How Stock Market Works in usa

The present turmoil that we are witnessing in our market and the world markets is nothing unusual and is the part of the game in the world of high finance. This has been around for centuries now…from lower levels, the markets begin to show positive signs of improvement, hope rises and people begin to buy but then the euphoria crosses the limits of rationality, bubble formation begins but is disregarded, it is allowed to swell with borrowed money till it bursts finally, avalanches of selling push the prices down, fear rises and then panic crosses the limits of reasonableness and prices drop way down below values, time passes, sanity is restored gradually and from the lower levels, the markets begin to show positive signs of improvement…. And so on.

It is the leverage or the borrowed money that is the root cause of financial chaos and havoc…be it the great crash of 1929 or the sub prime episode of the 21st century. Who has jeopardized the stability of our market at present? It is just those good old badla walas. They have led to the most unusual and unprecedented step that has ever been taken by KSE to handle a situation: freezing of share prices at 27 August levels. Psychological effects of this freeze on the thought processes of the market participants have been more devastating than the misery that falling share prices cause.

Common perception at the moment is that as and when this freeze is removed, stock prices in our market will go down sharply. This, it is believed, is inevitable mainly because the stock markets around the globe have witnessed steep declines recently and KSE is bound to align itself with this trend. While this is correct, it is very important to keep in view the fact that even before the current freezing of the prices, our market had already registered a hefty decline of about 41% which should be fairly comparable to the average slide that the world markets have gone through. Perhaps we should be prepared for a further trimming of, say, 20 to 25%, which would come into being while attempting to harness the mayhem caused in the process of rescuing the badla walas.

Personally I believe that things will Inshallah improve at KSE. By this I mean the opportunity to make money shall continue to be there in our market. But the problem is that for the people, generally, the definition of coming back of good times at KSE is only that the index should be at 15600 levels again and the stock that someone bought at 319.70 must hit that levels again. Yes, that or nothing else. Unless the possibility of seeing those same old high numbers flashing on the screens again becomes a reality, majority of the people refuse to turn optimistic about the market. This is a very misleading and unreal yardstick to gauge the future of the market. The levels that the market has seen (index 15600, size 4.8 trillion rupees) were actually overdone, overstretched numbers. We may see those levels again in four months but also we may not see those levels again in four years even. In the meantime, the market will ultimately find its new range and stock prices will stabilize at levels that are in line with this new regime of higher cost of production and slumping sales. We will not be able to see the opportunity to make money in the stock market in the time ahead until and unless we consciously accept the new environment in which the share prices will have gone through an intense phase of downward adjustment.

Another reality that must be accepted is that the days of making easy money or making money easily in the stock market are over now for the time being. In the bull run that we witnessed during past some years, even casual participation in the market would prove fruitful. Subsequent to the removal of this "floor", our market is likely to behave erratically in the most unpredictable fashion. It would not even fall in a straight line thereby making the option of going short as fatal as the decision to hurriedly pick up stocks at apparently discounted prices. On the other hand, staying completely away from the market till things are clear will not be viable either because, as they say, we miss 100% of the shots that we never take. We have to remember what Peter Lynch said about working in the stock market, " It is important to be able to make decisions without complete or perfect information. Things are almost never clear on the Wall Street or when they are, it is too late to profit from them"

So since we are into difficult times now, in order to survive and grow in the market we must have some business plan to which we must stick with great discipline. The main goal should be preserving our capital by preventing it from being wiped out. Such a plan requires strict profit and loss targets to be observed with extreme exactness. For example, let's have a look at this sample plan which carries the risk of being ignored by most of the people on account of being too simple as well:

Resolve that you would sell a stock that you have bought as soon as it goes up enough to give you a gain of 5%. More importantly, you would sell what you have bought the moment it drops to the point where it is giving you 5% loss. Stick to it: in case the stock moves favorably, profit from each trade: 5%, if it moves adversely, loss from any given trade: 5%, nothing more, nothing less. And be sure to continue to plough back the gains for a period of three months. To carry on successfully, you need just 6 winning trades out of 10 in every quarter. That is, if you make 10 trades over a period of three months and end up losing 5% in four of them while gaining 5% in the remaining six, you stand to get a return of 40 percent per year on your investment which is a fairly good return to say the least. Even if you trim this figure by a significant 35% to provide room for practical difficulties in achieving all the mentioned numerical targets in stipulated time, still you end up gaining a fairly reasonable annual return of above 25%.

To make this plan workable, you will have to control several temptations and will have to overcome the tendency to be overwhelmed by fear and greed. This is just a proposed plan. Every investor can devise a plan for himself according to his net worth, propensity to take risk and mental discipline.

How one looks at the market and what strategy he devises to survive in the market once this "floor" is removed greatly depends on whether one is a part time investor who is putting his savings occasionally in stocks or he is a full time independent investor, whose main source of livelihood is buying and selling of stocks solely. Also, for someone who is willing to hold his stocks for three years and longer, the process of generating wealth from the stock market is relatively steadier and less complex.

To excel in this line of business, it is worthwhile to study the careers of the masters who have generated considerable wealth from this trade, like Benjamin Graham, Warren Buffet, Peter Lynch, George Soros, Jesse Livermore, Bernard Baruch and so on. One should learn from one's own mistakes in investing in light of the experience of these star performers.