Knowing The Market

INVESTING SCENTS

Clearing the air on what the stock exchange is all about

PEOPLE plough their hard earned money into the stock market. If you get a good bonus, you may put a large chunk of that into the stock market.

If you strike gold with 4-D, you may also end up doing the same (investing a large sum of that in equities). When you retire, your EPF savings may be poured into the stock market.

So, if we are doing all of the above, it should at least make sense to know why the stock market is there in the first place.

If you fail to understand why we have stock markets, then your expectations might not be met. It's like a bad marriage. If your expectations are airy-fairy, nothing good will come from it.

There are only two main reasons why stock markets are there:

a) To tap capital – it allows companies to tap capital to fund future growth.

b) It enables the public to participate in that growth – in exchange for the capital, investors become shareholders, and will be able to be part of the company's fortunes (good or bad).

Anything else would be incidental, indirect and not guaranteed.

However, we all know that investors regard the stock market as something much more than that. Let's look at the unrealistic expectations, myths and realities surrounding the stock market:

a) Can make you rich – The stock market does NOT owe anyone a living. It may make you rich, it will probably make you very poor as well. It has no loyalty.

b) Prices have no memory – Stocks do not care how much you have studied a stock, or whether you have an MBA or not.

It does not care what price you bought at and couldn't care less what price you sell at. The stock does not know that you love it.

Your undying perseverance will never be acknowledged or taken into account.

c) Zero sum game – For you to win at stock market investing, somebody else has to lose. It's never a case of everybody winning.

If the KLCI rises from 1200 to 1500 in two weeks, and you bought at 1200 – your gains were at the expense of the “opportunity cost” of the seller who sold to you at 1200. This is a casino, but it has no banker. All cannot win at the same time and break the bank.

d) Paper gains – The ones who stand the best chance to make supernormal profits are the company owners. Grow a company then list it and you get an immediate leveraged valuation of the on going earnings of your company. Hence for investors to better the odds of making money from the stock market – go start a company.

e) Knowledge – The more you know and learn from books and other people's experiences, the better the odds of being better than the next person to make money.

Since this is a zero-sum game, you have to be better than 50% of the investing population to make money.

f) Size matters – Fund managers can move prices by the sheer size of their orders. Thankfully, they are also not difficult to beat.

Short term, their size will move prices in favour of whether they are selling or buying, but that aberration will sort itself out eventually.

g) Forecasting models – Stock markets are forecasting models, they try to make sense not of the present but what things will be 16-20 months down the road. Hence to get an edge on the market, would be to try and anticipate better and anticipate earlier what's down the road.

h) Behavioural science – Since it's a zero-sum game, to be able to read investors' likely moves will also gain you an edge. The most raw form guiding investors behaviour are fear and greed. These two emotions will cause people to act irrationally. To be able to impute and estimate how much of the stock price is due to irrational behaviour will help us anticipate and read markets better.

i) Technicals – They are pattern readers and pattern seekers. The basis for the emergence of these patterns is that investors never learn and always behave in the same manner giving similar investing situations. Hence technicals are useful because of that.

j) Analysts – They are well paid people who usually have never run any business in their lives. Learn to sift out the better ones from the run of the mill. Most analysts have a hidden fear – the fear that people will discover that they are really pretty average at best.

At the end of the day, the stock market will always be there. We are the ones who might not.

p/s photo: Vicky Zhao Wei