(1) Are you really making money in the Stock Market Trading???

One of my colleagues in the office trades heavily using an online trading portal. He claims to have made a pretty good profit over the past few years consistently.

As a common young Indian, he also hails from a middle class family, has done his engineering from a XYZ college of Engineering, and learnt programming languages to a sufficient level which enabled him to take up a job at the offshore center of a US based MNC. He started working in 2001. Came across the knowledge and fantasies of the stock market business and started trading in 2002.

Today, he’s a happy man with more than 40 stocks in his portfolio – which he keeps switching every now and then, claims a staggering “self-calculated” profit of 50% and feels proud that he did not keep the money in the bank or tax-saving schemes, else he would have ended up with a mere 5-6% returns. His career path has gone well since he started working. He switched 3 jobs in last 5 years, getting a decent salary hike each time, and enough money for him to play around in the stock market.

His daily routine today includes the following schedule: Reach office in time (basically, when the market opens), place the orders; carry on the usual tasks of office while continuously refreshing the webpages of his online trading portal so as to “track” the market. Occasionally he walks through the office, so as to discuss with other like-headed “trader” colleagues - on what to buy, what to sell and what to hold on.

Situations like these are quite common in the IT industry. All “Smart-Alecs” are today having sufficient money to trade/invest in the stock market.

Let us begin the analysis of this gentleman for his trading activities over the duration of his investments. He started trading in early 2002. Today he is sitting on a smooth 50% profit for all his investments. If we assume that he has invested 1 Lakh rupees in the market over the period 2002 to 2007, then with a profit of 50%, he is having an equivalent of 1.5 Lakh Rs.

However, what has happened in the market over the same period? In early 2002, the stock market was down. The Sensex was at 3200 level. Today, it is smoothly sailing at 14,000 levels. The % increase in the market has been

	(Final Value-Initial Value)	(14000 – 3200)
Profit =	--------------------------	------------------------	=	3.375 times or 337.5%
	Initial Value	3200

Compare this to the profit margin made by the individual – its only 50% v/s 337.5%

In terms of percentages difference between Sensex and Individual Investment:

	(337.5 – 50)
Profit =	------------------------	=	5.75 times or 575 %
	50

What it means? This person is actually LAGGING behind the market by a whopping 575% or 5.75 times – and still he seems to be very happy with his decision of investing in the stock market.

Now, let’s consider some more investments:

Suppose that instead of investing the money in stocks, he had invested it in Tax-Saving Infrastructure bonds (usually issued by banks like ICICI/IDBI/others). Lowest amount of interest these bonds paid during the period 2002-2007 was 6%. These bonds come with a lock in period of 3 years.

So, if my colleague would have invested in these tax-saving bonds, that too at the LOWEST interest rate of 6% – he would have made a year on year profit of 6%, which amounts to 18% for 3 years (roughly 18% - though some time-value calculations will give a slightly different value – only a few decimal places different). Along with the interest, he would have also saved on his taxes – 30%. Hence, the total saving would have been 30 + 18 = 48%, that too in just 3 years as compared to his stock returns of 50% in 5 years. This amounts to a yearly average return of 48/3 = 16% per year from bonds, while a 50/5 = 10% return from the stock market.

So, what is the problem here??

Well, the problem here is in terms of understanding and measuring the risk and returns.

The above example clearly shows the difference in our valuation and understanding. The Bonds are RISK FREE, they don’t carry any major risk – but the Stocks carry a major risk that we do not realize. The market is going up by almost 3.5 times, and the person trading in the market feels happy for a mere 0.5 times. He feels happy with 10% average annual HIGH RISK return from Stocks, but he does not realize the benefit of 16% RISK FREE Return from bonds.

After explaining this mathematics to my colleague, I also asked him if he has considered the demat account charges and the brokerage he paid on the trades he made. His response was NO. If you take these charges into consideration, the profit for stock trading would come down further.

It is quite possible that some of you may have made a 100% returns, but that would still be much less than the market return of 375%.

The above REAL LIFE example demonstrates a simple and clear practical situation that every individual can find him in. The ignorance that we have in terms of calculating the profits/losses and in terms of understanding the method to see exactly what is going on with our money clearly indicates a dangerous situation.

The evaluation period for our case study was 2002-2007, when the market had gone up 3.5 times. Imagine what could have happened if the market had gone down, as it happened in 2000-2001 period. In the good period, no body can pick up shares to match the market performance, but in the bad period, everyone still looses more than what the market lost. This gentleman would have lost money on his trading and investments, and also paid heavily on the brokerage and demat account charges.

So to begin with, please make sure you know how to calculate the profit/loss on your trading and investment activities. Most of the brokers and online trading sites do NOT have the facility of “Portfolio Tracker”, where you can see your NET profit and loss. They probably want you to live under the false myth that you are making good money on your investments, so keep trading and keep paying them the brokerage. Some online portals have the portfolio tracker functionality, but individuals don’t know how to use it and how to extract useful information from it.

Here is a simple way to calculate your profit/loss

1. Generate a list of all the trades that you made during your investment period
2. For every pair of Buy and Sell for a particular stock, calculate the profit/loss after deducting the brokerage charges on both the Buy and Sell legs of the trades
3. Take the sum of all the profits/loss so as to arrive at a NET value. From this net value, deduct the demat charges that you paid during the investment period. Let’s call it (a)
4. Take the total amount of money that you invested (b). Calculate the profit % as (a)/(b)*100 – Let’s call it (c).
5. Take the level of Sensex (or Nifty) on your 1^st day of Investment period and last date of investment period.
6. Take the % return for Sensex as shown in table above (d).
7. Compare (c) & (d) – where do you stand???
8. Also compare your returns (c) with the tax-saving risk free bond investments. – Did you perform better??

In next few articles, I’ll be talking about making efficient investments, so as to maximize profit and minimize risk/losses.

If you have any questions, do let me know. I’ll be happy to offer you advice and help. Please post your comments on this webpage with you Name and Email-id, so that I can respond to your query.