The Volatility Index

Keeping on track with my relentless drive to try and pull down Beta as an overstated tool for decision making, today I will discuss something that derives its essence from Beta or Market Risk, but provides a much more accurate and wholesome picture. The National Stock Exchange's Volatility Index (VIX) is tracked to find the Market Volatility. It is based on the Nifty 50 and is used to calculate the expected market volatility over the next 30 calender days.

A high VIX indicates market fear while a lower value indicates that the markets are cold. The thumb rule for VIX is:

20s indicate complacent market

mid 30s to upper 40s indicates market fear

above 50 indicates panic

Between July and October 2008 the VIX crossed the 70 mark 5 times.

Currently the VIX is at 51 which still indicates a state of panic in the market. This coincides with the fact that it has been so difficult for Sensex to break the psychological barrier of 10000 and for Nifty to break the 3000 levels.

Posted by Rahul

Polarity for Severe Redemption: Mutual Funds

The aftermath of the current financial crisis has been felt by many avenues of the financial world which theoretically should have done well as a consequence of the liquidity crunch. Rate cuts across the globe by various central banks were targeted at increasing liquidity and getting the money wheel rolling. But despite this, Bonds, Gilt Funds, Open Ended Mutual Funds etc. have all felt excessive redemption pressure.

Experts try and explain this phenomenon by various arguments but by far the most widely accepted explanation has been Herd Mentality which branches out of Behavioral Finance. It is a result of coordination failures between investors or their own beliefs that they try and find evidence for. This in turn reinforces the belief. So something that starts as a thought turns into fear and then belief, forcing the investor to act in a specific manner. Investors feel that other investors will withdraw their funds and a bank run begins. What follows is frenzy selling to try and secure cash. The worst thing is that this cash is then kept idle as savings and not as any other mode of investment. This stops the circular flow of money and adds to the liquidity crunch.

Mutual Funds in particular tend to face very high redemption pressure at such times due to their open ended feature and high degree of retail ownership. The redemption pressure in turn forces the fund managers to adjust their portfolios and enter into costly and unprofitable trades, thus damaging the overall returns of the fund. Most Mutual Funds try and diversify a major portion of the portfolio into midcap or small cap stocks which makes them illiquid to a large extent. In such a situation, this problem of illiquidity of the stocks in the portfolio makes it difficult to execute large trades without adverse price impact. This phenomenon is referred to as Forced Trading.

Posted by Rahul

Chekpoints to Stock Analysis

There is no thumb rule or perfect way to analyse a stock but there are a few basic rules that one can try and follow to minimise unwanted deviations. This post will try and discuss a few basic criteria and also a few common mistakes done while picking and analysing stocks.

Common Mistakes

• Running the criteria selected for only one year (usually the current year)
• Applying/ following the same framework for stocks pertaining to different industries
• Picking stocks purely based on low P/E and high EPS
• Not taking market news and Mass Psychology into account
• Blue Chip companies with the highest Market Cap are the safest

Checkpoints

• First pick an industry which is growing and relatively shielded from economic tremors. Usually this would filter down to Power and Core Infrastructure
• Do not analyze stocks purely based on Ratio Analysis. Take Technical Analysis into account as well. Look at factors such as Volume of trade, Price Volatility of the stock, adverse or positive news impacting the stock
• Analyse stocks from capital intensive sectors on the basis on ROCE (Return on Capital Employed) and others on the basis of EVA (Economic Value Added)
• Always analyse every parameter for at least past 3 years or more to try and figure out a trend. (Never take an average. It is never a true measure)
• Look for P/E between 10 and 15 if you have a slight appetite for risk vs returns. Historically if a stock has had high P/E but is currently trading at a P/E of 5 or less due to adverse market conditions, then make it your first choice
• Analyze company earnings and check the Profit Margin vs the industry average. At least 80% of the earnings should come from Core Operations of the business
• Make sure that your investment horizon is at least 1 year
• Invest money that you would not need in the near future assuming 100% capital erosion

Posted by Rahul Gosain

Pump and Dump

The year 2008 was definitely not the best for most stocks and Penny Stocks are one of the worst hit. This post is to specifically warn our readers about a certain threat in 2009. Several large brokerages in India have lost millions in Penny stock holdings and I have come to know from my friends in the market that the year 2009 will witness widespread use of the Pump and Dump strategy to trap investors.

"Pump and Dump is a form of microcap fraud that involves artificially inflating the price of a stock through false and misleading positive statements, in order to sell the cheaply purchased stock at a higher price". (Source: Wikipedia)

So don't fall for a call or an e-mail by your broker this year if he claims to have some inside information on a stock or assures you very high short term returns. You just might fall victim to an oversold stock while your brokerage house mints money in the process.
Be Informed. Be Safe. Be Smart

Posted by Rahul Gosain