Why stock market is irrational?

2 October 2018 12:00 am - 0     - {{hitsCtrl.values.hits}}

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The stock market is a place where investors with different knowledge and experience levels gather and take their investment decisions for their best interests. 


It is due to this difference of their knowledge and skills that they take either profits or losses. People invest in the stock market on the purpose of making profits. However, this can be done by rational investors only, as the stock market is irrational. 


Here, my argument is, if the stock market is rational, that should be able to precisely value stocks based on their assets and profitability. In other words, valuable business entities should be sold at higher prices and cheap business entities should be sold at cheaper prices in the stock market. 


Nevertheless, this can be called something that never happens anywhere in the world, since the market is irrational, creating a place where cheap stocks are being sold at higher prices and high valued stocks are being sold at very cheap prices, during certain period of times. This is the reason as to why people lose their money having been cheated by 
market irrationalities. 


Charlie Munger, investment partner of world-renowned investment guru Warren Buffet once said that they entered the business world to find huge, predictable patterns of irrationality. These irrationalities were obviously important to what we planned to do. In my view, these few words tell us well how irrational the stock market is as well as how strategically we can capitalize on it. 


Present
The Colombo Stock Exchange is also no exception from this situation. Currently, what can be observed in the market is that stocks of many listed blue-chips have gone down in price, due to the unfavorable market situation. 


Recently, All Share Price Index (ASPI) crashed below 6000 points. In my opinion, the index was conceptually below this level since few months ago, because many stocks depreciated in price. However, the index could survive at least such a period of time, because it was held by some big companies like John Keels Holdings and Commercial Bank. 


Accordingly, when their prices are down, the index is also forced to come down. This is what happened recently. Otherwise, almost every stock has been depreciated in price, despite their intrinsic value at higher level. 


Sensitivity 
The stock market is so sensitive that it responds almost to everything taking place within the country as well as outside the country. That is why it has turned out to be irrational. In other words, investors panic and sell their stocks, whenever something negative happens in the context of stock market. Furthermore, it is sensitive, because people engaged in trading quickly sell or buy stocks under the 
prevailing circumstances. 


Opportunity
In my view, Sri Lankan retail investors have got a golden opportunity to buy some valuable stocks as cheaper prices, while foreign investors sell and exit from the market, having been motivated by higher interest rate in USA. Warren Buffet said that opportunities come infrequently, when it rains gold, put out the bucket, not the thimble. 


Sri Lankan investors also should see this market turndown as an opportunity whereby they are able to make a sizeable profit in the future. An investor who actually wants to be successful has to swim against the tide. In other words, you should sell, when others buy. You should buy, when others try to sell. This is a time when many irrational investors try to sell their stocks, having put forward a lot of excuses that the market will crash, foreign investors are exiting, high interest rate and unfavorable business environment in the country so and so forth. Those that cannot see the future get restricted by myths of the present. 


Expectation 
The stock market has a cyclical behavior, which means that the past can repeat again. If you can see the graphical behavior of the Colombo Stock Exchange for past ten years, ups and downs can be clearly seen. For an example, before end of the war, the stock market was a mess. Nevertheless, soon after end of the war, everyone began investing in the market resulting in a market boom. Those that invested before end of the war were winners. 


When current economic situation is taken into account, it cannot be said that it will last forever. Therefore, people should take the advantage of market irrationalities prevailing at present. Increase your portfolio gradually, waiting for the market to further discount your preferred stocks. 
(The writer is an economist) 

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See Kapruka's top selling online shopping categories such as Toys, Grocery, Flowers, Birthday Cakes, Fruits, Chocolates, Clothing and Electronics. Also see Kapruka's unique online services such as Money Remittence,News, Courier/Delivery, Food Delivery and over 700 top brands. Also get products from Amazon & Ebay via Kapruka Gloabal Shop into Sri Lanka.

 

 

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