9 mins read . 14 Nov 2022
Like in any field, share market investment also has its own share of myths. Now, myths are not born out of thin air. They are influenced by the experiences of people, by how brokers sell equities to investors and by how the media portrays stock market investing. Stock market myths abound in the market and over time myths turn into stock market mistakes as people tend to believe that these myths are the reality.
Between the myth and the truth, the stock market traverses its path. There are many myths about share market but we will cover a few of them that are extremely popular. Stock prices are about the future, so most of the stock market myths invariable pertain to the way future share prices are determined. At the end of the day, share market price may be market determined, but there are ways of estimating it intelligently.
Here we look at 8 popular myths pertaining to stock market investing. These myths have been perpetuated over time and have gradually got into the investing ethos.
1) Investing in the stock market is like gambling. That is the first and biggest myth. At least, in India, most elders would dissuade you from investing in stock markets. Their contention is that stock markets are speculative and hence very risky. Since stock markets have an element of speculation, people tend to equate stock market investing and trading with gambling. However, that is far from the truth. Remember, that gambling is about odds and you have little control over the outcome. Like gambling, even stock markets entail risk to capital, but then it is possible to research and do intelligent investing in stock markets. Gambling is all about probabilities. The biggest difference is that in the stock markets, the long term always favours the investor. However, in gambling, the long term always favours the casino.
2) It is possible to catch the tops and the bottoms of the market. This may be possible at a very broad level. For instance, when the Nifty is trading at P/E of 10, you can say with confidence that odds are in favour of the bulls. Similarly, when the Nifty is at P/E of 35, you can say that the odds are favour of the bears. But to say that somebody can consistently catch the tops and bottoms of stocks is being too optimistic. Even the best of investors would tell you that catching bottoms and tops is just not possible on a consistent basis. In fact, timing the market is not even required, because in long term investing it is time that matters more than timing.
3) You can diversify by owning a large number of stocks. The question is what is the meaning of large number of stocks. Obviously, you don’t need to own 100 stocks to diversify your portfolio. The global estimates is that an investor can be sufficiently diversified if they own around 12 to 15 stocks. Beyond that point, it is hard to find stock with low or no correlation. Once you add up to 15 stocks with low diversification, you are well diversified. After that, you only substitute risk, you don’t reduce risk.
4) Penny stocks are good because down side risk is limited. That is a huge myth. Penny stocks are like falling knives. They will just keep falling. You can buy a stock at Rs5 and you can still lose money. That is because in most cases the company has become unviable shell company. Such companies trade at positive valuations only because stock prices cannot be negative or even zero theoretically. But once a company is in trouble and seeing a run on the stock price, think with your feet. Catching penny stocks is like catching a falling knife.
5) Stock market investing is for the wealthy. That is not true. Many wealthy and extremely successful investors have started with small capital and then made it big. In the stock markets it is easy to make profits with discipline and it is also easy to lose money without indiscipline. The choice is yours what you want to be. The moral of the story is that you don’t need loads of money to invest in the stock markets. You just need to identify quality stocks with the right growth trajectory and then be willing to wait.
6) Taking on higher risk means higher returns. That is a huge myth in the stock market. You must understand the causality first. Higher returns do entail a higher level of risk. However, that has to be calibrated risk. It is not just about how much risk you take but about how much of calculated risk you take. Just taking more risk is not enough to make more profits.
7) Stocks that go up must come down. That depends on what you are looking at. For instance, if you are looking to short a stock just because it has risen sharply, you could be in trouble. For instance, stocks like Bajaj Finance have gone up 100 fold in the last 8 years with no stoppage whatsoever. There are companies that are constantly getting re-rated positively and there is no limit to the price they can touch. It would be naïve to believe that any stock that goes up must come down. Despite intermittent corrections, many stocks have been on structural uptrend for years.
8) I can a buy a stock because FIIs are buying it and a star investor is also buying it. That is a very common myth. You cannot buy a stock just because an FII is buying the stock. Firstly, FIIs invest billions of dollars and have the ability to wait for years to get big returns. Secondly, their risk appetite and their capacity to take losses is of a much higher order. Unless you have a similar capacity, you must not attempt to copy them. Remember that many of the FII buying positions are arbitrage positions. That means; they buy in the cash market and sell in the futures market to lock in the risk-less spread. Just because you see the FPIs buying, it does not mean you should also jump in and buy it. If it is an arbitrage position, then it is not a bullish view at all.
These 8 myths are largely illustrative but would help you handle the investment journey with greater care and caution.