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01 June 2014

Why Mrs.Preethi Malhotra will not make money in Stock Market?

Mrs.Preeti Malhotra (PM in Short) is my neighbour in my apartment complex. What with my work taking me away from home early in the morn and dropping me back close to naptime, I hardly get to meet my neighbors. However, the news has gone around that I know a bit about investing and is enthusiastic about giving free advice.
So I have somehow become the neighborhood investment consultant.
I hardly get to meet PM. The other day, I met her in the market.
"Hello Ram, good to see you here", says PM, "I was planning to meet you. Needed some advice on investment. I have about 3 Lakhs (300,000) to invest. I was wondering where I can invest.. What are my options?"
"Why don't you invest in Stock Market?", I ask an innocent question.
"Baap re baap, no, no. no...I don't want to invest in Stock Market. Last time I invested, I lost some money. I invested in a stock of Wipro at 700 and soon after it came down to 500. I sold it off and cut my losses", came the emphatic reply.
('Baap re baap' is the ultimate emotional statement of dislike for an Indian Lady. It loosely translate to 'Oh My God', and is normally followed by a negative statement.)
"But now the price of Wipro is 1500", I pointed out.
"Yes, but I lost money no?" came the irrefutable statement. Who can argue with that?
"Let me ask you something. What are you going to buy in this market?", I enquired, pointing around.
"I came to buy some vegetables-you know tomatoes, onions and other vegetables", she responded.
"How much do you think is the fair value of a Kilo of Tomato?" I asked.
"I don't know, may be around 20 bucks", she replied
"What if you find that the price is 10 bucks per Kilo? ", I asked
"Then I will buy 2 or 3 Kilos. It is difficult to get good tomatoes even at 20 rupees. So 10 bucks per kilo will be a flea market bargain", she responded
"What if the price is 50 rupees per Kilo?"
"Then I will cut down on tomatoes. May be buy a quarter Kilo", said PM.
"Now let us look at Stocks. What do you think is the fair price of the stock of ABC Company?" I asked.
"Considering their last quarter earning and the earning potential, I think 200 rupees is a fair value for the Stock,", PM replied.
"Suppose today you open the paper and see that the stock price of ABC Company is Rs 100, will you buy the share?"
"Of course not", PM replied, "I don't know why the price fell. May be there are some bad news about the fortunes of the company that is floating around that is bringing down the stock price. I will wait for the price to turnaround."
"Assume that it has bounced back from 100 to 200 (your fair value), will you buy now?" I queried.
"No, I won't. I think that I should have purchased it at 100, I feel that all the profit potential has been factored in. I will wait for it to come back to 100". She replied.
"What if it didn't come to 100? Instead it went up to 500, will you buy?" I persisted.
"I think I will take an interest in it. When it has come from 100 to 500, there should be some news about it that I don't know of. I will buy it. Definitely", PM responded
"And you will sell if, after you purchase, the price come down to say 400. This is what you did with Wipro." I pointed out.
"True, I will assume that I made a mistake and get out of the stock", she was categorical.
You see, right there, you have the reason why Mrs.Preeti Malhotra will not make money in stock market. When she buys a food item like Tomato, she has a fair value in mind and if the price is less than the fair value she will buy more of the same and if the price is high she will buy less. This is the typical Demand Curve.
The demand curve based transactions have been tested and perfected over 5000 years. It is the most effective way to buy anything.
Except, for some people, when it comes to buying stocks.
When the price falls lower than the fair value, they get afraid and do not buy the stock. Or they buy less. And when the price have gone through the roof, when everyone and their mother in law has made money in Stock Market, people like Mrs.Preeti Malhotra become greedy and will venture into the world of stock market.
It is the cycle of fear - greed - fear.
Smart people in the market are waiting for people like her to enter the market. Her entry into the stock market is a cue for them to exit the market. Their exit leads to market downfall, bringing down the price of PM's shares as well.
So PM lose her money in the stock market. This reinforces her perception that she is not good at investing in stock market.
Let us summarize our purchase experience of buying Tomatoes vs buying Stocks.
In case of Tomatoes, if the market price is less than fair price, buy more.
In case of stocks, if the market price is less than fair price, wonder what you are missing, become skeptical and fearful and stay out of market. After all who can tell when a crash is impending?
In case of Tomatoes, if the market price is higher than fair price, buy less.
In case of Stocks, if the market price is higher than fair price, wait for it to correct. However if the price still keeps going up, become greedy and buy at a high price.
And when the price falls soon after you buy the stock, sell it and book a loss. And congratulate yourself on having got out of market with minimal losses. Vow to never invest in stock market again. Become an 'Anti Stock Market Propagandist'.  After all you are the living proof that investment in stock market is a gamble and that the game is rigged and that you can't win the game.
What about people who made money? 
They must have rigged the market. Or have insider information. Or they may be just lucky.
"So PM, where are you going to invest your three lakhs?" I asked.
"I think I will invest in some Bank Fixed Deposit", replied the lady.
There is no way Mrs.Preeti Malhotra will make money in stock market !!.

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