The way goose is cooked on stock market

Understanding the scepticism to could have/would have to boom to bust cycle.

MUMBAI: The markets never fail to confound the retail players. The retail segment is always the hardest hit as the loss-bearing capacity of the retail player is limited, whereas this segment invariably leverages itself manifold. Retail players are also the last to react, both ways. Here's an attempt to recount how the cookie is baked and then how it crumbles:

The first step: scepticism

In the initial stages of the uptrend (especially after a prolonged bear phase as in May 2003), the retail segment watches the upticks with an air of disbelief. The refrain is, this will not last, prices will come down again! The retail segment views the market with disdain and goes about his life in a "detached from the market" manner. The only umbilical chord which links the retail investor with the market is the morning newspaper. As the indices rally, the level of curiosity rallies too, but monetary participation is invariably a few weeks / months away. This phase is marked by rising volumes but not the fireworks that are witnessed in a strong bull market. The rising volumes maybe accompanied by a few small / midcap scrips hitting upper circuits.

Step 2 - Would have / Could have

This is actually the phase when the retail investor is actually roped in the markets. There is talk of how much wealth has been created in the recent months and how much has a notional investment multiplied into. At this juncture, the retail investor is forced to think how much he could have / would have made had he taken the plunge with the savvy players.

Mutual funds would have started advertising their NAV's and door-to-door calls are resorted to rope in the retail segment. Brokerages are prominently advertising their services and some savvy media planners also show clips of satisfied investors swimming / playing golf during working hours, exuding an air of wealth accumulating from the booming markets.

The retail goose is almost ready for the plunge. The favourite TV programme is not the family soap opera but the business news hour, the morning papers, especially pink papers get increasing attention.

This stage is marked by stronger volumes and midcap scrips that are flying higher than the large caps. This is a clear sign of operator interest in the markets as stocks with low floating stocks, concept and theme stocks are targeted by these operators. Complex and "new age" reasons are advocated for bullishness in these scrips.

Step 3 - Boom, boom, boom

This step is the most glorious in the market. Also the most heady and quite often the most volatile. The retail investors are rushing to their friendly neighborhood brokers and writing cheques to buy their share of glory under the sun. The old hands in the investment game know only too well that these pennies contributed by the retail segment add to pounds and these pounds propel the indices higher.

The retail segment, largely solid middle class investors with conservative attitudes are now overwhelmed by a rush of adrenalin and begin to splurge money as the profits start to trickle in. Expensive clothes, electronics and even holidays. Life couldn't be kinder. Somewhere in the subconscious mind is a nagging doubt that the gravy train may not chug comfortably forever. However, these doubts are laid to rest as the short lived corrections are overcome by the gutsy bulls. The retail segment is convinced that the bull market is underway. A life of their dreams is just a few months away as the retail player starts the deadly process of "linear extrapolation". Linear extrapolation is a process of making forward-looking projections based on past performances. For example, the recent heady gains made by the indices. 1000 points in 29 days, 1000 points in n number of weeks, if this rate of gain continues, the sensex will be at "x" by year end. This phase is marked by high volatility and even higher volumes. Remarkably, higher volumes and volatility fails to witness a rising top and bottom formation — clear signs of fatigue. The bulls are appearing tired and selling is unrelenting at higher levels. This is a sure sign of distribution by the "smart money" as weaker hands are only too happy to buy.

Step 4 - Would have / Could have / Should have

Every investor with even Rs 1,000 exposure to the investment game should acquaint himself with the pitfalls involved - before writing that cheque ! I never tire of recommending a book titled "trend watching" by the world famous CNBC (US) anchor Ron Insana. He has provided excellent insights into the complex business of stock markets. He is a strong skeptic when it comes to the cliché - "this time it is different". He says, it is never different. The more things appear different, the more they remain the same. The retail player is complacent just when he should be on high alert.

The slide normally starts like a routine correction and just as in the past, the retail segment takes it to be a regular dip that will rectify itself in due course. Only this time it's different, on the downside. The slide starts with thin volumes but with large falls, the exit routes are invariably blocked by circuit filters, akin to a movie hall on fire. There is a stampede to rush out as the players want out. Unfortunately, there are few takers for their shares. Ironically, this phase is also marked with disbelief as the rapidity of the fall numbs the retail investor. The retail investor invariably begins his journey with skepticism and ends it with skepticism all over again. The retail players have only memories of what would have / should have / could have been, if only the ending was different.

The author is a Mumbai based investment consultant and invites feedback at vijay@BSPLindia.com or 022 23438482 / 23400345.

Mandatory disclosure - The author has open positions in stocks and commodities across various exchanges.