Investing is like driving a car

28-04-2017 12:57:44

With the coming storm of driverless cars, driving as a skill may not even be relevant for coming generations, but as of now, I think most of us identify and cant’ do away with this essential skill for urban living. Good investing, in many ways, is very similar to good driving. Sometimes you get a long stretch of empty 6 lane road, you step on the gas and breeze through, happily humming a song. Sometimes you drive through crowded markets, barely moving, being very careful to not hit the next pedestrian, wondering when the road will clear so you can get on the highway. Sometimes, in rains, you drive through a water covered road and everytime you drive over a pothole, you skip a breath.

Markets are not very different. In the last 6 months (Nov 2016-Mar 2017), they have been like the drive on a highway, smooth, picking up momentum, moving up every day. In a way, the story is similar since May 2014, when Mr Modi powered through the Loksabha elections to form the central government. And in this euphoria, one can soon forget the slow ride of 2015, the bumpy rides of Jan-Mar 2016 and of course the crash of 2008.

However, unlike roads, nature of the market can change very quickly, and even the most seasoned professionals find it extremely hard to time the change in mood. So how can an average investor protect herself? That’s what we want to talk about today.

Like every good car driver knows, for safe driving, you need a few essential tools, which are constantly on and do the job of watching the car as well as the roads. Inside the car, you need a speedometer, a fuel gaze, a heat indicator, belt warning signs, internal temperature indicator, rear view mirrors and so on. Outside, you need headlights, turning indicators, may be a proximity sensor etc. With all this, you then control the accelerator and the break to go where you want to go.

Just like this, to navigate the sometimes calm, sometimes turbulent markets, you need some automated tools, which keep telling you the vital stats about various things in the market. You can do all the research and find worthy stocks, but imagine finding a worthy stock which is also in a hot sector and in an up-trending market and has also just started turning up, you just added significant tailwinds to your research. Similarly, these tools can also warn you much before the fundamentals deteriorate, signaling you to exit a losing investment before the rest of the crowd. A common approach is to rely on technical indicators for this purpose; however, we find it hard to see the merit in most technical indicators (quite often they are derived from price itself, which moves first, before the indicator). Statistical tools however, can give you an edge in creating such an early warning or opportunity identification system for your investments. There are many ways to build such early warning systems, which can use pre defined criteria to alert you about the big picture. For example, if most of the stocks in NIFTY500 are making new lows, chances are marker will also move lower. Similarly, a sudden jump in the volatility index should make you nervous. Commodities and related indices also offer a great way to see into the future as they signify demand, a precursor of economic growth or a lack thereof, i.e. contraction. For medium term views, a good awareness of the interest rate, currency, the credit cycle and the capacity utility cycles is also extremely important.

Lastly, the most important factor today is probably geopolitics. You can find the prettiest little stock with all the hidden value, however if a major geopolitical event were to take place, chances are even this stock will be in for a massive drawdown. Bottom line is – do your stock research, but don’t ignore the marcos and relative prices.