Why you LOSE money in the stock market

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You either get excited (greed) or scared (fear) when you think ofequity (shares/ mutual funds) as an investment product. Let us try tounderstand the mystery surrounding this investment option.

You have heard or experienced the following about equity investments:
~ Returns can be made quickly in the stock market.
~ People can lose a lot of money in stocks.
~ Stocks are a very risky investment.
~ To make money you need to continuously buy and sell shares.
~ To make money in equity you must invest for the long term.

Let us try to understand why a lot of successful investors say thatequity investments are for the long term. This is how the long-termapproach to investing works:

Take for example any standard blue chip company (maybe the companyyou are working in). Find out what could be the annualised growth rateof this company for a period of at least 5 years.

A person who understands macroeconomics will be able to tell you thatmajority of the best companies in the country (assuming the currenteconomic growth) will grow at a sustainable rate of around 15-20 percent every year for the next 10 years and maybe around 12-15 per centafter that.

Hence if you own part of these companies the value of yourinvestments can grow at the same rate at which these companies grow.Remember that in an ideal situation the net profits and share price ofa company are directly related. If profits increase, share price goesup and vice versa.

If you have understood this then making money in the stock marketis not very difficult in the long run. It is only a matter of findingthe companies that will grow at 15-20 per cent for the next 10-15 yearsand be invested in them. Here is the role that a specialist can play --identify the best companies which can continue at 15-20 per cent forthe next 10-15 years.

Why do people lose money in the stock market?
1. Investors need to keep track of the company that they are investedin. If there is some reason due to which the company may not be able tosurvive then you should not be a part of that company. But if you stillcontinue to own part of such a company then you lose your money.

2. There are a lot of people who trade in the market. Take anexample that a person has Rs 10 in her/his pocket. S/he buys and sellsshares on the same day. Assume that s/he is allowed to buy shares worthRs 100 even if s/he has Rs 10 with him. This is called leverage. WithRs 10 in your pocket you are busing/selling shares worth Rs 100. Thatgives you a leverage of 10.

The stock market being a dynamic place the prices of shares go upor down. Take for example that the share price goes down by 4 per centby the end of the day. Now if you had shares worth Rs100 which has gonedown by 4 per cent you suffer a loss of Rs 4.

That is, from the Rs 10 in your pocket you have to pay the Rs 4 loss.Hence you have lost 40 per cent of your capital in one day. This iswhat happens to most traders who use leverage for trading. And this iswhy you have heard stories of investors who have lost everything in thestock market.

Why do markets go up and down?
There are unlimited reasons for this. Let me throw some light onthis. You all have heard that the 'Economy is booming' or 'There is arecession'. What it means is that the economy is either doing well orit is not doing well. If the economy is doing well then the growth rateof companies is very high (maybe 20-25 per cent annualised).

Hence people feel that if they are part of this company then theirmoney can grow faster. Hence more and more people start to put moremoney in such companies. Hence the market value and the share price ofthese companies goes up. Such a phenomenon is called a bull market.

Similarly, if people feel that there may be a recession (leading to adrop in profits of companies) then the value of such companies goesdown (bear market).

But it is a fact that good times or bad times never last forever. Hence the markets always go up and down.