Smart traders question everything

An important step towards becoming a smart investor is your ability to question almost everything. When you get a hot tip in the market, question its logic. When your broker gives a buy or sell call, learn to question it. When you read the latest news on a company, ask how it can impact you. Also, when you expect prices to go up and they don’t, question yourself, if you are missing out on a message from the market.

More you question, more you get

We have all heard of the proverbial herd mentality in markets. Most people tend to follow others when they find them making profits on trades. It does not matter that you do not understand anything about the stock. It also does not matter that the stock is priced at a ridiculously high P/E ratio. It also does not matter that you never made money by jumping on the bandwagon. Welcome to herds!

Back in 1999, technology was the big story. In the US Cisco was quoting at a market cap of $500 billion and in India stocks were quoting at 150 times P/E. A bunch of investors in India asked a fundamental question; if the entire world economy is slowing down, can technology being a support service, ever hope to rake in the millions? It didn’t, and those who questioned it made a fortune.

A similar situation was visible in March 2009, both in the US and in India. David Tepper, a US fund manager started accumulating banking stocks. In India banking stocks were quoting at single digit valuations. It was more an outcome of panic selling than any fundamental issue. Once again those who questioned these valuations and bought made a fortune in the market. So learn to question!

3 REASONS WHY YOU MUST POSE THE OBVIOUS QUESTION:

You don’t get swayed by chartists…

Quite often chartists advise you to buy above a certain level and sell below a certain level. A fundamental question you need to ask is, if Reliance was a good buy at Rs.1150/-, should it not be a great buy at Rs.790/-? Logical, right!

Markets have a story to tell…

This happened in the case of Kingfisher Airlines. Investors were calling it a great value buy, but markets were ignoring it. The market was giving a message that all was not well at Kingfisher. Eventually, it turned out, markets knew a lot!

A good company need not be a good buy…

This is a cardinal mistake when investors do not ask questions. For a good company to become a good investment buy, it must achieve cash flows, profits and scale. It took Infosys over 18 years to become a good buy!

“The only value of stock forecasters it to make Fortune Tellers look extremely good and elegant” – Warren Buffett

6 QUESTIONS EVERY TRADER OR INVESTOR MUST ASK…

  1. Why should I not make the best of a bargain sale? Remember good stocks are better when they are available cheap in a panic. You don’t worry about overall markets and technical levels at that point of time. Eventually stocks find their equilibrium. When you ask this question, you do not miss an opportunity.
  2. If the company is so great, why is the valuation so bad? Remember, company managements and financial statements can conceal more than they reveal. The market is always smarter than all traders put together. If the market is giving an indication, asking this question can save you the blushes.
  3. Why are institutions not buying into this stock? This is a question every investor must ask, especially if major shareholders are body corporates and individuals. Institutions are disinterested in a stock if there is a problem of entry barriers, management quality or future cash flows. It throws up insights.
  4. Why is the stock at a discount to competition? This question throws up a lot of key insights. A bank may get a P/E of 10 and another bank may get a P/E of 20. The difference is hard to explain. It could pertain to quality of assets, quality of earnings, cyclicality of business, cost of funds etc. Never miss this query.
  5. If I am making a neat profit, why should I hold on? There can be two answers to this question. You have caught the right stock at the right time. As well make the most of it. Alternatively, you have made your money and it is smart enough to exit. Either ways, asking this question making the task easier.
  6. Last but not the least, ask questions to your broker / advisor. Remember, you as an investor needs to be convinced about the logic of any investment decision. Ask for a research report. Ask for the financials. Check out what other brokers are saying. Keep a tab on any negative media reports. Then act!

HOW ASKING QUESTIONS CAN HELP YOU

Back in 2006, an investor started asking himself an interesting question. While I am surely making profits in the market, how is my broker making more by way of brokerage than me? Is it fair that he makes more money when I take the investment risk? A closer analysis revealed that the broker was making him trade and churn his holdings for the sake of brokerage. Just asking himself this simple question, saved his day.

An investor or trader need to ask a variety of questions the moment they get investment advise. Is the advise in sync with the market or contrarian, and what is the logic? What has been the historical performance of the stock being recommended? Is this the best price I can buy the stock or does it make sense to wait for a better price? What is the holding period the advisor is recommending and what is the time frame I am mentally prepared for? These questions can address a lot of issues.

TAKEAWAYS FROM THE “ASKING QUESTIONS” DEBATE…

I still remember two classic instances. At the peak of the real estate boom in 2007, real estate companies were being valued based on the value of their land bank. The basic question was that for a realty developer, what mattered was the demand for units and not the value of the land bank. When reality dawned, the entire real estate space crumbled like a pack of cards. Of course, those who asked this fundamental question, either avoided real estate or exited from these stocks at the right time.

The second case was at the height of despair in March 2009. The basic questions to ask that point of time were numerous. Can it really get worse than this? If I was rushing to buy stocks at 6000 Nifty, should not be buying at 2500 Nifty? And if the problem is of liqudity, should not an infusion of liquidity solve all these problems? Those who asked the last question, actually struck gold. Markets are up almost four-fold from those levels. And it was all about asking that simple, fundamental question!

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