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| Edited By: G Chokkalingam |Source: DNA |Updated: Mar 19, 2018, 05:37 AM IST
The "Law of Demand" in economics provides a time-tested proposition that "lower the prices higher the demand" for normal products. However, it is difficult to understand the need for dichotomy in application of this "Law" in the equity markets. In practice, higher the stock prices, higher the demand (reflected in delivery volumes, not from trading volume alone) for the stocks!
When CEAT traded around Rs 100, the trading volume used to be in the range of 35,000 to 80,000 shares a day on the NSE. However, after the stock price rose 10-fold, the volume also increased manifold, touching as high as 29 lakh per day! It is not only the absolute price, but the valuation multiple (PE) also expanded manifold during the same period.
Similar is the case with JK Tyre – daily trading volume used to be around 10,000 to 20,000 per day on NSE when the stock was trading around Rs 122. When the same stock price crossed Rs 400, the trading volume remained at more than 1 lakh shares per day - on many days, it crossed a million shares!
In the process, its PE multiple also expanded from about 3 to 9! The violation of "Law of Demand" is not observed only in the case of tyre stocks – it is evident in almost 90% of the small and mid-cap stocks, which successfully expanded their market-cap over the years.
Of course, it is true that this anomaly is partly explained by the fact that the traders usually get in when the stock prices are high and hence trading volumes move up substantially. But it is also equally true that more than 90% of the investors exit these stocks much before they play out in a big (successful) way in the markets. Many of them get excited to re-enter (transform themselves as traders from investors?) after these stocks jump manifold – proving themselves a perfect contra on the "Law of Demand".
Interestingly there is one section of investors (?) which religiously follow the "Law of demand" – when stock prices slip below their face values and trade at low single digit (around 1 or 2 rupees with face value of Rs 10 or trade around 10 or 20 paise with face value of Re 1), their appetite (demand) increases manifold.
But history proves that almost all stocks, which had seen eventual "death" on the secondary markets have gone through this journey – slipping below face values substantially to a level below which the market prices wouldn't justify their transactions costs! There are numerous examples in the past – Alsa Marine fell from Rs 300 to Rs 4.70, at which price generated a lot of trading volumes, but the stock finally got exited at 35 paise in 2002.
In this bull market also, there are many more such stocks waiting to get exited from the secondary markets. Those investors who follow the "Law of Demand" in relative prices (price to earnings) while other parameters of fundamentals (balance sheet, business prospects, etc) remaining in comfort zone are the ones who create wealth in the medium to long term. Others who ignore this "Law" or apply in wrong context are the ones, who miss the opportunity to create or destroy the wealth.
