Sunday, 17 May 2015

Decoding Sensex - Do stock markets really help you make money?


Disclaimer: The post below is a result of personal work. The full version can be accessed at https://www.linkedin.com/pulse/decoding-sensex-do-stock-markets-really-help-make-money-pattar

The main purpose of the stock market is to make fools of as many men as possible.
Bernard Baruch

Indian stock markets have created a great interest among investors in India and world wide, yet again. While we aren't seeing the kind of euphoria that we saw in 2008, the interest is no less. Perhaps, the 2008 experience is still keeping a large number of retail investors at bay and thus, making it difficult for market makers to take the full advantage of the last 1 year's unprecedented bull rally. This rally definitely smells more sensible than the one we saw in 2005-2008 but the picture will only get clearer as we scroll further.

We all keep reading several articles and stories of how investing in stock markets has made people millionaires or billionaires. It appears such an easy thing to do. People keep saying how Rs 10000 invested in Infosys is worth some 2-3 crores today, how some x amount invested in mutual funds is 100x today and so on. All said, how certain can we be that the same will repeat over the next 10-15-20 years? To this, the market experts quote historical returns of stock markets and guide that this will be replicated in the future, although they add the disclaimer that past performance are not indicators of future returns. So, how do laymen decide whether or not to invest in equities or equity underlying instruments? A million dollar question.

Following are some numbers that give you interesting insights on performance of the stock markets in India from January 1991. For the purpose of ease and convenience, I have used data for Sensex (monthly data). All percentages are in absolute terms (unless stated otherwise)

Monthly performance
  • On a closing basis, in March 1992 saw a return of 42%, highest ever. In October 2008, the Sensex fell 24%, again the highest month over month decline.
  • Would you believe that in October 2008 (intra month), the Sensex fell 42%? The month high was 13203 while the month low was 7697.
  • The Sensex nearly doubled between Feb and Mar 1992. Lets say you are successful in buying at month's low and able to sell in the next month at the month's high, the highest gain you could make is 97% (March 1992 saw a high of 4318 and February 1992 saw a low of 2193).
  • Can you believe that you would never lose money if you bought at any of the month's low as the Sensex has always gone higher in the next month. In other words, in all the months, at least on one occasion, the Sensex has always gone higher than the previous month's low in the subsequent month.
  • On the other hand, lets say you bought at month's high and sold next month at the month's low, the worst possible case is that you would lose 49% and the best possible case is that you could gain 2%. It is even more unbelievable that you would make a gain only in 4 out of 291 months. (2.1%, 1.1%, 0.3%, 0.2%). You'd end losing money in the remaining 287 months.

3 month performance
  • The sensex has posted a 124% in the 3 month period ending March 1992. It declined 38% in 3 month period ending November 2008.
  • Assuming you picked the index at the lows of December 1991, you could have made a gain of 139% by March 1992. On the other hand, if you had picked up at the highs of July 2008, you could have lost 49% by October 2008.

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