Trying to understand the stock markets in India

This article is dedicated to a young friend of mine who has too optimistic a view of the stock markets and never sells when he should and then keeps wondering what happened when the markets collapse. He then walks around with a shell shocked look on his face which tells you he has missed the bus – again and again.

I have lived through three stock market boom-bust cycles starting with the Harshad Mehta days (1990-1992), followed by Ketan Parekh (1999- 2001) and the collapse which happened post January 18, 2008. The Harshad Mehta days were different from the other two because in those days physical delivery of shares was required – there was no dematerialized scrips then, you see. We used to have firm allotment of shares to NRI applicants of IPO’s so as to bring in scarce foreign currency. Those were the days when India had gone virtually bankrupt and had just about a months foreign currency reserves – in fact the Indian Government had to pledge it’s gold to finance it’s short term foreign currency obligations. That was in 1991 - the wake-up call leading to the reforms introduced by Dr. Manmohan Singh as Finance Minister that subsequently fueled the economy whose growth story reflects in the fruits we enjoy today.

For delivering shares sold one had to have a valid transfer form duly discharged – these transfer forms used to be valid for one year or the date of book closure whichever was earlier. No market operator would lodge shares for transfer unless he was a long term investor. So the shares used to do the rounds of various brokerages till the date of book closure or validity of the transfer form. On the expiry/or book closure date coming close, the brokerages would not accept delivery of the shares and would ask you to lodge the shares for transfer. All blue chip companies would effect the transfer within 30 days, but most of the fly by night operators who came to the market for easy money would take up to a year to transfer the shares. In those days, share prices used to move just on the rumor that the Big Bull was investing in XYZ scrip. ACC had crossed Rs. 10000 per share. There was a company called Ensa Steel which had crossed 450 without any fundamentals at all. These were scrips operated by Harshad Mehta who got his hands on to funds from State Bank of India by obtaining ready forward credit (basically a short term loan) which one bank used to give another with government securities as the pledge – just like a pawnbroker lends against jewelry. The borrowing banks actually sells the securities to the lending bank and buys them back at the end of the period of the loan, typically at a slightly higher price. It was this ready forward mechanism which was misused by Harshad Mehta and his group with great success to channel money from the banking system into the stock markets. This escalated in multi level marketing style with more and more money coming into the market based on non existent securities – till the balloon burst once it was exposed by Ms. Sucheta Dalal in mid 1992.

That is when the markets collapsed in a manner never seen before. I still remember, “paanwalas”, “raddiwalas”, taxi and auto drivers and vegetable vendors used to talk about investing in shares. There is a cardinal rule to follow while investing – when the hoi polloi start recommending shares to buy, the time to sell is well nigh. In all this, stocks with good fundamentals also got burnt, but the fall of such shares was not as steep as the fall of the manipulated shares. Lots of fly by night operators came with IPO’s in the range of Rs. 3-5 crores and disappeared with the money once the markets collapsed. This was the scam which raised an outcry from the public for more regulation forcing the Government to form SEBI on lines of SEC in the US. This scam forced the Government to form the NSE and forced companies to de-materialise their shares within a given time frame.

With the advent of online trading and demat shares the concept of physical delivery became history in the early nineties. A friend of mine began trading online on the NSE terminal when it started – the first day he made Rs. 60,000, second day he made in excess of Rs. 2 lacs. This was 1994, I told him, please stop, people do not make that kind of money in a year, you have done it in two days. He told, me I have got the knack of it and am confident of not losing any money. That was it – next day he came to office pretty late, I was waiting for him – he looked tense and was sweating profusely. I asked him what happened. He said he had lost Rs. 15 lacs that day. This was sometime in January that year, and subsequently during the pre budget trading , he tried to recover the loss and lost another Rs. 15 lacs and during the course of the year he lost about Rs. 70 odd lacs! Can you believe it – this was initially sheer greed which was followed by desperation and tenacity to recover the losses without understanding the market dynamics. Another cardinal rule – Never take the stock markets for granted as they can deliver a body blow when least expected.

In 1999-2001 period it was the turn of Ketan Parekh to milk the stock markets using benami people to buy and sell shares – misusing funds of Global Trust Bank and Madhavpura Mercantile Co-operative Bank to promote what were then known as the K-10 companies. He operated by ramping up the shares of the K-10 companies in collusion with the promoters. At that point in time also markets went up without keeping in step with reality. He was caught and arrested for price rigging after which the prices of these scrips crashed causing banks also to lose large sums of money. This was the second time I was witness to unwarranted euphoria with respect to the stock market. In this time period I used to buy and sell heavily, but with the grace of God, I did not lose money, in fact I made a few thousands – but the brokerage I paid must have been ten times that. After this scam I kept away from stock markets for a long time. Another cardinal rule - Never trade without having stop losses in place.

With the slight maturing of our markets and with the economy growing rapidly, the stock markets introduced futures and options and derivative trading. Now I found people who barely understood the stock markets being introduced to futures trading by marketing executives of various brokerages selling the concept by luring unwary people through greed. The usual refrain used to be “Sir, you only need to put the margin of 10% and trade in market lots - you could make ten times the money you would make through an ordinary trade”. With this line 90% of the people get sold on the concept through greed, without understanding that they could also lose ten times the money, which is what invariably happens! Who makes money? Guess? The broker of course – buy or sell he gets his commission and the marketing guy who made you a sucker gets his salary and bonus – who lost? – you!!

The Indian stock markets though “regulated” are not for ordinary investors. I would not even trust mutual funds – as they need to pay salaries and bonuses to their senior management – all that comes out of your hard earned money regardless of whether the fund is doing well or not. Who loses – again you – as the Net Asset Value (NAV) of your investment would probably be trading below your cost. The best thing to do is to set aside some portion of your savings and invest in certain blue chip “A” group companies. You can bet your bottom dollar that you will get at least a 25% annualized return on your investment over a two year horizon. In January 2008, I was telling friends that the markets would touch 8000 no one believed me – they were all talking of 30000 levels for the sensex!! If you look at the charts or the market cycles you will notice a 8 year cycle of tops and bottoms. We had hit the top based on huge FII investments through 2006 and 2007. The government and markets were ecstatic that the India growth story was solid and “India was Shining”! If you had been following the FII investment cycle you would have noticed that invariably the markets would fall in December as the FII’s had to pay dividends and redemptions to their investors! But this did not happen in 2006 and 2007 - I have a theory that hedge funds and hot money started coming into India through these funds – so everything was a “buy” order. When such huge sums come in to the markets there is nothing a lay investor can do – but to be sure of his stop loss position or be a long term investor. The funds manipulate and move the markets in whichever direction they want – fancy derivative products are introduced which I doubt even if the fund managers understand! The best thing to do - exit the market and sit on the cash – because in such a scenario CASH IS ALWAYS KING!

Suggestions for investing:
1. Never listen to “tips” – they invariably come from people who want to sell their shares to you;
2. If you trade short term – always have a “stop loss” in place;
3. If you are confident of a scrip – always buy/sell at “market” price and don’t set a limit;
4. Do not get greedy – if you get your desired profit – please exit – investment opportunities keep coming;
5. Money in the bank is much better than paper profits – invariably when your investment is climbing you keep tabulating your profits – and when the market goes the other way you keep telling your self “I did not sell at that price” so why should I sell now and end up a loser as the price goes below your cost. Now the rationalization is - why should I sell at a loss?
6. Invest long term by studying the industry, the company and the management profile – you will not lose money.
7. Never trade in the FNO segment or in derivatives, unless you have a thorough understanding of the products.