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Before understanding what really works, it is important to understand what does not work in the stock markets.
No points for guessing, it would be the “stock tips.” Chances are at some point you would have received an unsolicited text message from the “stock market punter” sitting in Indore or Rajkot asking you to buy a stock because he expects it to go up!
More often than not the stock moves in line with the “tipster’s” expectation and this convinces you to sign up for his “paid” service, which entitles you to receive such “hot tips” on a daily basis.
With a hope of a fabulous return you sign up for the service just to realise that the hot tips no longer work. You not only lose the money you paid towards subscription but also the money deployed in the trade.
Number game To begin with, the tipster manages to get hold of a large database of phone numbers, let us say 50,000 numbers. He now divides the database into two equal groups (group A and B). Assume you belong to one of the groups, say group A.
Now the tipster sends a message to group A saying that he expects a particular stock to go up, and to group B the opposite. Naturally, one of the groups is likely to get it right, assume it happens to be the group you belong to. Now the tipster ignores group B and concentrates only on group A (which has got the correct tip).
He further divides the 25,000 people in group A into two groups; say group AA and group AB.
Assume you belong to group AA. He now sends a message to group AA saying he expects the stock to go up and the opposite to group AB.
One of the groups gets it right, assume it is group AA. This also means you have got two consecutive perfect tips from the tipster.
Just a tip Now the tipster ignores group AB and concentrates only on Group AA. He divides group AA into two equal groups and repeats the exercise.
Assume again you fall into the right group and you end up getting the third perfect tip. By now your faith would have increased enormously. The fourth time, when he sends a message asking you to subscribe for his service on a daily basis, is when you fall prey!
At this stage he gets a few hundred subscribers (out of the initial 50,000) paying him a fee.
He collects all the money, starts sending a few junk trades until people get frustrated and start ignoring him.
Knowledge edge What really works in the stock market? Is it the Warren Buffet style long term investment, or George Soros style momentum trading or James Simons styled high frequency trading that works.
Well, unfortunately, the answer to this is not straight forward and really depends on many variables involved.
The writer is Vice-President – Research & Education Services, Zerodha
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