What volatility!

Just as we closed this issue with a comprehensive package to help you plan your taxes, the stock market started shaking with tremors of volatility again. The Sensex fell 15% in 4 trading sessions, most of which happened in the last two sessions. Regular readers have been given enough ammunition to deal with, and profit from, such gyrations in our past issues.

But the latest crash has raised doubts about every lesson investors may have learnt, we decided to add this page to take you through a quick refresher course— updated till 12 noon January 22. For more definitive details, wait for our next issue.

WHEN TECHNICALS TAKE OVER...

There has been a surge in leveraged buying (buying on borrowed money) in recent times. This escalates the extent of market fall beyond what the fundamentals merit. Here's how:

It's a double-edged sword

Leveraging allows you to buy stocks worth up to 5-6 times the margin you deposit. While potential gains are amplified, so are the potential losses.

It induces artificial liquidity

Investing borrowed money can be a double whammy if your bet goes wrong. You pay a high interest rate of 18-24% and suffer capital erosion.

Could play havoc with your finances

If a stock price falls, the margin money is used to cover the loss. The investor has to then provide additional margin. If he can't, shares are sold to recover the loan.

Amounts to double leveraging

Buying shares anyway amounts to leveraging on future earnings of the company. But the futures market and margin trading offer instant and another layer of leveraging which could be disastrous for the small investor.

We spoke to several investors across the country, who hold portfolios ranging from a few tens of thousands of rupees to several lakhs. What unites them is the fact that volatile markets hold little fear for them. Most of them started off by investing small amounts. As profits grew, so did their confidence. Investors tell you how to build wealth despite volatility (Money Today dated November 15, 2007)

Share prices fluctuate--but a long-term investor who ignores those fluctuations actually has a better chance of being on the right side of price movements than a trader punting on tips. With a little thought, you can develop a rational strategy that works over the long term. Take a look at nine golden rules of equity investing (Money Today dated November 2, 2006)

Over several months, we found that there are sound mathematical reasons to believe that the upside in volatility is more than the downside. Indeed, historically stock markets generate higher returns than other, less volatile assets. Which leads us to conclude that holding volatile stocks may work well, especially in the long run. A list of potential biggies, "almost there" winners and "safe" bets (Money Today dated July 12, 2007)

Regardless of the market's gyrations, there are some stocks that it makes sense to invest in. Picking these is not about timing the market (which investors should never do), but about spotting an opportunity. So, it doesn't matter if the markets are volatile—as long as the stocks are chosen with care, you can rest easy. Volatility is not necessarily a bad thing; it can offer bargains (Money Today dated September 20, 2007)

WHAT'S GOING RIGHT AND WHAT'S NOT

Everybody is talking of fundamentals being strong and stock prices will recover sooner rather than later. What does strong fundamental really mean? Actually a mix of economic, political and social factors. Here's a list of 6 positive and 6 negative factors for stock markets. A glance will tell you that positives still overweigh by a huge margin.

POSITIVE FACTORS:

Money inflows from foreign funds
Rising corporate profits
Low interest rates
Low unemployment
Political stability
Low taxes

NEGATIVE FACTORS:

Fewer fund flows
Low corporate profits
High interest rates
Political uncertainty or elections
International conflict
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