Do investors have the ‘if-its-free-I’ll-take-two’ syndrome?

Before I can answer the question, I need to tell the story about the syndrome.

A young boy was being taught by his father about prudence in handling money. Here are the three important guidelines provided by the father:

• Live within your means and try to save money from whatever little you may have
• Always ask the price of anything you wish to buy, and then decide if you can afford to buy it
• Don’t blindly accept a quoted price; try to bargain and buy at a lower price

Well-versed in the guidelines, the young boy went to the local ‘paanwala’ to buy some candy. On being told that the candy cost a Rupee, he promptly started to bargain. Despite repeated pleas by the ‘paanwala’ that there was no discount on a candy costing a Rupee, the boy would not relent. A small crowd had gathered on hearing the commotion, and potential customers were walking away. In desperation, the ‘paanwala’ handed over a candy to the boy, saying: “Take this. It’s free. Now please leave.” The boy was delighted, but refused to budge. “It’s free? Then I’ll take two!”

That boy must have grown up to be a stock investor. He also must have told all his friends – who also became stock investors. How do I know this? Because of the proliferation of web sites offering “sure-shot free stock tips” and “99.9% success guaranteed Nifty tips”.

There was a time when I used to go out of my way to provide free advice to young investors about what stocks to pick and how to build a portfolio. But I no longer give free advice – except in my blog posts. Why? Because I found out that most investors were not following my advice at all. In fact, they were doing just the opposite. They would not buy the stocks I’d recommend, and would go right ahead and buy the stocks I suggested that they avoid!

Then a wise reader related the story of a doctor in a small town who decided to treat patients for free after his retirement. Hardly any one showed up at his chamber. Then he decided to charge a reasonable fee. Soon, he had several patients visiting his chamber every day. The moral of the story is: No one respects free advice.

The other day, I received an email: “Can you please suggest one multibagger stock?” Usually, I ignore such emails, or answer back: “I don’t provide free stock advice.” But I was in a genial mood that day, and wrote back: “Buy Tata Steel.” The response floored me completely. Let alone thank me, this smart fellow came back with: “Any penny-stock multibagger?” This is what I meant by ‘if-it-is-free-I’ll-take-two’ syndrome!

A more dangerous affliction is the ‘if-it-is-free-I’ll-take-as many-as-possible’ syndrome. I got this email from such an investor: “I would like to buy some fundamentally strong stocks in this bear market. Please send me a list of such stocks.” I answered: “I don’t give individual stock advice for free. But you can take a look at some of the beaten down stocks in the Sensex and Nifty indices.”  Back came a response: “OK, I promise to send your fee, but send me the list of stocks now.” I didn’t bother to reply, only to receive this reminder: “I still haven’t received the list of stocks.” Later, I found out that this freeloader was regularly providing free stock tips in one of the investor forums!

The answer to the original question is: Many investors do. I think it is part of the human psyche that we get swayed by products that are offered ‘free’. That is why retailers periodically offer “Buy-1-get-1-free” deals to get rid of unsold or unfashionable or oversized/undersized stock. Shops tend to be overcrowded during such offers.

When it comes to stock advice, ‘free’ usually means ‘not good’. Investors need to appreciate that. If some one really knew which stocks will become multibaggers in future, he would not tell a soul and buy as many of those stocks he could afford before the stock market got wind of it. 

The Sensex Fool’s Four stocks

This is a sequel to last Thursday’s post: Fool’s Four stock investment strategy. Before proceeding further, let me thank readers Googol, Purnendu and Rishi for providing me with their lists.

There are a few stocks common in their lists with mine, but there are differences due to changes in current market prices, adjustments for split/bonus and calculation of dividends. I have checked the list to the extent possible, without turning it into a research project. But there may be errors in my list as well.

The point to note is that the stocks that make the list – with one notable exception – have under-performed the Sensex by various degrees. That is the whole idea behind the Fool’s Four strategy. Without further ado, here are the Sensex Fool’s Four stocks:

1. NTPC
2. Jaiprakash Associates
3. ITC
4. ONGC
5. Wipro
6. Tata Steel

Why 6 stocks? Well, if you read the previous post, you will know that the stock ranked 1 – viz. NTPC - is supposed to be dropped from the list. That leaves 5 stocks. Regular readers may be aware that I am biased against PSU stocks because the government treats them as ‘free ATMs’ and run them to the ground. That eliminates ONGC from my list.

Given below are the one year closing charts of the remaining four – compared with the Sensex (in green):-

Jaiprakash Associates

Jaiprakash Associates has been a significant underperformer for the past one year, and it isn’t a surprise that it is at the top of the list. The company’s ambitions have far exceeded its execution capabilities. The huge debt burden is a millstone around its neck. Since it has fallen so much, the chances are better for a higher percentage gain when the market eventually turns around.

ITC

ITC is the odd-one-out of this list. It was a market performer till Feb ‘11, but has significantly outperformed the Sensex from Mar ‘11 onwards. The special centenary dividend boosted the dividend yield. The dividend is unlikely to be repeated next year. But this is a great stock to own – even if it wasn’t on the list.

Wipro

Wipro had outperformed the Sensex till mid-Jul ‘11. It is the last two months that haven’t gone well. There are management issues that haven’t yet been sorted out to the market’s satisfaction. Of late, it has fallen behind aggressive competitors like Cognizant and HCL Tech. But it is a good company and may fight back.

Tata Steel

Like Wipro, Tata Steel has underperformed the Sensex in the last two months. It is the lowest cost integrated steel maker in India and extremely well-managed. The Corus integration is still a work-in-progress, and the real benefits of the acquisition may be a couple of years away. But I have no doubts that the current problems in Europe will be overcome, and the company’s bottom line will significantly improve.

The Fool’s Four strategy suggests that you invest equal amounts of money in all four stocks, and make any adjustments only after one year. Will the strategy work? There is only one way to find out – by investing. Or, you can opt out by only investing ‘on paper’ and check back after one year.

Stock Chart Pattern - Tata Steel (An Update)

The previous update to the technical analysis of the stock chart pattern of Tata Steel was posted a year back. The stock rallied strongly from its Mar ‘09 low of 150 to its Apr ‘10 peak of 694, followed by a correction down to 450, and was struggling to escape the clutches of the bears at 520.

Let us have a look at the one year closing chart pattern of Tata Steel, to find out what kind of progress it has made in the past 12 months:

I had recommended that investors use a drop below 500 to enter the stock. An entry opportunity presented itself when the stock closed just below the 500 level on Aug 25 ‘10. The next leg of the up move started almost immediately, and the stock quickly rose to close at 678 on Oct 6 ‘10 – falling short of its previous closing high of 694.

A correction ensued, during which the stock price fell below the 50 day EMA on several occasions, and in the process, formed a bullish rounding bottom pattern that propelled the stock to a new closing high of 703 on Jan 3 ‘11.

Note that while the stock managed to reach a higher top, all four technical indicators failed to follow suit. The MACD and the RSI touched lower tops, and the ROC and the slow stochastic reached flat tops (marked by blue arrows). The combined negative divergences pushed the stock price into a down trend that has lasted more than 7 months, and has formed a bearish descending triangle pattern.

The closing level of 559 on May 23 ‘11 meant a more than 20% drop from the peak, and the ‘death cross’ (marked by the light blue oval) on May 24 ‘11 confirmed a bear market.

The Tata Steel stock is a component of both the Sensex and the Nifty indices. So it isn’t a great surprise that the stock has formed a descending triangle pattern similar to the ones formed on the Sensex and Nifty charts. The difference is that the price peaked two months later – in Jan ‘11 instead of in Nov ‘10 – so the duration of the triangle is two months less.

Will the stock bounce up from the long-term support of 557, or will it break down below the descending triangle? All four technical indicators are looking bearish, so any bounce up is likely to be temporary. The MACD and ROC are negative. The RSI is below its 50% level. The slow stochastic is in its oversold zone, where it may remain for a while.

The height of the descending triangle from the peak of 703 to the support level of 557 is 146 points. On a break down below the triangle, the stock price can fall to (557 – 146 =) 411. However, there are long-term supports at 500 and 450 levels, and the stock price may turn back from one of those two supports.

Bottomline? The stock chart pattern of Tata Steel is trading below all three EMAs and looks all set to drop below the support level of 557. This is the best stock to own in the steel sector. Any drop below 500 can be a good opportunity to start accumulating again. 

Why building a stock portfolio is like buying a car

One of the requests I receive most often from blog readers and newsletter subscribers is to help them in building a ‘good’ stock portfolio. Many think that this is a trivial task. All they need is a list of ‘good’ stocks to buy. It is not that simple. A portfolio is not a ‘T’ shirt with a ‘L’ written on its label that will fit 90% of investors. It needs to be custom-tailored for a near perfect fit, to suit each individual investor’s background, experience, financial commitments, risk tolerance, and future plans.

But the real problem lies elsewhere. Most young investors can spare Rs 1 - 2 lakhs. Some have recently started earning and can only spare Rs 3000 – 5000 per month. These are insufficient amounts for building a ‘good’ stock portfolio. So, I use the analogy of buying a car.

One doesn’t go out and buy a car – specially if they have just started earning. Some prior planning is required. (Car loans are readily available nowadays, but the EMIs can burn a big hole in your pocket.) A better option may be to buy a scooter or motor cycle for immediate transportation needs. Even then, you need to learn the rules of the road, and get a driver’s licence before you buy anything.

Unfortunately, there is no licence required to invest in the stock market. Most small investors jump into the market without any knowledge of the basic rules of investing. No wonder their stocks crash and they suffer heavy injuries (to their savings). Grow your capital by regularly investing in fixed deposits, recurring deposits, PO MIS, ETFs, mutual fund units till you have sufficient capital to buy a ‘good’ car.

Can’t you buy Rs 3000 – 5000 worth of stocks every month? Yes, but which stocks? You can’t even buy 10 shares of Tata Steel. So you’ll probably buy 100 shares of Suzlon instead, or worse still, 800 shares of Cranes Software! Your risk of loss will increase proportionately. You are far better off investing that amount of money every month in a ‘good’ fund like DSPBR Top 100 or HDFC Prudence. After 5 or 6 years of regular savings, you may have sufficient capital for a ‘good’ portfolio.

How much is sufficient capital? I suggest Rs 5 lakhs as a bare minimum. Rs 10 lakhs is a more reasonable figure. Can’t cars be bought for Rs 1 - 2 lakhs? Yes, they can. But they won’t be ‘good’ cars. How about a used car? That may work, but is likely to require regular trips to the service centre for repairs. And you really can’t be sure if a used car is really a ‘good’ car. The previous owner may not have driven or maintained it properly.

Even with Rs 5 lakhs, you will only be able to buy a decent entry-level car. But if you are ready to spend Rs 10 lakhs, then your choice of ‘good’ cars increases significantly. And if you own a Rs 10 lakh car, chances are that you will take good care of it by following scheduled maintenance procedures, getting repairs done promptly, adding accessories that will enhance your driving comfort and experience.

A ‘good’ stock portfolio needs sufficient capital, and has to be nurtured and maintained as well – by keeping track of market happenings, individual stock results, using opportunities to book part profits or add more on dips. The emphasis should be on safety, and not about driving/investing recklessly.

The state of the stock market – a broker’s views

I cornered my erudite stock broker friend just after he had finished his morning round of golf, and asked him about the current state of the stock market. Here, in no particular order, is the gist of his uncensored views during a freewheeling discussion:-

1. The Sensex is very likely to test its recent low of 17300. It may even go down to 16000, but the probability is low.

2. The market is likely to trade in a range for another 3 months, or even longer. With high oil prices further messing up India’s fiscal deficit, markets won’t be able to move much higher.

3. The second half of the year should be ‘technically’ better. That is when the ‘big players’ have decided to sit down together with the Udayan Mukherjees of the business channels to decide (and announce) where they are going to push up the stock market.

4. Oil prices won’t come down any time soon. The turmoil in the Middle East and North Africa will be fomented by the USA for two main reasons. The first is their insatiable desire to corner oil resources, which was the main reason for their invasion of Iraq. Every one knew that there were no ‘weapons of mass destruction’ in Saddam Hussein’s armoury.

The second reason is the dismal state of the US economy. All the dollar printing hasn’t improved anything. The US economy thrives after wars. A Republican president would have used the Tunisia and Egypt uprisings as excuses to send troops. The Democrat president is pussy-footing around. But he will soon have no choice but to start a war by sending in the US marines. There is already talk of enforcing a no-fly zone in Libya.

5. The talk of ‘valuation difference’ between developed and emerging markets being the reason for the recent correction is all hogwash. Valuation differences were there a year back, when FIIs were pouring money into emerging markets.

6. The export lobby has been moaning and groaning about the rupee appreciation against the dollar hurting the country’s exports. There is not a peep from the import lobby because none exists. The government is the biggest importer. They should ignore the exporters and let the rupee appreciate against the dollar. That is the only way to cushion the rising cost of oil imports. Imports far exceed exports anyway.

7. There is no greed and fear in the Indian stock market. There is only more greed and less greed. Nothing else explains the paltry cash volumes compared to the huge F&O volumes of trade every day.

8. Small individual investors in the more evolved and sophisticated US market invest mainly through mutual funds. In India, any one who has Rs 5000 to spare wants to invest in equity shares. Since he doesn’t have enough money to buy even 10 TISCO shares, he goes out and buys 15000 shares of Cals Refineries. How smart is that?!

Part of the blame lies with us brokers, who want investors to regularly buy and sell stocks, because our livelihoods depend on that. But, small investors will be far better off investing regularly in an index fund or a balanced fund.

Should investors join the ‘Bollinger Bands’ wagon?

Bollinger Bands are a technical analysis tool, developed about 30 years ago by John Bollinger. Before we get into the nitty-gritty of what these bands are and why investors might find them to be a useful tool, a few words about a statistical concept called ‘standard deviation’.

Standard deviation, in layman’s language, means the amount by which a series of measurements vary from the average value of the measurements. Let us say, we are measuring each day’s maximum temperature, and the figures for 5 days are 24, 25, 25, 26, 30. That gives an average value of (24+25+25+26+30)/5 = 26. The absolute variations from the average are –2, –1, –1, 0, 4 respectively for the 5 days. A series of arithmetical manipulations are done on these variation data (squaring, adding, averaging and taking the square root of the average) to arrive at the standard deviation.

Investors need not be math wizards to understand and apply the Bollinger Bands tool - thanks to readily available charting software. But it is always good to know the concept behind the tool. So, what are Bollinger Bands?

It is a technical tool to measure the volatility in prices of a stock or commodity. It consists of a band with three lines. The one in the middle is a 20 period simple moving average (SMA) of the price. The two other lines – one 2 standard deviations above and the other 2 standard deviations below the 20 period SMA – complete the band.

Volatility is measured by standard deviation. As volatility increases, the Bollinger Bands automatically widen. When volatility decreases, the bands contract. Since standard deviation is calculated using a 20 day SMA, a 20 day SMA is also used as the middle line in the daily price charts.

The 20 day SMA with the upper and lower bands 2 standard deviations away is the most commonly used set-up in Bollinger Bands. But other combinations can also be used, depending on price volatility and investment styles. Standard deviation values are higher for stocks (or commodities) trading at higher prices than those trading at lower prices. A higher value of standard deviation doesn’t necessarily mean higher volatility.

Now let us take a look at Bollinger Bands drawn on the 1 year bar chart pattern of Tata Steel:

How do we interpret Bollinger Bands? They do not give ‘buy’ or ‘sell’ indications by themselves, but are used together with other technical indicators to confirm a ‘buy’ or ‘sell’ decision. A contraction of the bands can be used as an early indication of a price rise. Note the contractions in Jun ‘10, Aug ‘10 and Nov ‘10, which were followed by sharp up moves.

If prices keep touching the upper band on a regular basis, it is a sign of ‘overbought’ conditions, usually followed by a correction. Sep ‘10 and Dec ‘10 show such overbought conditions. If prices keep touching the lower band regularly, it is a sign of ‘oversold’ situation, usually followed by a rally. May ‘10 and Jun ‘10 are examples of oversold situation.

Note that the RSI and slow stochastic also confirmed the overbought and oversold conditions on the stock chart. Charts can remain overbought or oversold for long periods. So, selling when the price touches the upper band or buying when price touches the lower band may not be a good idea. A useful strategy when the chart is overbought is to maintain the 20 day SMA (middle line) as a trailing stop-loss. (If you have read my eBook, you will know what a trailing stop-loss is used for. If you haven’t read my eBook yet, why not? It is FREE.)

Some times the price moves above the upper band, or below the lower band. That doesn’t mean that these are sell or buy signals. It gives an indication of relatively higher or lower prices. Note that in Feb ‘11, the stock reached a lower bottom (below the lower band) while the RSI made a higher bottom. This positive divergence gave a ‘buy’ signal.

In Jun ‘10, the stock also reached a lower bottom, but failed to even touch the lower band. This was an early sign of a possible trend reversal. A ‘buy’ signal was generated because the RSI made a higher bottom.