The idea of making money overnight is what brings most people to stock markets. However, its easier said than done. Making money in markets is not easy. No matter what anybody (me included) tells you, it is not easy. But it is also not impossible if you have the common sense to understand one simple concept.
I know the title of this post sounds spam-like. But its not, I swear. 🙂
Now stock market is a volatile place. If you have been in markets for last few years, then you will agree with me on this. And if you are new in market, then you will agree with me pretty soon. 🙂
Many people believe that just because they can easily calculate CAGRs using excel calculators, markets will respect their efforts and only move up or down in straight lines. But I am sorry to disappoint. This notion is as wrong as the idea of Sun rising in West. Markets never go up or down in straight lines. Never.
So then why are stock markets volatile?
Why is it that many times, markets suddenly fall by 5% or maybe 10%?
Think of it like this…
All companies exist to make money for their owners (investors). So a company needs to make money to exist. But nobody actually knows how much money a company can make in future. And all those who claim to know are only referring to their opinions and projections about it. Now everyday, on basis of these opinions and projections, lacs of people buy and sell stocks of these companies. Those buying feel that they have got a good deal and those selling feel that they have got a good deal. But in real world, both cannot be right simultaneously. 🙂
This constant buying and selling is what makes the market do up and down… When either of two (buying/selling) increases many times of other, markets either crash or go through the roof. This is what makes markets volatile.
This volatility is exactly what makes market, an ideal place to make truckloads of money. But only if you have the patience to wait and the courage to invest when things are worth investing.
You may ask…
When are markets worth investing?
The answer, atleast for long term investors is that when markets are cheap.
You might feel that it is quite easy then. After all, there are many indicators that tell when markets are overvalued or undervalued. Isn’t it?
True. But as Buffett famously said, Investing is simple, but not easy.
So the right question to ask here is…
When are markets reallyworth investing?
The answer is, when markets are cheap, even by low IQ (no-brainer) standards.
Ofcourse, you won’t get such opportunities regularly. May be you will get such chances only 3 or 4 times in your life. But that is what real successful investing is all about.
Talking of volatility reminds me of an interview held in India, where Warren Buffett said:
If you look at the typical stock on the New York Stock Exchange, its high perhaps, for the last 12 months will be 150% of its low. So they’re bobbing all over the place. All you have to do is sit there and wait until something is really attractive that you understand.
Now this quote made me curious.
I know that individual stocks do ‘bob around’ a lot and can be quite volatile. But even if we were to consider broader markets, it can be quite volatile within short periods like 1 year.
This short-term volatility offers tremendous opportunities to investors to build long-term positions, even at broader market levels.
Now I tried to evaluate Indian markets from the lens of Buffett’s High/Low wisdom. Also, instead of choosing individual stocks and complicating this analysis, I picked our bellwether index Sensex, whose data was easily available here.
And this is what I found…
Buffett is right. Even for Indian markets. As you can see, even indices are volatile in line with his statement. Though high/low volatility seems to have decreased since 2010, stock markets are still volatile enough for us to contemplate about it with all seriousness.
Volatility is not just important for long term investors. Even short-term traders understand its importance and make a career (and at times, fortune) out of it!
Have a look at the High/Low gaps in table above. Its clear that markets give numerous opportunities, even on an annual basis. You just need to have the patience to wait for the right opportunity. You can use market’s volatility as your friend.
John Huber of Saber Capital Management (Base Hit Investing) says,
There is no logical way to explain why large, mature businesses can fluctuate in value by 50% on average in any given year. It makes no sense that the intrinsic values of large mature businesses can change by tens of billions of dollars in a matter of months—and this dramatic price fluctuation occurs on a regular basis—in fact, every year.
Lets take an example of the year 2014. The high and low for Sensex in that year were 28,822 and 19,963 respectively. So that means that yearly-high of Sensex was 44% higher than its yearly-low.
This begs the question:
Are the 30 largest Indian businesses really 44% more valuable than they were just few months earlier?
Though in hindsight, its obvious that due to the euphoria around installation of new government at centre, government’s underestimation of economic problems and people’s overestimation of new government’s ability to solve those problems, market behaved in such an irresponsible (!) manner.
But this is how markets function – they first overestimate and then underestimate.
Pick data for any year and trend remains same. And so does our question:
Are the 30 largest Indian businesses really XX% more valuable than they were just few months earlier/later?
Answer this time too, remains same – Unlikely.
And mind you, we are talking about (averages of) 30 largest Indian companies and not even small companies having comparatively unpredictable businesses. If we were to choose smaller companies, my guess is that their values will fluctuate even more.
Again quoting John Huber here, greater volatility brings greater opportunity for investors as the more a stock fluctuates around its true value, the larger the potential gaps are between price and intrinsic value.
Obviously this list [above] tells us nothing about the intrinsic value —only that the prices fluctuate widely. But it should be fairly obvious that prices are fluctuating much more than intrinsic values—which provides us with opportunity.
So be sure of this – markets are volatile and will remain so. This is the nature of market. It will not change. And understanding the nature of market is the key to have the confidence that you are not doing anything stupid. This confidence will allow you to invest large amounts when markets are down and others are selling out. This is when you will make some real money.
Talking of building confidence, I leave you with words of a financial blogger Pete (of MMM) that exactly voices my thoughts about stock markets:
It’s worth gaining this confidence, because investing knowledgeably in stocks has always been the single best thing to do with your money in terms of getting lifetime income with absolutely no effort on your part.
Where else can you hire people to work for you and you own their companies.
So embrace volatility and make money in stock markets.