Who gains most in a volatile market?

Who gains most in a volatile market?
23 Nov, 2007, 0521 hrs IST, TNN

Long-term passive investor gains most
Anurag Tripathi Executive VP (Equities), AGSL*

Every time the stock market touches a new high, it enters into an unchartered territory associated with higher volatility. History shows that the so called “intelligent money” is seldom able to exploit such bullish moves in the market. This happens because conservative investors move out of the markets into cash or cash equivalents. Attracted by the euphoria and sensing an opportunity to make quick money, new investors enter the market.

There is a general belief that increased volatility favours day traders as they get more opportunities to trade. Increased volatility is a double-edged sword which can result in higher profits or losses. As volatility increases, the ability of a day trader to hold a leveraged position declines. Stop losses in relation to the underlying volatility become smaller/tighter and as a result the likelihood of the stop loss being triggered on a given trade increases. The risk reward ratio thus favours risk rather than reward.

Further, the market often opens with large gaps as compared to the previous day closing. This implies that the day trader is not able to exploit the entire upward move in the market. Higher volatility often leads to panic reaction by the various market constituents, which results in inadvertent financial mistakes.

A passive long-term investor on the other hand is not influenced by the volatility in the market. He is usually sitting on deep notional profits and consequently has a much higher ability to hold on to his investments. His investment decisions are based on fundamentals of the company in which he is invested and the general macro environment. As long as these two factors remain positive, the long-term investor stays invested. He does not give much weightage to the price movements of stocks.

Further, the ratio of profitable trades to loss making trades is also skewed in favour of the long-term investor. This happens because as the investment horizon increases, the ratio of trades resulting in profits to the trades resulting in loss improves in a bullish volatile market.

The cost of doing the trade is negligent in the case of a long-term investor, but is extremely high in the case of a day trader. Hence, a bullish volatile market generally favours the long-term passive investor.

Day traders may gain, but not continuously
R Swaminathan VP, IDBI Capital Market Services Ltd

Volatility is the result of pricing upheavals in the market due to irrational market response. The liquidity in the market pushes demand beyond a level creating valuations that are illogical. Even a perfect market with reasonable pricing can turn volatile due to sensitive issues like political or global issues or even liquidity.

One who invests for long term reaps the benefit, subject to the fundamental strength of the stocks invested. Long term sustainability of the prices denotes the inherent strength and the potentials of the future. As such a long term investor depicts the character of calm and patience over the investment decisions made and the possibility of certain growth. As for the day traders, they are hitting in the dark and trying their luck.

The market is surging on liquidity and expected liquidity. The valuations at PE of around 25-plus and PBV of around 6-times with a negative dividend yield (unheard of in recent times) with a swinging open interest positions in derivatives all denotes the market imperfections and gyration.

Day traders may succeed on a hunch once or twice but not continuously. The order of volatility even in percentage terms vary with the base. The markets have entered a different plane with the sensex over 12,000, 15,000 and 17,500 and even touching 20,000. Hence, the upheavals are wild.

In market swings, only long term investors make profits. In the upward market volatility, the day traders cannot benefit continuously. One should not get swayed by the consistent upward market. As the index moves up continuously, with every 1,000 points, the base for volatility increases. Hence even small percentage change of 1% can move the values in big way. As such investors who stayed invested have benefited, as growth over a period is always higher than the one time gain.

Last but not the least, churning always proves costly in missing opportunities and also results in expenditure like brokerage, STT and other charges. Long-term investors benefits on the taxation front too if the investment and sale is planned properly. Investing is like running a marathon and not a sprint. As such day trader’s greed cannot be compared with the long term yield.