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Seven deadly sins for investors

'We ask friends and dealers before buying a cell phone. But rush in and buy stocks on a hot tip.'

With the advent of electronic trading screens and the proliferation of visual media, stock exchange trading floors have entered middleclass drawing rooms. The Internet is also serving as a reliable medium of research for the inquisitive investor. So much free content has made direct equity a fertile breeding ground for the wannabe “do-it-yourself investor”. But not all free “expert” advice is right. Or you might misinterpret the information provided. Here’s a list of seven strict nos while putting your money on the roller-coaster markets.

Getting swayed by the short-term movements: Perhaps the most common mistake of equity investors is over-reacting to short-term gyrations of the markets. While a stock may have been bought for the long term, there is tendency to sell the stock if it has appreciated quickly. Similarly, those who watch the screen continuously get scared by a sharp intra-day fall and may end up selling what may have been bought for the long term.

V K SharmaTaking small profits and huge losses: It is fairly common for investors to book early profits and prolong their losses. As a result, well-performing stocks will exit the investor's portfolio while loss-making ones remain. And if these loss-making “jewels in the crown” do start going up after sometime, they are promptly sold when their value crosses their acquisition cost.

Buying on tips: If you are prone to accepting tips, you might do well as a waiter. We speak to three friends, call two dealers and do some research on the Net before buying a mobile phone or plasma television. But we don’t think twice before buying a market lot of stock on a hot tip. When such decisions go wrong, a trading stock becomes an investment decision. And then we call the agony uncle or aunty on a business channel to seek advice on the newly acquired stock. This is the first of the many steps we take in our post-buying research.

Fancy for penny stocks: There is a false sense of security with penny stocks and an unnecessary fear associated with stocks of apparently higher value. We believe that if things go wrong then more money is lost in larger stocks than in the penny stocks. This is not true. We will lose equal in percentage terms and that is what matters.

Other things being equal, you shouldn’t fear a large stock and feel comfortable with a penny stock. But things are rarely equal. A seemingly cheap Rs 30 stock of Re 1 face value is more expensive than a Rs 10 face value stock quoted at Rs 200. How a stock is priced is not necessarily a function of absolute value but the price-earnings (PE) multiple. Also, investing in a low PE stock need not be safer than investing in a higher PE stock as the companies could have very different growth prospects. It all boils down to looking beneath the surface and not getting carried away by appearances.

Tax considerations: Some investors tend to hold stocks for a longer period of time to avoid paying capital gains tax. Currently, stocks held for over a period are exempt from any capital gains tax if securities transaction tax has been paid on them. While it is a good idea to hold stocks for the long term, clinging on to them just to avoid paying capital gains tax, especially when the stock’s future does not look bright, is committing hara-kiri. Profits may completely vanish if fundamentals go wrong. So hold stocks for the long term if they continue to look attractive and the fundamentals are intact or becoming better. If fundamentals warrant a sell, exit. The tax angle will come in only if you make money. Do that first.

Copy cats: Investors blindly follow what the poster boys of Indian markets are buying. While the pundits make a move after deep research, following in their footsteps will result into profits only if you have the same risk appetite, discipline and time frame. The big daddies of the markets will buy a stock and add more if it slips and may have tremendous patience. Investors following them just because it seems intelligent may end up in losses if they also don't share the same patience.

Impulsive behaviour: Investment requires patience, perseverance and passion. If you do not have these traits and the ability to separate the grain from the chaff, it is better to hand over your money to the mutual fund managers. If you do have it in you then spend 90% of your time doing research on what you plan to buy rather than justifying what you have bought on impulse. As entering and exiting stocks is easier than twiddling your thumbs, successful investors will be those who have a strong control over their impulse.

By V K Sharma, Director, Anagram Securities