. We may rethink. We believed that you could go to the terminal in the morning and come back richer at the end of the day with Rs 5,000 or Rs 50,000 simply by buying.

The bigger you bet, the greater was the gain. We may rethink on that. We believed that we could build our own portfolio and save the asset management charges that mutual funds charged. We may rethink on that.

The bottom line
Make no mistake: I think the key to being a successful long-term investor is designing a well-diversified asset-allocation game plan that suits your timeline and tolerance for risk, then sticking to it over the course of many years.

That said, it is possible to be intelligently opportunistic along the way. A top-notch fund that specialises in out-of-favor stocks is a great way to do just that. So remember these facts and find your way around them:

Mathematically speaking, for a 50% fall in your portfolio to be recovered, the market has to go up 100%

Asset prices fluctuate