Are stocks worth investing in

For anyone who has looked at the stock market during the last 1 to 1 1/2 years has probably turned aghast at the extent to which stock prices have fallen. Between Jan 08 and Oct 08 the BSE index has fallen by about 64% i.e. fallen to about 1/3rd of its peak value. Many high profile so called popular stocks have been reduced to as much as 1/10th to 1/20th of their peak value. For anyone who had put in money around this time it probably has been a shattering experience and the wealth so lost might not be recoverable easily. This therefore raises a very fundamental question . Is it worthwhile to invest in stocks or are stocks suitable only for gamblers. An important question at this point could equally be how many people asked this same very question at the peak of the bull market and exited the market. If they did, then they would be, like the proverb, laughing all the way to bank.

Lets face the facts . Stock markets are not gambling dens. Stock exchanges, where stocks are traded, are public institutions where millions of people engage in buying and selling of stocks and are regulated by government. As regards other avenues of investment i.e. the traditional real estate and gold etc, well real estate also had its share of fall too. There is a property glut at present as evident from large number of unsold properties and discounts of whopping 30-40 % . Besides property has with it an attendant maintenance expenditure as also the stamp duty etc. which basically boils down to reduced return on investment. Then, not long ago, we were grumbling on measly returns on FDs . Gold did not appreciate for a considerable period . Whereas anyone who has been able to catch the bull market which started in 2003 and remained invested has succeeded in making handsome gains in spite of the downturn. It therefore appears that stocks cannot be ignored for getting above normal returns. The question can then be, if stocks cannot be ignored, do people have to loose money buying stocks.

Not if we understand how the stock market behaves. Following should explain very briefly.

Stock prices continually change, in that it keeps going up and down. Our nature is such that we always want to wait for prices to go up still further before we sell and vice versa i.e. we go on postponing the buying decision expecting prices to fall further. But this never happens in reality however much we want. And at some point the trend reverses itself and in most situations leaving no time for people to grasp what happened. And before long, gains are wiped out and losses mount. This is the greed and fear factor. All of us are prone to it. He who has conquered it is already on way to profits. Whether profits will be made depends on a few other aspects.

One is, to get an indication of whether a top or bottom is close by , for it may never be possible to catch the exact top or bottom. It is best to keep an eye on previous year high. If the prices have reached a level where it has greatly exceeded previous years high, it is time to sell. And we shouldn’t bother if prices still go up further for it will invariably come down but profits will have been captured. Look out for the frenzy in buying where people start buying all sorts of junk stocks whose prices reach abnormal levels and IPOs start flooding the market . By all means sell at these times. Getting a clue on whether a bottom is at hand is more difficult and a little risky too. While in the case of a bull market one will have made lesser profit but in the case of a bear market one stands to loose if the buying decision goes wrong and prices correct further. However few generalistions appear to work . Look out for the absolute apathy where people just don’t like stocks. The market is dull and listless and doesn’t react to any kind of news. A large number of good quality stocks record new 52 week lows . In both the extremes markets gets detached from realities of economic fundamentals and represents an aberration . This signals an imminent trend reversal.

The above illustrates when major tops and bottoms are formed in long term bull and bear cycles. A long term investment strategy focused on these cycles is more likely to generate extraordinary returns when compared to short term strategy.

Happy investing