Possible ways of losing money in Stock Markets -2

Overview:

Since March last week after the crash, the stock markets are on the best Bull Run ever witnessed in history. Nifty shot up from 7500 to 11200 in just four months. It’s around a 50% increase. NASDAQ has rocketed by 52% as of 24/09/20. Normally, it would take at least two years of excellent economic growth and prosperity for that to happen. It’s not clear why stock markets are on this crazy upward trend (If I say the reasons, I will be labeled as a quack or goon).

Apart from some skeptics who are hedging in order to stop losing from that unexpected crash that never happened, most of the newcomers are enjoying this awesome Bull Run. It’s all well and good, but we should be cautious in these uncertain times where the economy is still collapsing and rising Covid-19 cases.

According to recent data, almost 3 million new trading accounts were opened since April this year.

In total, I made a list of eight possible ways where new retail traders and investors fail in stock markets. In the last article, we have discussed how new investors and traders could lose their money by blindly following fake social gurus. We shall continue the discussion further.

1. Following Fake gurus on social media
2. Trading Penny Stocks
3. Falling prey to Value Traps
4. Purchasing high premium stocks
5. Intraday trading with Margin money
6. Trading Options and Futures without prior knowledge
7. Investing in stocks that you don’t understand
8. Taking short term positions against the market move

Trading Penny Stocks:

Penny Stocks are the shares of either micro or small-cap companies and mid-cap companies which have slumped revenue and business for the last few years. Usually, in India, these shares trade at below ₹10/- on the exchanges. Because of their extremely low pricing, new and small rookie investors get attracted to these stocks. 

I think it feels great for people to feel satiated since they own thousands of shares of a company. It feels like owning the company holding more shares. Sometimes, if the investment idea pays out, the returns would be more than 1000% or ten times (Multi-Baggers). But, 90% of such stocks turn out to be of utter failure investments. You can find one such company, Birla Cotsyn.

There is very limited information available on Penny stocks. Hence, thorough research is necessary before putting your money. The financial information provided by the companies also lacks credibility. For example, HDIL, which is involved in loan default and other scams, shows an exemplary balance sheet.

Companies and scammers purchase large volumes of penny stocks which result in value inflation; this attracts retail investors to follow the hype, purchase the stocks, and falling prey to it. These scammers exit the stock leaving the other investors trapped in it. This is “Pump and Dump” scenario.

The trading in such penny stocks has increased at an alarming rate in the last three months. Many new rookie investors are putting their money in these stocks. Here’s a link to Bloomberg’s article explaining the current situation. 

Falling prey to Value Traps:

Value Investing involves researching for the companies with great fundamentals and purchasing the shares at 50% of the intrinsic value. There are many formulae and calculations of intrinsic value like Ben Graham’s Number, DCF analysis, etc. 

Value Trap is a purposeful delusion created by operators, insiders, company management by manipulating the financial data and business prospects for trapping inexperienced Value Investors. The mainstream media also play their part by elevating and advertising such stocks on their channels and platform. I have already posted an article on Value Trap. 

Many new investors read some great books on Value investing like “The Intelligent Investor” and start their investing career. I did exactly this when I started investing directly in stock markets three years ago. Basically, what most of the new investors in this informational age do is, go to a website like www.screener.in and search for the fundamental parameters like Price to Earnings, Price to Book, ROCE, Debt to Equity, etc. 

When they feel that if a company has most of these fundamental ratios correct, they finalize their investment in that company. The common mistake a newbie does is investing all their capital in one or two such stocks. To be frank, we can’t find a large-cap or mid-cap with good fundamentals available at a Bargain price. If a company has good fundamentals, it would be trading at a high premium 95% of the time in Large and Mid-caps. 

Small Caps Stocks as Bait:

There is a good chance of finding such stocks at a bargain price in small-cap companies. Small-cap stocks are the least known and offer great investing opportunities. But the major concern investing in such stocks is small-cap companies with around ₹100 Crore Market Cap cannot fight against the might of large traders, operators, and insider trading. 

A stock may get battered and stay at the bottom for more than a year before finding its way back into the upward trend. For it to happen,company has to post tremendously positive results or get acquired by some large company. The investor should have the patience to wait for a long time. 

Mostly, even such opportunities in the small caps are also very rare. At most, there is a 10% possibility of finding good investments. Another 90% of the cases are where we get to see unbelievable spikes like Alok Industries recently. When the trend reverses, the stock will hit lower circuits continuously giving no chance to investors to exit. 

Remember that Stock Markets are not meant to be gambling casinos. But, that’s what happens all the time. If everyone understands how stock markets perform, there would be no one willing to do other jobs.

Note:

I provide the information and my views on the website only to educate new investors, stock market enthusiasts, and the common public on equity or stock market investments. Please consult your financial adviser before making any investments in the stock market. In case of any queries, you can contact me via email ID: shivakumar.lachapeta@valueinvesting.online.