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Thursday, December 18, 2014

Q&A about falling petrol and diesel prices, and its effect on investor psychology

Q. Rapidly falling crude oil price should reduce India’s current account deficit – which should be good for the economy and therefore, the stock market. Then why did the market correct sharply?

A. Because FIIs suddenly turned heavy sellers of equity.

Q. Was it routine year-end profit booking, or is there more to it than meets the eye?

A. Year-end profit booking was only a part of the story. FIIs are worried about oil price falling even further, which will hurt the economies of oil exporting countries like Russia and Venezuela. Also, economic slowdown in China and Europe means lower consumption of oil, which in turn will affect the global economy.

Q. Isn’t Saudi Arabia a big oil exporter? How will they survive at lower oil prices?

A. Saudi Arabia’s earnings from oil are far in excess of their expenses. They have built up huge savings that will allow them to survive in a low oil price regime. Also, by not reducing their output, they are helping to keep oil prices low in a bid to close down costlier shale oil extraction in the USA, which partly caused the supply glut in the oil market.

Q. So, what should small investors be doing in this scenario?

A. From anecdotal evidence – confirmed by a local petrol station owner – sale of petrol was actually higher when price was above Rs 80/litre. Sales have gone down since petrol price dropped below Rs 70/litre.

Q. Isn’t that counter-intuitive? Shouldn’t consumers be buying more when prices are lower?

A. That psychology works well during a day-long sale at a department store or an online store because lower prices are available only for a limited time period.

Q. Does that mean consumers are going slow on their buying because they expect petrol and diesel prices to fall even further?

A. Exactly! That is also what happens during stock market corrections. Investors who rush into buying when the market is at a lifetime high panic and sell when the market corrects sharply – and hold off on re-entering expecting the market to fall even lower. Then one day (like today), the market suddenly jumps up, and small investors blame their luck.

Q. Is that one of the reasons why small investors don’t make much money in the stock market?

A. Definitely. The behavioural term for it is ‘loss aversion’. Behavioural scientists have established through their research that a loss of profit is psychologically half as painful to investors than an actual loss. That is a major reason why small investors tend to hold on to their loss-making stocks – because they think by not selling, they are not incurring a loss.

Q. Is there a way out of this behavioural cycle?

A. Of course. Learning to manage ‘loss aversion’ comes with experience. It also helps if investors learn the basics of technical analysis that will help them to identify the underlying trend of the market. In a bull market, one makes money by ‘buying the dips’. In a bear market, one makes money by ‘selling the rises’.

7 comments:

kumar shah said...

good post for small investers

Subhankar said...

Appreciate your comment, Kumar.

Karthikraja K said...

Subhankar Ji,
Based on my experience, Loss aversion can be avoided only by Learning from Mistake. Otherwise it will occur if not now, then.

Also, I request you to inclrease the posts for educational purpose or sharing your experience/wisdom.
Thank you sir.

Subhankar said...

Thanks for your comments and suggestion, Karthikraja.

In the stock market, experience comes from 'Learning by losing money'.

Subhankar said...

Saudi oil chief: No conspiracy behind oil prices

https://in.finance.yahoo.com/news/saudi-oil-chief-no-conspiracy-105800100.html

videv said...

Nice Q&A format, esp liked the petrol price bit

Subhankar said...

Thanks for your comment, Vivek.