Five common Equity Investment Myths you must overcome…

Unwittingly, most traders and investors become victims of myths in the stock market. It is not just about the get-rich-quick syndrome. Most people build their investment strategy based on some wrong conceptions of the stock market. Here are 5 popular myths that any trader or investor needs to debunk before embarking on trading and investing in equity markets…

The most important thing in investment is returns…

This is the common myth among traders and investors. Remember, your most important thing is not return, but your risk. As a trader or an investor you make more money by knowing and controlling your risk than by chasing returns. Once you learn to control and measure your risks your returns in the markets will automatically follow. Remember, risk wipes out your capital and at the end of the day every investors operates with finite capital. That finite number may be small or large, but then it is finite nevertheless.

There is another perspective to the superiority of risk over return. Let us say you took a wrong decision and lost 50% of your capital. Now on this smaller base you need to earn a 100% return to come back to parity. Which is why risk becomes so important? That is the reason you need to put a lot more focus on putting stop losses while trading. You need to focus on hedging your investments with appropriate puts or short futures. The bottom-line is that you must put more focus on managing risk. The returns will follow logically.

Success in the markets is all about studying the market…

As an investor you must focus more on understanding the companies you are investing in. As Warren Buffett said, “Behind every stock is a company with a business. Try to understand how that business is doing”. That is critical for an investor. Nobody has ever made money by consistently timing the market, or through bottom fishing or by trading each shift in the market precisely. Even the great trader, Jesse Livermore, had to live through multiple bankruptcies during his trading career despite being regarded as one of the sharpest traders in the history of the stock markets.

Focus only on the tried and tested large cap names…

While it sounds quite safe and secure, it is not a very great idea. The investing game is all about alpha (excess returns) that you can make from a given stock by understanding why it is a great business model. Most large cap stocks tend to be tracked heavily by analysts. For example there may be over 100 analysts tracking stocks like Infosys, Tata Motors and Reliance. Finding opportunities in such stocks for the long run is extremely difficult. That is where you have to take a calculated risk on stocks that are likely to emerge as large cap winners in the coming years. Remember, in this business the biggest risk is not taking any risk.

The best performers in the last 5 years are actually mid cap stocks. Stocks like Motherson Sumi, Lupin, Eicher Motors, Page Industries and TTK Prestige have multiplied many times over in the last 4-5 years. During this time a large cap stock like Reliance, Tata Motors or ONGC may have actually gone nowhere. As a smart investor, you need to be on the lookout for such opportunities in the market. Do you homework, talk to your broker, check with the market and then commit money.

Past returns are the best indicator of future performance…

Warren Buffet used to occasionally joke that if the past was what the market was all about, then librarians and archaeologists would be the wealthiest people in the world. Unfortunately, the market is not about focus on past performance. That can at best give you a comfort level. But that does not make your investment grow. Remember, a company with a great track record like TCS or HUL would already be trading at rich valuations in the market. The margin of safety for you as an investor would be quite limited. That is not the idea of investing. You need to invest in stocks that have the potential to grow in terms of size, revenues and profit over the next few years. These are the stocks to bet on. After all, a nimble future is always preferable to a stodgy past!

You need complex strategies and algorithms to profit in the market…

That is a big myth. You do not need complex strategies and algorithms to profit in the market. In fact, complex strategies and algorithms are means to make a small return on a large capital outlay by identifying inefficiencies in the market. That is not the way an individual investor can ever make profits in the stock market. Firstly, not everything that is complex is great. As Peter Lynch used to say, “A great idea should be so simple that you should be able to illustrate it with a piece of chalk”. Look at the case of Eicher Motors 5 years back. A growing market, hardly crowded, low capital requirement and a high ROE was a classic combination to create wealth. No doubt, the company was an outperformer in the last few years. Same with Britannia in the last 3 years! A focus on the premium biscuit segment with low competition and high margins almost turned the tables for the company. The company appreciated almost 10 fold in just about 3 years. That is how simple it is!

To cut a long story short, try to understand these myths and try to overcome them. Your journey to the stock markets starts with knowing the basic myths to bust. This may not make you a great investor by itself, but will surely help you avoid the standard pitfalls.

You can ask us your stock related questions with #AskReligareOnMarkets via our Twitter channel @religareonline

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