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Mystery Resolved: Why Investors Loose Their Money in The Stock Market

Summary:

Simple statistics suggests Indian stock investors had more than 60% chance of making profit in the last five years. This was based on the assumption that they chose their stocks randomly. In a survey we found that more than 90% retail investors have lost their money during the same period. Most of these investors had taken tips or professional help from one or multiple sources.

For investors with random pick strategy, the winning percentage was 60% while contrary to that 90% investors in sample group had made loss. Hence, we can conclude tips were working against the investors in disguise of favour.
WithAndWithoutTips.png

Introduction:

Safe Analytics research team has discovered a new type of virus and named it Tips(y) virus. This is neither a physical (e.g. flu) nor a computer virus. This is third kind of financial virus which attacks stock market investors and eats away their hard earned money. They reach the victims through various mediums and worst thing is that they reach through friends and family. Often carriers of the virus do not know that they are the medium and hence victim hardly suspects them. Victims of Tips(y) virus often think that loss of their investment is nothing but bad luck.

Analysis

In this analysis we have used simple high school mathematics. First of all we selected three groups of stocks:
  1. Universe: All stocks trading on Bombay Stock Exchange 5 years back (Jan. 2009) and are still in the market. This excludes those companies which got out of the stock market or were listed after Jan2009. Total such stocks in our study are 1703.
  2. TOP500: Stock exchange recognized top 500 stocks which were existing 5 years back. Total such stocks are 410.
  3. NIFTY50: Current top 50 stocks excluding stocks which did not exist 5 years back. Total such stocks are 49.
Following table has raw data which is basis of our analysis:
Universe Top500 NIFTY50
Stocks in profit / Total Stocks 1111/1703 319/410 43/49
Stocks in Profit (%) 65 78 86
Average Profit (%) 383 370 267
Average Loss (%) 45.6 37.5 24.3
Net Profit (%) 234 280 227
Normalized Average Profit (%) 176 236 231
Normalized Average Loss (%) 38.7 26.8 16.5
Normalized Net Profit (%) 105 186 209
Annualized Return (%) 15.5 23 25
Basis 5 years (Jan. 2009 to Dec. 2013)
Normalized data has removed top 5% gainers and bottom 5% losers to make data more realistic.
Observations from the above table are:
  1. Chances of positive experience in stock investment improves as we move to the top group (NIFTY 50 is better than Top500 and Top500 is better than Universe).
  2. As expected, moving to the top group improves overall return.
  3. A random selection of the stocks has given average 15.5% return. During the same time, a stock pick from NIFTY 50 has given more than 25% return.
  4. Top500 stocks have higher average profit in comparison to NIFTY50. However, on net return, NIFTY50 has won the game due to low average loss making record.
  5. If we manage the loss part prudently, then Top500 stocks have chance of giving much better return than any other groups.
Following charts have summarized the above conclusion visually.
FiverYearAnalysisChartUniverse.png
Red colour is depicting loss making stocks while green is profit making stocks. Height of the bar depicts percentage profit/loss made by the corresponding stock


FiverYearAnalysisChartTop500.png
Red colour is depicting loss making stocks while green is profit making stocks. Height of the bar depicts percentage profit/loss made by the corresponding stock


FiverYearAnalysisChartNIFTY50.png
Red colour is depicting loss making stocks while green is profit making stocks. Height of the bar depicts percentage profit/loss made by the corresponding stock

Above analysis has basis of 5 years. The very next question that arises in our mind is what if the investor was in the market for less than 5 years. We selected two groups to study and their results are here: 1 Year Holding Analysis (Top500)
2009 2010 2011 2012 2013
Stocks in Profit/Total Stocks 398/410 295/410 63/410 354/410 137/410
Stocks in Profit (%) 97 72 15 86 33
Average: 61%
2 Years Holding Analysis (Top500)
2009-10 2010-11 2011-12 2012-13
Stocks in Profit/Total Stocks 394/410 165/410 188/410 269/410
Stocks in Profit (%) 96 40 46 66
Average: 62%
Average profit is approximately 4 times of average loss and the chance to make loss by an individual stock is 40%. Following table is showing how it reduces your chance of making loss as you increase number of stocks in your portfolio.

Number of stocks in portfolio Minimum no. of stocks required to make loss for overall portfolio loss Chance of portfolio to make loss
1 1 2 out of 5
2 2 1 out of 6
3 3 1 out of 16
4 4 1 out of 39
5 5 1 out of 98
8 7 1 out of 120
10 9 1 out of 600
15 13 1 out of 3600
20 17 1 out of 21000
Portion shaded with Light Green are showing the zone which we recommend to keep your portfolio size. Top observations from the above tables:
  1. 61% of investors have made profit even by investing for a short period of one year. A sample period of 5 years was taken for testing the concept.
  2. As the number of years of investment increased, chances of profits have improved. More stability can be seen in the table.
  3. Increasing number of stocks in your portfolio will decrease chances of overall loss exponentially.

Conclusion:

  1. Your chance to make profit in the stock market improves drastically if you just avoid tips from unaccountable sources. Do not believe in insider tips stories. Do not trust analysis which has no statistical evidence to support their claim. Read our other article ‘The Mythical P/E Ratio’.
  2. Average profit made by stocks is always higher than average loss made by them. Hence, dividing the money across multiple stocks will increase the chance of overall profit.
  3. Restricting your investment within Top500 stocks improves chance of making profit as well as rate of return. If you do not like to review your stocks periodically then it is better to restrict yourself to NIFTY50.
  4. Net return improves significantly if we reduce the size of loss. Exit from the stocks which have confirmed downward trend (Read Rule-X). Hence, periodic review of the stocks in one’s portfolio improves profits on most of the stocks.
  5. A random year may give very bad return in the stock market. Always enter the market with a long term perspective. Do not expose your money which you may need in near future (say 3 years).

Active Portfolio Service (APS) and Tips(y)

APS is the only known vaccine for Tips(y) virus. This service automatically takes care of most of the best practices concluded in this article. APS provides universe of Top500 stocks and suggests investing in at least 10 stocks (better to invest in 20). It has Portfolio Builder tool which helps in creating true diverse portfolio to minimize sector specific risk. It takes care of money management. Enforce equal distribution of money across stocks in the portfolio. It does market watch and checks for change in trend (follows Rule-X). It alerts investors through SMS and e-mail. It has statistical evidence of giving 21% average across 5 years. 80% of investors make profit in the range of 15-26%. First timers can use this service to practice virtual trade (no risk on actual money). APS supports paper trade.


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