Spend, Save and Invest Smartly

Why does an Investor Put his Money in the Stock Market

Why does an investor put his money in the stock market? The answer would be to earn higher returns. Ask him if he is sure that he is going to earn money that he intends, we don’t think that there will be a confident answer from his side. This has been the story ever since the trading has started. There has been a continuous battle between the investors and the stock markets if you consider the history of stock market there have been some wins which have gone in favor of stock market and some in favor of investors. The investor, from the moment he invests tries to outperform the market, the billion dollar question is “Is it possible…..???”, but it cannot be said that it’s just impossible to outperform the market because there are some examples such as Warren Buffet. The behavioral finance has proved that the tendency of investors is "to Buy the Stocks at Lower Price and Sell them at Higher Price". How do they do that, it depends on the perception and analysis of various events that are happening around the world. It is mandatory to consider the events that are taking place around the world because Indian market is open to foreign investments and if anything (only concerned to financial system) happens in that country then it will have an effect on behavior of stock prices. One of the examples that can be given is the subprime crisis. The stock markets in America fell because there was a crisis and it had a huge impact on Indian stock market and we all know and experienced the worst period of our life.

Random walk

Have you ever heard someone saying that price of company ‘X’ will definitely be Rs. ‘A’ after a week or after a month or after a year…..? We don’t think you would have come across anyone. You might have heard that stocks may be of price M or N. why is this so? It’s mainly because of a theory called as random walk theory, which many believe does not exist but are continuously trying to get some findings to back up their belief. The stock markets have been behaving in all ways. One person is right at least one time that’s the reason why there are so many people trying to figure out what’s the exact pattern that stock markets follow. It’s said that if a person understands two words SUPPLY and DEMAND then he can play with the market, but till today no one has been able to do that. That’s why you must have seen people who have earned thousands by losing lakhs together in the markets. The random walk proposes that the prices of stock markets does not follow any trend, but move in random. It says that prices of stock moves like a drunkard walking. If you have seen a drunkard walking on road then you will definitely realize what this theory is proposing and sometimes it’s true too.

For example let’s have a look at the share prices of a company

Day Open price (Rs) Close price (Rs) % change in opening price %change in closing price
1 2331 2319.65
2 2320 2333.4 -0.47 0.59
3 2345 2340.3 1.07 0.29
4 2409 2354.6 2.7 0.61

Here you can see that the prices have been increasing but the percentage increase is random. This is just an example; there are many instances which have shown very random results even though we have many of the analysis techniques such as fundamental analysis and technical analysis. This theory implies that all the techniques that we use to find the future prices of stocks are useless because the prices move randomly.

Types of Information

The information which plays a crucial role in the stock behavior is of three types ;
• Historical data
• Public data
• Private information
Historical data: This refers to the past prices, volume of the stocks Public data: The data which is accessible to the public Private information: Information which is available or accessible to the key people in an organization.

Depending on the above three types of information market has been divided into three based on their efficiency.
• Strong form
• Semi-strong form
• Weak form

Strong form

It says that all the information historical (prices, volume), public, private information has been absorbed by market and the present price is derived from that. Analysis (fundamental and technical) is not applicable.

Semi-strong form

According to this the stock market prices adjust quickly to the information available. It’s not possible to earn superior earnings using the publicly available information unless you have access to some inside or confidential information.

Weak form

According to this the market price has considered all the past price and volume data and it’s not possible to get superior returns just by keeping in mind the variations that had taken place in the past.

Indian stock market has been acting weak and semi-strong. So it is important for the investors to bear in mind the market characteristics when the efficiency of the market changes. Now the question arises when should you apply analysis techniques (technical and fundamental) or should you go ahead with the random walk theory and invest in stock market.

Tips for investors

  • It is said that for a piece of news the market over reacts in the short term and under react in the long term. So an investor must capitalize on this and must make the right decision of buying or selling. Usually what happens is investors panic when market over reacts to some bad news and prices fall looking at this investors sell their shares only to realize losses. On the other hand an intelligent investor who knows about the efficiency of markets picks up stocks of good companies and makes profit once the market recovers.
  • The stock markets in India are very much susceptible to changes on the news that’s occurring. For example the budget announcements, dividend announcements, mergers and acquisitions, fiscal policy, monetary policy etc.
  • An investor can capitalize on the opportunities wherein if he can use his analytical skills about the economy. For example investors who knew that there would a direct impact on Indian stock markets due to slump in American markets would have sold their shares before there was a slump in market to be on safer side and many of them would have purchased number of shares when the market had hit the bottom because they know that market will recover and they can make some money by selling those shares then.
  • An investor cannot keep quiet because he has a broker to look after his investments. An investor must keep his eyes and ears open to news updates and try to foresee its impact on the investors’ psychology.
  • There have been many anomalies and the investor must try to capitalize on that.
  • Do not try to make quick money by using the publicly available information. It’s because the information on which you are banking will be available to all and it’s a belief that the market will have adjusted itself to that information.
  • Indian stock markets are reactive to the news. So if you are a speculator or an intraday trader then make sure that you capitalize on the information very quickly or even before the stock market absorb the news.
  • There are some stocks whose prices move in trends. The changes in markets do not have a great impact on the prices. So if you are looking to make bucks taking advantage of changes in these stocks, then better think once again.
  • Make sure to pick the stocks of the same company when the prices fall or of those companies which come in the same industry. It’s seen that the stock prices of the companies which are in same industry are also affected.
  • If you are trying to make some money by doing arbitrage then be careful because recent studies have shown that many stock markets move in unison so just make sure that your decision is right.
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