10 don'ts for smart stock market investing

This is a great check list of 10 habits, impulses and tendencies you steer clear of in order to keep your investments healthy.
1. Don't be arrogant
The market teaches humility and that is how you must approach it. As soon as you believe you know why the market acts the way it does, you will be proven wrong. Arrogance can kill a portfolio. You must be able to admit defeat and preserve enough capital to fight again.
Following point and figure charts, which depict the battle between supply and demand, helps keep you out of the 'I know why' attitude of investing.
2. Don't wait until you feel comfortable to buy when a sector reverses up
Falling into the waiting trap is a great way to ensure that you buy the stock at a higher price. When sectors reverse up from oversold levels, it is often when the news is the most dire.
Conventional wisdom would suggest this is the last place in the world you would want to invest. Buying at this time is gut wrenching, but to be successful you must act with complete confidence.
As the sector moves higher, the comfort level increases. If you use comfort level as your guidance, however, you will for sure leave a lot of money on the table, or worse, buy as the sector peaks.
3. Don't be afraid to buy strong stocks
Don't avoid stocks just because they have gone up. Doing so will keep you out of the long-term winners. In the United States, for example, this mentality would have kept you out of General Electric, which was up 188 per cent between January 1995 and December 1997 only to see it rally another 96 per cent by the end of 2000. It also would have kept you out of Cisco, which was up 376 per cent between January 1995 and December 1997, and then it moved up another 312 per cent by the end of 2000. These are only two examples, but there are many others.
More important than how much the stock is up is its supply and demand relationship. By evaluating the point and figure chart, you can gain insight into this relationship and whether or not the stock is likely to move higher. Stocks that double can easily double again. Don't miss out on these great opportunities.
4. Don't sell a stock simply because it has gone up
Doing this cuts profits short. Buying a stock right is only half the battle. You have to be able to sell it right to win the war. Just because a stock has rallied 30 per cent or 50 per cent, don't be tempted to take your trade off for that reason alone.
Consider trimming the position and leave part on the table to continue in the uptrend. Let profits run.
5. Don't buy stocks in extended sectors because 'it's different this time'
On the surface, the stock market appears different all the time. The leadership changes: in come new stocks into the Nifty 50, and then out they go. Small-cap stocks outperform for a while, then it's back to the large caps.
However, the underlying forces that drive the stock market are always the same. They are true and time-tested and do not change. They are supply and demand. That's why buying sectors that are extended (overbought) will not be different this time.
6. Don't try to bottom fish a stock in a downtrend
'The trend is your friend' is a true statement. So don't go against it without some inkling that the trend has changed.
Bottom fishing a stock in a downtrend is the opposite of being afraid to buy strong stocks. Do not buy a stock just because it fell sharply. You want to buy a stock that is likely to move higher, not one that is not likely to fall further.
At a minimum, wait for the stock to show a sign that demand is back in control and suggesting higher prices. That may be a simple buy signal on the chart or a reversal back to the upside after holding an area of support. Also remember why you initiated the position. Be careful not to let a trade turn into something else.
7. Don't buy a stock simply because it is a 'good value'
These days, value is in the eyes of the holder, and therefore it is a subjective term at best. If a stock has become a good value, ask why. This is important, because a stock can stay a good value by not moving for the next decade, or worse, become a better value by dropping another 20 per cent.
The true value of a stock is determined by its capital appreciation potential, not numbers on a balance sheet. The basis for capital appreciation lies in the supply and demand relationship of the stock. Appreciation can occur only if demand grows stronger for the stock and buyers are willing to pay a higher price. Watch the point and figure charts to determine if a stock is likely to move higher in price and become a good value.
8. Don't hold on to losing stocks and hope they come back
Hope is eternal, but your portfolio is not. Holding on to a losing stock is the best way to let your losses run. Combine this mistake with selling a stock that has gone up and you can create a portfolio of dogs.
When buying stocks, there will always be some losers: Count on it. However, how you manage that loss often determines the success or failure of the overall portfolio. Keep losses small so that you have the capital to play again. Hanging on to losing positions, hoping that they will come back, can be deadly.
A $50 stock that is stopped out at $40 is a 20 per cent loss. It's a bad trade, but it is manageable. In order to recoup that loss you would have to make 25 per cent on a $40 stock. What if you held on to that $50 stock, hoping that strong earnings would come in and turn it around, but instead it continued lower to $25?
Finally, you decide to exit, but now it takes a 100 per cent return from a $25 stock just to get back to even. Those results are hard to find, and if you are able to find one, you don't want to waste it on getting back to even
Learn to recognize your losing positions for what they are. If a stock cannot trade above its support line or is not outperforming the averages, find one that is and swap it.
9. Don't pursue perfection
There are two types of mistakes to discuss here. The first is the constant belief that there is a better system out there, and you need to find it.
Using a new system to invest each week will not get you to your goal. You will become good at nothing and moderate to bad at everything. To be good requires that you stay focused, disciplined, and skilled at whatever methodology you choose.
You need to have the strength of conviction in your chosen discipline to learn from mistakes rather than to run away from them and find another methodology. There is no Holy Grail in investing.
The second mistake is to wait for the perfect trade. There is no such thing. If you only buy stocks that have all positive attributes you will maintain a portfolio of cash. Rarely, if ever, do you find a stock that has all the pluses on its side.
Look for the big ones like relative strength, trend, and signal. Also remember that 80 per cent of the cause of price movement in a stock is based on the market and sector. You are better off being approximately right than precisely wrong.
10. Don't do anything based on a magazine cover
Following the hot news that appears on magazine covers is a shortcut to the poor-house. Why should you follow the advice of someone who has just moved from the society pages to the business section?

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The worst is yet to come

Let's begin with some good news. Large companies with proven track records haven't disappointed the market. In fact, the third-quarter results of Reliance Industries, Infosys, ITC and ICICI Bank have been either along expected lines, or better than the Street's estimates. But that's not true for the rest of India Inc. The earnings of most mid- and small-cap companies have deteriorated alarmingly.
The net sales of 450 firms, which declared Q3 results till 23 January, have grown at a healthy 19.34% compared with the same quarter in the previous fiscal. But their net profits have fallen by 22.15% during the same period. The steep drop in profits is worrying because these companies registered a robust 40.29% growth in profits in the third quarter of 2007-8. The real problem is with the small and mid-sized firms, whose net profits in Q3 2008-9 have fallen by a massive 39%.
"Most large corporates haven't really disappointed us. The stress is more pronounced in case of midcap firms, where some of the results were worse than the already toneddown expectations," says Gaurav Dua, head of research, Sharekhan.
So, should you invest across stocks as the indices fall to attractive levels? Or should you look only at blue chips? To answer these questions, one needs to figure out what is likely to happen in the next few quarters.
The third quarter of 2008-9 was expected to be one of the weakest in recent years. By November 2008, analysts had scaled down their expectations and the markets had discounted the prices of most stocks. Profit margins were under pressure during Q2 due to inventory losses as most companies were saddled with raw materials purchased at the peak of the commodity cycle in July-August 2008.
Sadly, there may not be any respite in Q4. Reasons Dua: "Though some of the companies will begin to show relief on margins due to lower raw material costs, the demand environment will remain muted." This will happen because of several factors. Fragile sentiments, cash crunch and falling exports will take their toll on the Indian companies. As firms curtail investments, cut costs and reduce production, it will lead to a slump in economic activity.
"Industrial growth will slow down to 2.5% this year, against 9% in the previous fiscal. Given that the business confidence will remain low, the slowdown will spill over to 2009-10," predicts Anubhuti Sahay, associate economist at the Standard Chartered Bank.
In such a scenario, even sectors such as IT and banking, which were insulated from the drop in demand so far, can face problems. Commenting on the Q3 results, Wipro chairman Azim Premji said, "We are living in tough times; the macro-economic challenges are impacting businesses across segments." Both Infosys and Wipro have cut their annual guidance.
"The revenue visibility across companies appears to be, at best, limited to a quarter," says Abhiram Eleswarapu, analyst at BNP Paribas. Therefore, in the case of IT stocks, existing and potential investors need to wait and watch before taking investment decisions.
The same is true for banks, which posted an amazing profit growth of over 30% in Q3. But this is not likely to sustain. Moderate credit growth, lower interest rates on government bonds and rising NPAs will put pressure on earnings. "We foresee a slowdown in banks' earnings over the next few quarters as the G-Sec gains become muted," says Sonam Udasi, vice-president of research at Brics Securities.
Analysts say that despite low interest rates and the government's intention to trigger a demand-led growth cycle, the situation might improve only in the second half of 2009-10. "Once the impact of the interest rate cycle is passed on and firms begin to reduce their working capital requirement, the bottom line growth is expected to improve," says Sankaran Naren, CIO, equity, ICICI Prudential AMC.
Among sectors, while realty and commodities might slip, FMCG and pharma may continue with their growth story. Cash-rich companies with low or negligible debt are likely to outperform. "Investors should avoid aggressive or leveraged sectors, and focus on companies with excellent financial and operational management," concludes Naren.

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Why being a copycat investor can hurt you

While some investors are trailblazers and do their own research, many investors attempt to mimic the portfolios of well-known investors, such as Warren Buffett of Berkshire Hathaway, in the hope of being able to cash in on those investors' world-class returns. But copying another investor's portfolio, particularly an institutional investor's portfolio, can actually be quite dangerous. So, before you jump on the copycat bandwagon, get to know the pitfalls of this approach to investing.

An inability to adequately diversify holdings

It is not uncommon for a major institutional investor, such as a mutual fund, to own more than 100 stocks in a given portfolio. Even Berkshire Hathaway (Warren Buffett's investment vehicle), which has a tendency to invest in fewer stocks as opposed to more, owns shares in some 38 (as of June 30, 2008) different public companies!

Institutional investors like Warren Buffett are able to spread their risk over a number of companies so that if one particular company, sector, industry, or even country hits a rough patch, there are other investment holdings that may pick up the slack. Unfortunately, most individual investors have neither the funds, nor the financial wherewithal to ever achieve such diversification.
So what do investors do when they realize that they cannot maintain as many positions as an institutional investor?Usually, the individual investor will copy or mimic a small portion of the institution's holdings (that is, heavily invest in some holdings and ignore others entirely). Unfortunately, this is where trouble can occur - especially if one or more of those core holdings heads south.An individual investor's inability to adequately mimic an institution's diversification profile and mitigate risk is a major reason why many individuals fail to outperform major mutual funds - even if they maintain similar holdings.

Different investment horizons

Many people like to refer to themselves as longer-term investors, but when it comes down to it, most investors want to see results in the first 12 to 24 months that they own a particular stock.

In fact, according to an often-cited November 2001 study by Gavin Quill (a senior vice president and director of research studies at Financial Research Corporation, a financial services research and consulting firm), mutual fund holding periods in 2000 were only about three years! That is well shy of the more than 30 years that Berkshire Hathaway has owned shares of Washington Post Company. In other words, on average, institutions seem to have much more patience than their individual-investor counterparts do.

In short, even if individual investors achieve diversification similar to the institutions they are looking to mimic, they might not be able afford or have the patience to sit on a given investment for five or 10 years, as they may need to tap into the funds to buy a home, to pay for school, to have children or to take care of an emergency situation, and doing so may adversely impact their investment performance.

Institutional knowledge/research

In spite of regulations meant to level the playing field between individuals and institutions (such as Reg FD, which outlines a company's disclosure responsibilities), institutions often employ teams of seasoned industry analysts. These trained experts typically have many contacts throughout the supply chain and tend to have more frequent contact with a given company's management team than the average individual investor.Not surprisingly, this gives the institutional analysts a far better idea of what is going on at a company or within a given industry. In fact, it is almost impossible for the individual to ever gain the upper hand when it comes to such knowledge.This relative lack of knowledge about future earnings potential, opportunities for growth, competitive forces, etc. can adversely impact investment results. In fact, a lack of knowledge is another major reason why many individual investors tend to underperform mutual funds over time.
This is compounded by the fact that analysts can sit and wait for new information ,while the "average Joe" has to work and attend to other matters. This creates a lag time for individual investors, which can prevent them from getting in or out of investments at the best possible moment.
Keeping tabs on institutions is tough

Even if an individual has enough money to adequately diversify him- or herself, the willingness to hold positions for an extended period of time and the ability to accurately track and research multiple companies, it is difficult to copy the actions of most institutions.Why? Because, unlike Berkshire Hathaway, many mutual funds buy and sell stocks with great vigor throughout a given quarter. In fact, take T. Rowe Price as an example. According to the company's website, its Capital Opportunity Fund (which invests primarily in domestic securities) has a turnover rate of 63.5 as of July 31, 2008. That's big. This makes positions like these are hard to mimic because even if you had access to databases that track institutional holdings the information is usually updated on a quarterly basis.What happens in between? Frankly, those looking to mimic the institution's portfolio are left guessing, which is an extremely risky strategy, particularly in a volatile market.
Trading costs can be huge, and treatment may vary

By definition, institutions such as mutual funds have more money to invest than the average retail investor. Perhaps not surprisingly, the fact that these funds have so much money and conduct so many trades throughout the year causes retail brokers who service these accounts to fawn over them.Funds often receive favorable treatment. In fact, it's not uncommon for some funds to be charged a penny (or in some cases a fraction of a penny) per share to sell or purchase a large block of stock - whereas individual investors will typically pay 5-10 cents per share.In addition, even though there are rules to prevent this (and time and sales stamps that prove when certain trade tickets were entered), institutions often see their trades pushed ahead of those of retail investors. This allows them to realize more favorable entry and exit points.In short, the odds are that the individual, regardless of his or her wealth, will never be able to garner such preferential treatment. Therefore, even if the individual was able to match an institution in terms of holdings and diversification, the institution would probably spend fewer dollars on trades throughout the year, making its investment performance, on a net basis, better overall.
Bottom Line:While it may sound good in theory to attempt to mimic the investment style and profile of a successful institution, it is often much harder (if not impossible) to do so in practice. Institutional investors have resources and opportunities that the individual investor cannot hope to match. Retail investors may benefit more, in the long run, from an investment strategy more suited to their means.

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Do sinking stocks make you grind your teeth?

Millions of people clench and grind their teeth without realizing it, particularly while they’re sleeping. Both habits can escalate into serious pain and problems of the temporomandibular joint, or TMJ, which joins the jaw to the skull. And they are far more common in times of stress.
“TMJ and Wall Street go hand in hand, especially lately,” says Anthony Chillura, a long-time dentist in New York City’s financial district. “Some people get ulcers. Some people get high blood pressure. Some manifest their stress dentally.”
While most people clench or grind their teeth — a condition known as bruxism — from time to time, about 10% suffer from TMJ problems — and those can set in suddenly. Sarah Aroeste, a professional singer, woke up one morning last summer with shooting pain every time she tried to open her mouth. “It was excruciating, and it happened right before an important concert,” she says. The pain persisted for weeks until a combination of a mouth guard, painkillers, Valium, a liquid diet and massage made it ease.
TMJ disorder can mimic migraine headaches, earaches, sinus infections and tooth abscesses. It can cause dizziness, ringing in the ears and muscle pain that radiates down the neck and shoulders. Adding to the frustration, it’s often hard to get insurance coverage for treatment, since medical insurers view it as a dental problem, and dental insurers view it as medical.
In some people, the real culprit is a misaligned bite — either from birth or a trauma such as a fall or a collision in sports. “It’s like you’re chewing with a limp,” says Harold Gelb, an oral orthopaedist in Manhattan. He says such problems can build for years and flare up under stress.
Other people “brux” only when they’re under stress, especially during times of change, like a divorce or financial crisis, says Andrew S. Kaplan, another Manhattan TMJ expert and former president of the American Academy of Orofacial Pain. “Once they get acclimated to the new situation, the grinding sometimes stops.”
Much of the tension comes out at night, when higher centres of the brain that keep it in check during the day are asleep, says Noshir Mehta, director of the Craniofacial Pain Center at Tufts University School of Dental Medicine.
A clenched jaw can exert up to 300 pounds of pressure, which can wear teeth down and crack them, particularly where there are cavities or old fillings. Over time, arthritis, inflammation and degenerative changes can occur in the jaw joint. The disc in the joint can shift and make clicking or popping sounds. It can also “lock” out of place, making it impossible to open the mouth more than an inch or so, as it did with Aroeste.
Women have more TMJ problems than men — possibly because the jaw muscle bulks up in men, whereas it becomes dysfunctional in women, says Dr Mehta. He notes that people taking antidepressants are also more prone to bruxing, for reasons not well understood.
If you suspect that you’re bruxing — if you wake up with a sore jaw or your partner complains about a grinding noise — it’s a good idea to check with a dentist before it escalates.
The most common treatment for TMJ is a night guard that fits between the teeth and makes grinding more difficult. Custom-made appliances cost anywhere from $300 (around Rs14,430) to $1,800. Devices that correct misaligned bites can cost $2,500. Over-the-counter mouth guards cost as little as $20 and are better than nothing, some dentists say.
Once TMJ problems have set in, anti-inflammatories or muscle relaxants can be helpful. Studies at Tufts have shown that magnesium citrate — 250-400mg daily — can also help relieve muscle tension.
Physical therapy — with massage, ultrasound or electrogalvanic stimulation — can help relax contracting muscles, and exercises can help keep them limber. Injections of Botox can temporarily weaken jaw muscles that are in spasm. A trained dentist or physical therapist can relieve activated trigger points with an injection of saline or even a dry needle. Massaging the trigger points can also keep them from becoming active.
In rare cases, surgery — either open or arthroscopic — may be used to reposition the TMJ disc, but that’s generally a last resort. Some specially trained dentists now can manipulate the disc back into position in an office procedure.
Learning some new habits can be just as effective. If you work at a computer, keeping your keyboard low and your monitor high — propped up on phone books if necessary — will straighten your posture and keep your chin from jutting forward.
Avoid sleeping on your stomach, which can strain your neck and jaw muscles. Try reducing your stress with exercise, yoga or meditation.
Biofeedback techniques can teach you to deal with it differently. In one method, electrodes are attached to the patient’s jaw and the level of muscle tension is displayed on a computer monitor. The patient learns relaxation techniques to bring down the level of tension. Portable gizmos rest in the back of your jaw and emit a beep or a bad taste if you try to close it.
Try this no-cost, low-tech tip: Get in the habit of resting your tongue behind your upper teeth and closing your lips as you go about your day. That will naturally keep your jaw open and at ease.
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