Weighty trading rules

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Siva Nara
Priya Raghavan

"Barring Sumo wrestlers, I think everyone is concerned about weight loss." On this light note Adam began his weekly weight loss group meeting.

Sheri quipped, "Here is a solution: Invest in the stock market. When you see your money going down, you lose weight."

A frail 60-year-old lady, Anna, who didn't quite belong there, said: "Actually, there are three great ways to invest in the stock market. One is to follow fundamental analysis and the second is to follow technical analysis. The third approach is acquiring knowledge about a particular industry or understanding a particular company's products."

Someone remarked, "No offence, ma'am but this is like saying, eat right and exercise. Easier said than done!"

"Let me explain," began Anna. "Fundamental analysis, which is being used by mutual funds, is considered the best approach. It involves looking into a company's facts and figures to find the actual worth of the company.

"For example, a fundamental investor would invest in Microsoft (MSFT) over Apple (AAPL), because Microsoft has better operating margins and lower P/E ratio compared to Apple.

"He would believe that Microsoft would be providing better returns in the coming years even though the stock didn't move up much in the last five years."

Sheri interrupted, "I guess a fundamental investor has to be very patient while both buying and selling, just as a person trying to lose weight must be patient."

"Yes," said Anna. "A fundamental investor wouldn't buy DELL at $35. If DELL drops below $20 as the P/E ratio would be around 12, then a fundamental investor would invest and wait for the market to realise that the opportunity with DELL is abundant. It may take months or even years for DELL to appreciate and that is what makes a fundamental investor succeed in all market conditions.

"Another classic example is Garmin, the manufacturer of GPS devices installed in vehicles. When the company was fundamentally strong a year ago, a fundamental investor would have invested when the price of the stock was around $40. Today, the price of the same stock is around $94 and that is a 100 per cent growth in a year's time.

"A fundamental investor invests in companies that have strong balance sheets and are available when the actual share price is less than what the company's worth. After waiting for years, the stock market would let the price go up and the fundamental investor would be partying."

Adam said, "I thought we were going to talk about body mass indexes, but we are headed in the direction of financial indexes."

He got a laugh and Anna continued, "A technical investor doesn't believe in `buy and hold' approach. He doesn't believe in buying low and selling high. He believes in buying high and selling higher. He finds a stock that keeps going high and believes that it'll still go higher.

"He doesn't hold the stock for a long term; only until his profit potential has been reached or when the stock doesn't perform as per his expectations."

"The third type of investing is not discussed much but is both a powerful and profitable method of investing. It is to learn about an industry very well and follow the stocks in the industry. To start, what is the first drink you avoid when you want to lose weight?"

"Coke." The answer came in unison

"Yes,"Anna smiled. "In fact, when the stock market crashed during 2001, the entire investment community not only avoided technology but also beverages. Consumers preferred natural drinks.

"A keen observer of this trend would have picked up Hansen Natural (HANS). An investment of a mere $10,000 in 2001 would be worth much more than millions today and that is a whopping 11,000 per cent returns in five years. However, any knowledgeable investor who had been observing the taste of consumers would have quickly learnt about Hansen.

"You can choose your style of investments that works the best for you."

Sheri remarked wryly, "In the stock market, unlike weight loss, losses happen much faster than profits."

Anna replied, "True. As a first rule of investing, in order to make more profits, your losses must be minimal. Say, you had bought DELL at $45 and if you had waited for it to bounce back, then the mistake is yours, not the market's.

"As an investor, you should determine your maximum loss percentage tolerance. For some, it would be 7 per cent and for others, it would be 10 per cent. If you had to cut your losses of DELL at 10 per cent, then you would be better off today, as the stock has gone below $25 which is a loss of 46 per cent. It would really take a very long time for DELL to go much higher than $45. If, as a smart investor, you had sold the stock at $41, you can always buy back the stock now at $25 and when it goes to $50 in a year's time, you would enjoy 100 per cent profits than just 10 per cent profits."

Adam quipped, "I am not sure if I can cut back on fatty foods. I am certainly going to cut down my losses."

"Oh you need to cut down both," Anna declared. "The second rule is when you are a buying a stock, it is very important that the sector is generally liked by the institutions. For example, Fed-Ex (FDX) is a great company that delivers not only products on time but also delivers good results during its quarterly shareholders' meetings. However, if the investment community doesn't like transportation sector, then the stock price of Fed-Ex has limited potential to go higher."

"Anna," Sheri asked. "There is no grand unified theory for weight loss there is a no-carb diet, lot-of-carb diet, high protein diet. Is there one for investing?"

Anna laughed, "You want a gastric bypass solution. Let me tell you the third important rule. Identify if the market is a bull market or bear market. The simple method to do so is if the action persists for at least a few days. On a bull market, the major indexes and the price of exchange-traded funds would be going higher on a strong volume. On a bear market, the major indexes go down almost on a daily basis on a strong volume. Neither the media nor pundits can define if the market is bearish or bullish but the prices and the volumes speak for themselves.

"In a bear market, even a small bad news would cripple the market; in a bull market, any positive news would make the market go to a new high.

"An investor can choose bank deposits during bear markets and should wait for the right opportunity to enter the stock market which will eventually turn bullish."

Adam asked the question that was on everyone's mind: "Anna, I am curious why you chose to attend this meeting."

"Oh!" Anna responded. "I wanted to tell you all how the once-obese woman lost weight. Run everyday like a bull, as if a bear was chasing you."

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(This article was published in the Business Line print edition dated June 12, 2006)
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