Monday, January 21, 2008

End of the Markets

When the market moves in a single direction for a long time and all analysts are making claims that the markets will go higher, many investors come and invest in the markets. Most active are those who have been waiting for a long time on the sidelines and those who have “missed the bus” till now and are thinking that if they wait more they will “miss the bus” again. This leads the markets to go higher and at a much faster pace. This was what was happening in the market when they started rising since August 2007 from a level of 4000 (Nifty). Such an increase in the markets make valuations expensive and the “smart money” (the large investors and FIIs) start getting out because of two reasons:

1. The valuations are expensive and they would not like to stay invested at such high valuations.
2. They have bought at much lower levels and would like to sell to realize their notional profits.

This leads to bouts of selling in the market but the “not so smart money” (the retail investor) is still buying, which makes them happy because they wanted to buy in a correction but that correction was actually caused by the selling of the “smart money”. So, the “smart money” sells and prices come down, the retail investors buy and the prices go up. This process goes on till all retail investors make an entry into the market and all the FIIs are out. Then comes a time when there are no new buyers and the prices start coming down. The retail investors keep waiting because they have heard analysts speaking about higher levels and view this as a temporary fall.

Gradually, with more fall, some risk averse investors start getting out which leads to more selling. More selling means prices coming down further and then because of the increased risk, the margins by the exchanges go up. To meet those increased margins, there is more selling of stocks in the cash market, which leads to a further fall in prices. This leads to increased margin calls across the board and more selling and a sharper fall in prices. By this time, the retail investor has lost a lot of money and does not have any more money to put in in the form of margins. This forces the stock exchanges to close their positions and it leads to a drastic fall, as was witnessed today. This is what has happened in the markets the last week and today when the Nifty came down by 1400 points and the Sensex by about 5000 points from their respective all time highs. This process is known as capitulation when all the retail investors have got out and have vowed not to enter the markets again.

Suddenly, the valuations become cheap again because the fundamentals remain the same and the “smart money” is prepared to enter again. And the markets start rising again. That is why it is commonly said in the market parlance that, “When you think everything has finished, that is, actually, just the beginning (of another bull market)”.

We, at Surakshit, feel that capitulation was witnessed today and we should see the markets rising again. The worst may, finally, have been over.
The following articles may prove to be interesting reading. Click on the links below to proceed:

Happy investing!!!