How to benefit from the top and bottom in the markets?

 Now-a –days all of us are calculating in our mind how much we would have earned if we had sold some of our holdings in January 2009 (Sensex at 21000) and bought some good quality undervalued stocks in March 2009 (Sensex at 8000).

The questions is how we could have identified before the markets fell that markets are near their peak and sold at least a part of our portfolio to lock in some profits and keep cash in handy for buying after the fall. 

Indicators of a top in markets are: 

• Everyday people are present either in broker’s office or in front of the trading terminals at exactly 10:00 AM. 
• We look at our portfolios at least 3-5 times a day and calculate each time how much we have earned that day. 
• Everyday many unknown penny stocks hit upper circuit of 10% or 20% making new 52 week high. 
• There is no effect of any bad news on a particular company, sector or market as applicable.
• Suddenly you find analysts recommending stocks which you have never heard of. 
• You go to a party /social gathering and you find everybody discussing about stocks most of the time. 
• People generally shy of equities and no knowledge of equity markets like gardeners or drivers start investing aggressively. 
• When you tell somebody that you made a profit of 20- 30 % in equities this year and people feel sorry for you as they expect returns to be at least 70—80% . 
• Companies which are loss–making and out of business start to rise unexpectedly. 
• Analysts dump the traditional valuation methods and find new ones to justify the rise of markets (Example china trading at higher valuation then India so markets should go up or value of land assets should be included in the price etc.). 
• Suddenly you find number of shares being traded on exchanges dramatically increasing (It actually happened in October-December 2007 quarter when this figure went up from 1000 to 2500). 
• You have 40-50 stocks in your portfolio and still feel that you should buy few more. 
• You are not happy with the stock exchanges for putting an upper circuit filter of 5%, 10% or 20% each day on the individual stocks. 

Indicators of a bottom in stock markets are: 

• People do not want to have a look at their portfolios at all for many days. 
• Everyday many unknown penny stocks hit lower circuit of 10% or 20% making new 52 week low. 
• There is no effect of any good news on a particular company, sector or market as applicable. 
• Suddenly you find analysts recommending people to stick with blue chips only. 
• You go to a party /social gathering and you find everybody discussing why people should stay away from stock markets. 
• Suddenly you find number of shares being traded on exchanges dramatically decreasing. 

Learning of the week: 

While it is impossible to exactly identify the top and bottom of the markets we can have a sense that we are near the top by using above signs as indicator and have some cash (5-20% recommended) in our portfolio. Similarly we can start buying good quality undervalued stocks when we find markets are near their bottom.

Common mistakes we make in stock markets as newcomers

• We think that we can become millionaires in a few months. 
• We limit our profits but do not limit the losses. 
• We take many days and do detailed analysis of all the options available to buy a fridge or TV of  Rs 10-20,000 but take only few seconds to decide about buying stocks worth lakhs based on a tip/rumour. 
• We buy a stock just because it has fallen 50-60% from its peak.
• We think we can buy stocks in the morning & sell in the evening thus making profits without making any investment (possible but not as easy as it sounds!). 
• When the market goes down, we sell our ‘winners’ thinking that we can buy them at lower price later. 
• We do not sell the ‘losers’ thinking that sooner or later they will recover. 
• We sell a stock but when it goes up 10% or 20% then buy it again thinking that it will go higher. 
• We buy stocks which have gone up 100 times in last few years thinking that it can never go down. 
• We see/hear a big news about a company in the morning and are ready to buy at whatever price we get even if the news is already factored in the price for last few days. 
• We think that futures & options is the shortest way to becoming a millionaire. 
• We sell a good stock in our portfolio just because it has not appreciated as much as the stock in our friend’s portfolio and buy that stock ourselves. 
• We sell a great stock just because 1 quarter earnings are not good. 
• We buy a stock because an analyst recommended it on TV and sell it in next few days because another analyst said so. 
• We try to minimize our tax liability first before maximizing profits. 
• We take all the credit ourselves when the stocks in our portfolio rise but blame the government, stock exchanges, SEBI and all the big players in the market when they are down.  
• We average out stocks after they go down a little thinking that we have made a profit or we average out our bad investments after they have fallen a lot thinking that we will at least recover our initial investment.(We should average out only good investments when they have fallen at least 30-40% and we are sure that future is bright) 

Learning of the week: 

There are no mistakes made only lessons learnt in life as well as stock markets. But we have an option of learning from other’s mistakes. 

Articles of the week (Please copy and paste the URL in browser): 

• Tips for small investors to ease their nightmares 

http://indiainfoline.com/news/innernews.asp?storyId=62008&lmn=1 

• Seven things to remember in bear run 

http://economictimes.indiatimes.com/Market_Analysis/Seven_things_to_remember_in_bear_run/articleshow/2883025.cms

What will financial analysts never tell you?

• An analyst will never tell you that markets can go down during bullish times and that markets can go up during bearish time.

• A share market analyst will never tell you when he sold the stock he recommended to buy recently on TV/Newspaper.

•  An insurance agent will never tell you to buy term insurance instead of Unit Linked Insurance Plan’s.

•  A MF agent will never tell you to go for an existing fund instead of new fund offer(NFO)

•  An IT officer will never tell you about opening a HUF account to save tax.

• Your broker will never tell you to go for long term investments of 3-5 years.

•  A loan officer will never tell you not to take more then 1-2 loans.

Morale of the story is that you should not take investment advice from a
person who may directly/indirectly benefit from that decision.

How Indian budget 2008-09 affects us and our financial planning?

• It means less taxes for everybody as the income tax exemption limit has been increased. It is even better for those people who have now moved to a lower tax slab e.g from 30% to 20% tax slab

• All of us should plan to open an account for non-earning female members of the family to take advantage of the Rs 1.8 lakh expemption limit for women.

• Short term capital gains tax increased from 10% to 15% – this should act as an incentive for long term investing rather then short term trading.

• Service tax of 12% on entire investment amount of ULIP rather then only the risk premium. This should encourage us to go for term insurance rather then ULIP.

• Reduction of duties on small cars will surely help people to move from owning two-wheelers to small cars faster.

• Raising of Medical Insurance tax benefit limit to Rs 15000 in case we include our parents should motivate us to get insurance cover for our parents.

Overall the budget is good as FM has tried to boost the growth by giving more money in the hands of people ( Less taxes spur people to spend more on TV,AC,FMCG goods etc. ) while keeping inflation in check(reducing duties on several items etc.)

Whether giving farm loan waiver is good or bad is debatable. Some benefits are :

• Perhaps less suicides by farmers as seen is the past.
• More borrowing power to farmers for the next crop leading to better grain output.
• More consumption of goods in rural sector
• Clearing of bad loans from the books of banks ( mainly public sector banks like SBI )

Potential negatives are reluctance of borrowers to repay loans next time thinking that another FM will waive off their loans again. 

How much to invest in equities?

• First priority should be to have adequate life and health insurance for the entire family. Planning for unfavourable time should precede planning for favourable time. An umbrella health cover of 3-5 lakh for the family and life insurance cover of 10-20 times annual salary for every earning member should be sufficient in most of the cases.
• Second priority should be to build a house for the next generation. It is the best asset we can give to them because as the population grows, good housing in good locations will become more and more expensive with time. For this purpose 20% to 40% of the income can be allocated. 
• We need to keep aside cash requirements to meet general expenses and fulfil commitments like marriage, higher education, loans repayment etc. for next six months/one year in short term bank deposits/liquid assets. This is based on individual needs and cannot be generalized. 
• Around 10% of earnings should be for retirement planning so that you can live with pride and respect in old age. It can be invested in PPF, pension funds, NSC, KVP etc. (safe returns). Fortunately for salaried people this is taken care of by the PF component of the salary to a great extent. 
• After fulfilling all of the above, we can think of investing 10% to 30% of our net worth (Assets – Liabilities) in equities. The lower limit ensures that we benefit from the high returns offered by equities while upper limit ensures that we are not broke financially in adverse conditions. People who are more experienced and can withstand the shocks can go for higher exposure. 

The above guidelines are general and can be customized for an individual based on his needs, age, risk taking abilities, family commitments etc.