Small investors, beware! Watch out for the speculation trap

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Young woman working at modern office.Technical price graph and indicator, red and green candlestick chart and stock trading computer screen background. Double exposure. Trader analyzing data

Certain events and policies lead to unintended consequences. The sharp market crash in March 2020 caused by the outbreak of the pandemic Covid-19, which took the Nifty to a low of 7,511, and the subsequent rally which powered the Nifty to a high of 18,604 in October 2021, triggered many unintended consequences.

The most significant consequence of this rally has been the explosive growth in the number of demat accounts from 4.09 crore in March 2020 to 10 crores by the end of 2022 and above 11 crore now.

The WFH (work from home) arrangement necessitated by the pandemic facilitated TFH (trade from home). While seasoned investors were sceptical of that one-way rally, which was not supported by fundamentals, the newbie investors who mushroomed after the pandemic, merrily traded in the market.

That unique one-way rally in the market enabled the newbies to make a lot of money and many thought that trading in the stock market was an easy way to make money.

Many newbies even quit their jobs and opted for trading in the stock market as a profession. That was a classic case of what the poet Alexander Pope called “ fools rushing in where angels feared to tread.”

The explosion in the number of demat accounts from 4.09 crore in March 2020 to 10 crore in September 2022 was like manna from heaven for the so-called ‘experts in trading’.

Dozens of YouTubers arrived with ads claiming to teach ‘how to trade and make money.’ Ads like ‘Make money sitting at home’, ‘make Rs 10 lakh with just Rs 1,000’ propped up.

One outrageous ad even showed a boy who looked like in his early teens executing an option trade and making money from that trade.

Separate the wheat from the chaff:
To be fair to the new crop of YouTube influencers, it has to be said that there are many who are promoting financial literacy. There are high-quality YouTubers who are handholding the newbie investors into healthy investments.

But the problem comes from two sources: One, the YouTubers who manipulate the market through the ‘pump and dump schemes’ and, two, YouTubers who attract newbies into day trading and trading in derivatives through their trading courses.

‘Pump and dump’ manipulation involves pumping the stock prices of some low-grade companies by spreading false news like a possible takeover and later dumping the stock at higher prices.

Recently, SEBI banned the Bollywood actor Arshad Warsi and his wife from the securities market for pump and dump manipulation.

A major trap into which many newbies are walking into is the ‘trading as a profession’ trap being set up by some of the new crop of YouTubers.

Some are targeting women through claims that women can earn a regular income sitting at home and doing day trading and trading in derivatives.

Many small investors who have mushroomed during the last three years are walking into this trap. Most of them have already lost heavily and many are set to lose unless they realise the mistake and stop day trading and trading in derivatives.

Learnings from history:
I have been an investor since 1985 and have seen and studied many bull and bear markets. From my experience, I can say the following with conviction:

a) One, it is possible to earn excellent returns from the market, for the long term, through disciplined systematic investment in high-quality stocks/mutual funds.

b) Two, the vast majority of retail investors don’t get good returns from the market because they invest in cheap low-grade stocks. They don’t invest based on research; instead, they go by market tips.

c) Three, the vast majority of traders lose money in reckless overtrading in the market.

SEBI study finds that 89 per cent of traders lose money:

A recent SEBI study found that 89 percent of individual traders in the equity F&O segment lost money in FY22 with average loss of Rs 1.1 lakhs.

Only one out of ten traders made profits with an average profit of Rs 1.5 lakhs in FY22. The number of traders had exploded to 45.2 lakh in FY22 from 7.1 lakh in FY 2019.

The SEBI study only confirmed what was known to the market all along. The founder CEO of India’s largest discount broker with millions of customers had gone on record that 95 percent of traders lose money.

Out of the 5% that makes money only 1 per cent get returns beating fixed income returns. This has been the case in the past and will continue to be the scenario in the future too. The earlier the new entrants to the market realise this, the better for them.

First published in ET Moguls

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