THE SECRET MANTRA TO BE A SUCCESSFUL INVESTOR

Very broadly, there are three approaches to investing/trading in the markets:

A. Technical Analysis

B. Fundamental Analysis

C. Information, tips  and event based investing

So which of these approaches leads to financial nirvana??? Here is my take on each:

A. Technical Analysis

Technical analysis is an approach to trading in any market wherein one analyses the price and volume movements of the security/commodity/index/currency in question and develops a view on likely future movement in the same. To take a simplistic example, a technical analyst looking to invest in, say, crude oil would analyze the movement in crude oil futures over the last months and days. Using glorified and seemingly sophisticated techniques, importance would be ascribed to certain price levels of crude oil. Hence, if the near month WTI crude oil is presently at USD 72 per barrel, it will be determined which are critical levels below and above the current price level. The critical price levels below the current price are known as ‘supports’ and the critical price levels above are known as ‘resistances’. Thus, if the supports are determined at, say, 70, 68 and 66, and the resistances are determined at, say 74, 76 and 78, the technical chartist then suggests trading strategies around these levels. Thus inevitably, the technical analysis would suggest that you buy the crude at say 72 levels…if it goes below the nearest support of 70, you sell it as it has ‘broken’ support and is heading for 68…conversely, if it goes to the resistance of 74 and reverses, you book profits as it has hit resistance, but if it crosses over then ride the profit to 76 and so on.

Well so far so good. It seems like a miracle formula and too good to be true. Well, like they say, if it sounds too good to be true, it is!!! For if it was so, the ‘technical experts’ who appear on CNBC and spin their web all day long would be on the Forbes list, and not Mr. Gates et al.

I have tried technical analysis, with and without the help of ‘experts’. It worked sometimes and didn’t work other times. There were plenty of occasions where the price would break support, you would end up liquidating the position and immediately the price would recover…much to your angst and frustration!!! Similarly, there would be times that the price would shoot past resistance, only to reverse dramatically and erase all your accrued profits. It thus got me introspecting. What good is the technical analysis if it doesn’t work…and if the so called supports and resistances are rendered meaningless when you have a position? The fact remains that the price movement is a function of the buying and selling at a particular point of time. Hence, even if I go long on crude at 72 dollars and see it go down and break the support of 70, whether it will go down further or not, will not be known to any technical analyst, coz it may just shoot back up if there is suddenly a major buyer in the market and thus the ‘support being broken’ argument would not hold. Conversely, it could just keep falling and trashing all so called ‘supports’ if there is a major seller in the market.

My conclusion is that the price movement of any security/index/commodity/currency is a function of the buying versus selling pressure at a particular point of time and no one…repeat no one…can predict the movement in short run, for the simple reason that no one has visibility on the entire queue of buyers and sellers in the market at a point of time, let alone having visibility on the behavioral patterns of such buyers and sellers.

Furthermore, the short run is much more prone to events and environmental fluctuations affecting the behavior of the prices, thus throwing technical analysis out of the window. For example, you may take a long position on the market index, basis technical analysis that the price is near a critical support level and should bounce from here…however any extraneous event, such as an adverse regulatory announcement  could cause the markets to tank the very next day, making all support levels redundant.

In conclusion, technical analysis as a tool for making money in the markets is fraught with risks and pitfalls and I do not recommend the same to anyone.

B. Fundamental Analysis

Fundamental analysis is an approach to investing which is followed by stalwarts of the industry, from Benjamin Graham to Warren Buffett to Mark Mobius. It involves an analysis of the fundamentals surrounding the company/market/commodity/currency with a view to arrive at a decision on whether it’s current market price is above or below its intrinsic worth. Fundamental analysis works on the assumption that in the ‘long run’ the market price would gravitate towards the intrinsic worth as determined by the underlying fundamentals. Thus if the current market price is considered below the intrinsic worth, the followers of this approach go long on the security/market/commodity/currency and if it is considered higher, they either let it alone or go short on it.

Well, if you have the mental faculties and the wherewithal to put in the time and effort which is required for a proper and in depth fundamental analysis of the company/market/commodity/economy that you are intending to invest in, you are well on your way. However, fundamental analysis suffers from certain pitfalls due to which it is at the outset doomed to fail in the vast majority of cases.

Any analysis is based on certain input information and assumptions. In case either of these is, or becomes inaccurate, the whole analysis and conclusions thereof become shaky. For example, an analysis of any company starts with its financial statements as an input of its financial position and historical performance. However if the financial statements are fraught with inaccuracies or accounting juggleries which disguise the financial deterioration or liabilities of the business, a la Satyam, the entire analysis becomes worthless.

 Similarly, while computing intrinsic worth of the business, you would make certain assumptions which would determine future performance of the business and its earnings. These assumptions may be fallacious, or may become so due to events or changes in the environment which may ensue. For example, in valuing the business of a power generation company, you make certain assumptions regarding the spot power prices going forward, but this assumption may be totally wrecked by the Central Electricity Regulatory Authority announcing a cap on spot power prices (as it did recently).

The problem with long term investing is that while longer periods have the comfort of ironing out short term aberrations, it is also susceptible to fundamental shifts in the markets which can dramatically alter the environment and basic equation for a business. One of the best example for this is the paper business. While ten years back the paper business may have appeared lucrative, and fundamental analysis would have induced one to take a Buffett inspired ‘long term’ position, a lot has changed in the ten years and with electronic modes of communicating, working and recording coupled with environmental consciousness, the demand growth assumptions for paper industries have been belied. Thus, while you may have started out with a sound fundamental analysis, you may still end up losing money, since the price would not move up to the intrinsic value, rather the intrinsic value may sink way below the price.

Furthermore, the fundamental analysis also assumes that the management of the company would be efficient and would appropriately capture the strong points of the business. Alas, as we have all seen, whether in India, or in any other country, managements are far from perfect. More often than not, the management fails in running the business and taking decision in an idealistic manner and thus the excel forecasts of the fundamental analyst do not translate to reality.

It is thus evident that even fundamental analysis does not hold the key to eternal wealth and superlative returns.

C. Information and Event based ‘investing’

This is one of the most popular approaches and has found takers since time immemorial. Tips, inside information and event based arbitrage, as a school of investing has been followed by all of us at one point or another. And as all of us will bear witness, it fails more often than it works.

The reason for the failure of this approach, apart from the obvious regulatory risks brought on by the inherent illegalities, is that there is no such thing as ‘perfect information’. All information is incomplete as it does not factor in the changes which may occur between the time that you take a position based on such information and the occurrence of the predicted event.

Thus, if you get a tip regarding a company declaring an exorbitant dividend and take a position in its stock at say Rs. 100 with a view to capture the price rise on the back of the dividend declaration after a couple of weeks, it may well happen that in these couple of weeks, there occur events, whether specific to the company, or pertaining to the market as a whole, which drive the price of the stock to Rs. 80 and any subsequent jump on declaration of dividend barely even manages to help the stock recover above your cost!!!

Similarly you may have inside information of there being a buying of 1 million shares of a company by a major fund on a particular day and based on the same you may go long on the stock. However how would you know if on the same day, another fund decides to offload its position of 5 million shares, thereby causing the price to tank rather than rise, as you assumed based on your ‘inside information’?

Even on the mergers and acquisition side, no information is fool proof. You may be privy to information regarding an acquisition offer for a company by another at a price which is at a premium to the current market price, and basis such information, you would take up a position in the stock. However you would very well find yourself in a soup if the management does a turn around and changes its mind on the offer or the offer price, or the negotiations between the acquirer and target fall owing to the finer aspects of the acquisition.

At the end of the day, every information appears perfect and foolproof at the time you initiate the position, but it will inevitably unravel after you take up a position. And just in case it does not unravel, you will probably not see the price respond to the outcome, as the information would have already been priced in by the market.

Well you must be thinking, if you are one of the few who has read this far, that it has been a royal waste of time, as there doesn’t appear to be any prospects of any secret mantra being spewed forth from my ruminations here. But please wait. Here it is.

As per my experience and ‘wisdom’ there is only one factor that determines how you fare in the market. And that is – DESTINY. Everything else is subsidiary.

You may adopt any approach to investing and initiate positions based on technical analysis or fundamental analysis or on the basis of tips and information, or astrology or even by literally throwing a dart on the stocks page of the financial dailies, it will only determine the starting point. The outcome would be determined by your destiny. You will make or lose what is destined for you, nothing more and nothing less. You may choose to attribute your successes to any approach but the fact is that it is your destiny which affected the outcome.

I have followed closely people who have made major gains in the market, from Buffett to the so-called Indian gurus and have realized that for the large part they do not have any secret mantra or discipline which yields them results. Their approach is substantially similar to what may be adopted by many others. What has made the difference for them is their destiny. So if you invested in Infosys 25 years back and made a killing, don’t pat yourself on the back so soon, for you could very well have fallen for one of the many other tech stocks which went bust, though they had appeared just as lucrative at the time.

I have even seen instances where two people, based on the same approach/information have initiated a position in the same security at the exact same time. One has made money and the other hansn’t, because each exited the position at different times and out of different perspectives and considerations. At the end what differed were their destinies.

Hence, I will just conclude by saying that we all may continue to harbour illusions of self grandeur over the superiority of our approach to investing and intelligence over others, but underlying it all is our luck and our destiny, and remember that in the end what we will be left with is what was in our destiny and that which wasn’t will be all gone.

I do not mean to dissuade anyone from investing, in fact it’s the exact opposite. I hope everyone takes it up and adopts an approach which best appeals to their respective sensibilities. After all it’s better to have fought and lost than to never have fought at all. All I am saying is that we must take the pain and make the efforts, for it is our karma to work. But we should not commit the blasphemy of ascribing results to ourselves…we can only take the credit for hard work and effort and leave the credit for the outcome to God.