Behavioural traits of a successful investor

To be a successful investor in the stock market, one needs to develop several skills:

• Learn how the stock market functions – the roles played by short-term traders, long-term investors, operators, company promoters, brokers, FIIs, DIIs, NSDL/CSDL, stock exchanges, SEBI
• Know about the various types of securities that are traded – stocks, convertible and non-convertible debentures/bonds, warrants, ETFs, mutual funds, bonus/rights shares, bonus/rights debentures
• Be aware of related information – dividends, interest on debentures/bonds, tax implications of buying and selling of various securities
• Have working knowledge of economic concepts – supply and demand, money supply, inflation/deflation/stagflation/recession, surplus/deficit, interest rates, impact of global economies on domestic economy, effect of economic changes on different business sectors
• Reasonable proficiency in accounting concepts – debit/credit, assets/liabilities, capital/reserves, equity/preference shares, payables/receivables, raw materials/inventory, profit/loss, cash flows, and ability to calculate and compare EPS, P/E, P/BV, RoNW, RoCE, Debt-Equity ratio, etc.

But the most important skill of all is to learn about oneself – the behavioural traits that determine who will be a successful investor and who will be an ‘also ran’.

In a recent article posted at investopedia.com, the following behavioural model developed by Bailard, Biehl and Kaiser was presented:

Investors are classified according to their decisions and actions (‘impetuous’ at one end and ‘careful’ at the opposite end) as well as their levels of confidence (‘confident’ at one end and ‘anxious’ at the other end). Based on these behavioural traits, investors are divided into five groups:

• Celebrity – anxious and impetuous, a follower of the latest investment trends
• Adventurer – confident and impetuous, a strong-willed risk taker
• Individualist – confident and careful, with an analytical and self-reliant approach
• Guardian – anxious and careful, willing to sacrifice riskier growth for more stable returns
• Straight Arrow – equally shares the above four behavioural traits

Apparently, greatest investment success is achieved by those with the ‘Individualist’ behavioural trait. What if one has one of the four other behavioural traits? Should they exit from the stock market?

With discipline and perseverance, behavioural patterns can be changed – provided one is aware which behavioural category one belongs to.

Moral of the story? To be a successful investor – know thyself.

Related Posts

Become a successful investor by avoiding 'herd mentality'

Are you an irrational investor?

Some practical examples of Behavioural Finance

A strategy to beat that ‘missed out’ feeling

A sudden gush of FII money has propelled the Nifty to a 1000 points gain from its Dec ‘11 low, and caught experts and small investors unawares. What had looked like a typical bear market rally is beginning to look more like the first stage of the next bull market.

Many who failed to buy at the low prices of 2011, and those who booked profits and moved to cash in the hope of buying at much lower prices, are feeling that they ‘missed out’ on the rally. How do investors ensure that they don’t miss out on opportunities to buy (or sell)?

In this month’s guest post, Nishit discusses the FoC (Free of Cost) strategy to beat that ‘missed out’ feeling.

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The stock market has rallied more than 20% from the Dec ’11 bottom. Many of us are feeling left out from this rally. What must one do to avoid such a situation? The stock market is one place where one can create a lot of wealth over the long-term. So, how does one go about doing this?

Step 1: Identify about 10 businesses which you feel will do well over the long term (as in next 5-10 years). Remember you are investing in businesses - not only stock prices.

Step 2: Once these businesses are identified, keep a watch on their stock prices. The strategy one will adopt is to keep investing into these stocks at regular intervals.

Step 3: With knowledge about the stock market and Nifty, buy these stocks at attractive valuations. There are 3 things which can happen to the stock prices. They can go up, go down or remain flat.

1. If the prices go down, be ready to average the stocks and buy them at a cheaper rate. For doing this, awareness of the broader trend of the market helps a lot.
2. If prices go up, be ready to book profits. One very effective way of doing this is by making the shares ‘Free of Cost’. Let me give you the example of SAIL. Say 100 shares were bought at Rs 90. Now the price has rallied to Rs 110. I feel I had enough of the ride and expect a correction in the markets. I book out 84 shares and remove my cost price. Now, the remaining 16 shares are free for me (i.e. my holding cost becomes zero). I know that SAIL will continue making steel for the next 10 years (and may be much longer than that). These 16 shares I will not touch unless there is a blow out rally where the Nifty trades in 22 + P/E which would be around 6300+.
3. If prices remain flat, I just wait and watch.

With this strategy, I will not be sad if prices go up and I have not bought anything fresh. If prices go down, I will be having cash to add to my holdings.

The risks to this strategy are the identification of the companies. If one goes for fly-by-night operators and the company goes bust, then one is in trouble. The ‘Free of Cost’ shares become worthless. Hence one has to keep a watch on the fundamentals of the companies and take a call to move on to other stocks.

This approach combines both fundamental and technical aspects. In the last year itself there were 4 bear market rallies. Even if one had booked with about 15-20 % profits one would have had a sizeable quantity of ‘Free of Cost’ shares right now.

This is one way to create long term wealth in the stock market.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)

10 Reasons why small investors should love a bear market

Most small investors detest a bear market. The helpless feeling of watching stocks bought with hard-earned money falling into oblivion can be quite traumatic, and cause sleepless nights.

In a desperate and misguided effort to salvage a losing position, investors start ‘averaging’ – buying more shares at progressively lower prices. The stock doesn’t know that some one is ‘averaging’ it – and keeps going down further! The ‘average’ price of the stock decreases, but the losses increase.

Is there any remedy for this fairly common ailment? Turn a disastrous situation into a learning experience. Find out the reasons why small investors should love a bear market. Here are 10 of them.

1. Every one loves bargains. The best bargains in stocks are found during a bear market. Good stocks are available at 40%-50%-60% discounts to their recent peak values.

2. Experts and analysts appearing on TV or writing in business papers stop recommending third rate stocks. They may actually discuss about some decent companies. No longer will you hear that Suzlon is a great buy or Bartronics is the next Infosys.

3. Email or cell phone inboxes will not get overloaded with SMS stock tips about unknown companies from unknown brokerage houses. Most of those brokerages go belly-up during a bear market.

4. No one wants to discuss about stocks at weddings or college reunions. One can actually have intellectually stimulating conversations with relatives and friends – instead of saying “I’ve bought this” or asking “Why did you sell that?”

5. Working hours will not be wasted by staring at stock tickers scrolling on computer terminals. Up to the minute stock updates on cell phones will get disabled. Productivity at work places will improve.

6. One can get a haircut or a shoeshine in peace without getting stock tips from the barber or the shoeshine boy.

7. A bear market separates the short-term, one-hit rock-star companies from the true long-term wealth creating companies. The stocks that don’t fall much in a bear market are the ones that provide dividend income and stability to your portfolio.

8. If one is unfortunate enough to come face to face with a bear in a forest, the best thing to do is not to run or try to fight but to play dead. In the stock market, one can play dead by investing in fixed income avenues. Interest rates are usually higher at such times.

9. The importance of proper asset allocation becomes clear. Spreading investments among equity, fixed income, gold and cash not only saves a portfolio from annihilation but the asset allocation gives clear signals about when to buy and when to sell.

10. A bear market tests an investor’s mettle. Those who turn tail and run are just not meant to be successful investors. Those who can stick it out and learn from their mistakes are the ones who may be able to build wealth over the long term. 

Why do small investors get ‘cheated’?

The cynical answer to the question is: Because they deserve it. The cynicism can be explained by a recent incident during my last visit to the local market.

I was buying half a kilo of Kashmiri apples – the small, roundish kind with alternate patches of bright red and light green colours. They have a crisp, lightly sweet and fresh taste that takes me back on waves of nostalgia to my only trip to Kashmir more than 50 years ago. A place of such pristine and gorgeous beauty I have rarely ever seen again. But I digress.

As is my habit, I asked the rate per kilo, and was told by the young fruit vendor that it was Rs 80. As the young fellow was weighing the fruits, a middle-aged gentleman came by. He wanted to buy half a kilo of the Kashmiri apples as well, and proffered a Rs 50 note with this comment: “It is Rs 100 a kilo, isn’t it?”

The fruit seller glanced at me quickly, and observing my blank expression, simply nodded his head and promptly took the Rs 50 note. Now, being overcharged Rs 10 for half a kilo of apples may not seem like a big deal. The point is, the buyer unnecessarily tried to show-off that he was a knowledgeable buyer, and allowed himself to be ‘cheated’.

Should I have pointed out the correct price to the buyer and saved him Rs 10? That would have broken the mutual trust that has developed between the young fruit vendor and me over the past several years. I pay him whatever rate he asks, and he always gives me the best fruits from his pile.

What does all this have to do with investments? Change the ‘half a kilo’ to ‘500 shares’; ‘Kashmiri apples’ to ‘Dabur India’ (say); and ‘young fruit vendor’ to ‘Rakesh Jhunjhunwala’ (or, Ramesh Damani). A small investor could have bought Dabur shares for Rs 80 a few months back, but may choose to buy them at Rs 100 now. Due to the bear phase, the stock goes nowhere. After a couple of months, the stock’s price may drop to Rs 90, and the investor will probably exit in a hurry with a Rs 10 loss. Except that the loss is not Rs 10, but Rs 5000 – since the original quantity bought was 500 shares.

The investor feels ‘cheated’ because he bought a well-known FMCG stock, and still lost a decent amount of money. The fact that he made a couple of serious mistakes - buying at a higher price, and then selling at a loss because of a short-term mentality – may not dawn on him. A few more similar experiences may keep the investor permanently away from the stock market – with the feeling that the market is ‘manipulated by operators’ to ‘cheat’ innocent investors.

The moral of the story? Don’t allow yourself to be cheated. Do some prior preparation and planning. Talk to veterans of the market. Read a few books. Understand how the game is played. Opening a demat account and a trading account is a necessary formality but not adequate preparation for buying stocks.

Fool’s Four stock investment strategy

Let me first assure readers that the Fool’s Four (or Foolish Four) stock investment strategy is neither foolish, nor is it meant to make fools out of investors. It is a ‘mechanical’ investment strategy that can be useful for those investors who haven’t yet developed their stock-picking skills, and have probably lost money chasing ‘cheap’ small-cap stocks.

The Fool’s Four strategy was designed by The Motley Fool investment group as a refinement to the Dogs of the Dow strategy. I had written about the Dogs of the Dow strategy in a post back in Apr ‘10. The strategy works just as well with Sensex stocks. (If you are a recent visitor to this blog, or have forgotten what I wrote more than a year back, you may want to read the earlier post first.) 

Since it is a variation of the Dogs of the Dow strategy, the Fool’s Four involves selection of four stocks from the Dow index (or Sensex) based on low price and high dividend yield. The dividend yield is calculated by dividing the actual dividend per share in Rupees (not the percentage dividends usually announced) by the current market price (CMP) of the share in Rupees.

The selection process involves calculating the square roots of the CMPs, and the dividend yields of each of the 30 Sensex (or Dow) stocks. Next, divide the dividend yield by the square root of the CMP to find a ratio for each stock. Then rank the 30 stocks based on a descending order of ratios (i.e. the stock with the highest ratio will have a rank of 1, and the stock with the lowest ratio will have a rank of 30).

If calculating the square roots of the CMPs is too much of a challenge, you can calculate the square of the dividend yield (multiply the dividend yield by itself) and divide it by the CMP. The ratios will be different, but the rankings will be the same.

Now comes the interesting part. Drop the stock with the rank of 1, and choose the next 4 (ranked 2 through 5). Buy equal Rupee (or Dollar) amounts of each of the short-listed four stocks, and hold them for a year. Why drop the stock with the number 1 rank? There is a good possibility that it may be in financial difficulties. Sensex (or Dow) stocks are supposed to be financially stable, but the odd JP Associates do get in trouble by being over-ambitious.

Is there any logic behind the Fool’s Four strategy, or is it just some foolish number crunching? Apparently, academic studies have proven that (a) high dividend yield leads to better market performance (which is the logic behind the Dogs of the Dow theory); and (b) stock price variations (or ‘beta’) is correlated with the square root of the price.

So, the Fool’s Four strategy gives slightly better results than the Dogs of the Dow (or Sensex) strategy. That doesn’t mean that all four stocks will beat the Sensex. The underperformer(s) should be replaced by stocks from the short-list of four selected next year. The Sensex-beaters can be retained.

(Note: Interested readers can do the exercise of selecting the four stocks from the Sensex that meets the above selection criteria. I’ll post their brief technical analysis once I receive your feedback. Then we can check back after one year and see how well the strategy works.)

How many shares of each company should I buy?

A common question vexing many small investors is how many shares of each company to buy. A young investor friend did quite a detailed analysis of a particular company, and took some inputs from me to fine-tune his analysis process.

After a few iterations to arrive at a proper valuation, he decided that the current price had enough ‘Margin of Safety’ and decided to buy the shares of the company. How many shares did he buy? 100. Nothing wrong with that. Small investors can’t always spare a lot of cash.

What happened next? Within a short time, the stock spurted on large volumes and doubled in price. My friend was left ruing the fact that he didn’t buy more shares even though he had spare cash. Shortly thereafter, the company announced a bonus issue, and the stock spurted even higher.

In spite of doing due diligence, a big money-making opportunity was lost because a sufficient quantity of shares were not purchased to start with. Such opportunities don’t come often. So, how do you decide what is a ‘sufficient quantity’?

In last Tueday’s post: How many stocks should I buy?, I had outlined how a Rs 5 lakh portfolio can be allocated to large caps, mid caps and small caps. The suggestion was: 8 large caps worth Rs 50,000 each, plus two mid caps and two small caps worth Rs 25,000 each.

While the money allocation to each category of stocks would automatically limit how many shares of each company you can buy, it won’t eliminate the risk factor. Different investors have different risk tolerance levels, and that should be built into the allocation.

Here is a simple example. Suppose you decide that the maximum loss you can afford in the large cap stocks is 5%, and 10% in the mid and small cap stocks. Your large cap allocation is Rs 50,000 to each of 8 companies. Your mid and small cap allocation is Rs 25,000 to each of 4 companies. A 5% loss in the large caps and a 10% loss in the mid and small caps would limit the loss to Rs 2500 per stock.

(If all your picks fail to perform and hit the respective stop-loss levels, your total loss will be limited to Rs 30,000; i.e. 6% of your Rs 5 Lakh portfolio.)

If you decide to buy a large cap with a current price of Rs 100, you can buy 500 shares with a Rs 5 stop-loss to ensure that you limit your loss to Rs 2500. What if a mid cap is trading at Rs 100? Should you buy 500 shares in that case?

Since mid caps tend to fluctuate more, you had chosen a 10% loss as your limit. That would mean buying a Rs 100 stock with a Rs 10 stop-loss. Buying 500 shares may incur a loss of Rs 5000 if your stop-loss is hit. So, you need to buy only 250 shares with a Rs 10 stop-loss.

The example is simplistic to make a point. You need to adjust stop-loss levels for each stock that you buy according to your comfort level and the beta value (i.e. the amount by which a stock fluctuates with respect to an index) of each stock.