Inexperienced investors ..

23 jun 2018

Inexperienced investors...How to waste their money and destroy the market?

-Historically, stock markets have seen about of overvaluation of the market, from the "Tulip madness" 400 years ago to the US housing bubble that has caused a global financial crisis.
 

-What is remarkable is that there is something common to all the bubbles that have exploded throughout history. These events are always preceded by the entry of huge numbers of inexperienced new investors into the market looking for a quick richness, believing that the market is a fabric machine, Cloth from the other.


-It usually starts with the idea of suddenly capturing the minds of people and going with their logic and their hearts. This is what happened in the "Tulip" bubble, which killed the whole of the Netherlands, and pushed the public from all classes (from lowest to highest) to neglect their factories, craftsmen and farms, and sell their lands and homes for trade in Tulip.
 

-The same scenario occurred in the Internet bubble of the late 1990s, where the main driver of the huge rises in technology stocks was the large increase in the number of new participants in the stock market, as well as the poor experience of young fund managers who had a larger share of companies Technology compared with their experienced counterparts.
 

-In the same vein, the housing bubble was in the United States. Suddenly, the Americans became aware of real estate and considered it an investment of life. For the 14 years between 1980 and 1994, the proportion of US-owned homes in the United States remained at 64%, but rose to its highest level ever in 2004 and 2005, before reversing and declining in 2006 and 2007 and posting the largest annual decline in its history In 2008.
 

-In this report, we will address the impact of large numbers of inexperienced investors suddenly entering the market, how most of them are losing their money and may cause their behaviour to destroy the market. In fact, this point was ignored by most of the theoretical literature on financial bubbles, which focused on the total and partial conditions under which the bubble arises, and did not consider the role of new investors in creating and expanding.


-Apart from the famous bubbles that everyone knows, we will deal with an incident in the Chinese stock market known to many professionals and academics, because it illustrates more than others the seriousness of the control of the poor experience on the market, the Bausteel Group's Call Guarantee, China's largest steelmaker, to see how much investor experience can play a role in guiding the market.
 

This was the first derivatives contract to be traded on the Chinese stock exchange after a nine-year hiatus. Once put on the market, people (most of them inexperienced in the market) rushed towards it, creating a big bubble, during which the price of the paper rose to more than 5 times its estimated core value.

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The rush of new investors
 

- Shanghai Stock Exchange, founded in 1990, is one of the two major exchanges in China. In parallel with the rapid growth of the economy, the stock exchange has expanded significantly, and by 2010 the number of investors approached 80 million, trading 894 listed companies, with a total market value of about 18 trillion yuan (2.7 trillion US dollars).

 

- The development of the market for guaranteed contracts in China can be divided into two periods: the first from 1992 to 1996 and the second from 2005 to 2011. Between 1996 and 2005, these contracts were cancelled from the Chinese stock market due to reckless speculation activities.

 

Baoshan Iron & Steel, known as Baosteel, is China's largest and most advanced iron and steel company, listed on the Shanghai Stock Exchange in December 2000, and by 2005 the company had 17.5 billion shares.

- Following a number of regulatory reforms, the Chinese stock exchange allowed this type of contract again, with Baosteel offering 388 million purchase guarantee contracts on August 22, 2005, with a maturity of 378 days, and Exercise Price 4.2 yuan.

 

- This means that the holder of this contract can buy one share of Bausteel from the same company for 4.2 yuan by the date of implementation, which is 30 August 2006. This contract is of European type (the holder can not execute it and replace it with a share only on the due date, But can sell the contract).

 

- On this basis, trading began on the contract, and on the first day the price reached 1.263 yuan, higher than the estimated basic value of 0.688 yuan (calculated according to the Black Scholes equation) by 84%, and the next day jumped to 2.088 yuan, By 203.5% compared to the opening price on the first trading day.

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If all these will buy ... Who will sell?
 

- There was a huge rush by investors on the contract, which led to huge imbalances between the buy and sell orders, where the number of investors on the purchase side is 20 times higher than the number of sales on the first trading day, and the total purchase orders 719.3 million contracts in While at least twice the size of the source.

 

- During the last 60 trading days, the purchase price fell from 1.6 yuan to almost zero, and the holders of these contracts lost most of their money, but the reason for their loss is not to drop the value of the contract to zero, but because the share price on the day of implementation (August 30, 2006) It was less than the total implementation price (4.2 yuan) and the warranty price.


- The following paragraph will need all your focus:

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How did they lose their money exactly?
The purchase guarantee is a type of options contract, giving the investor the right to buy the company's shares for a predetermined price at a predetermined date as well. This guarantee has a price paid by the investor to the company.

 

- The price of the implementation in the contract "Baosteel" was 4.2 yuan, assuming that the share price of the company was equal to 10 yuan, when the maturity of the contract will give the investor to the company only 4.2 yuan and get from the share, thereby achieving a gain of 10 yuan (market price per share ) Less the total implementation price (4.2 yuan) and the investor paid for the guaranteed contract.

 

But what happened in the case of Baosteel was that when the maturity date was reached, the share price was much lower than the total price of the implementation (4.2 yuan) and the guaranteed price.

- Simply put: Let's say for example that you are trading in real estate. A friend who wants to buy an apartment comes a year from now and wants to ensure that the price of that apartment will not go much higher than its current level. Then you are offered a guarantee contract price of 10 thousand riyals.

 

- In this contract guarantee that you will sell the apartment for 100 thousand riyals a year later, he accepts and gives you the 10 thousand riyals and takes the guarantee. Days pass and the maturity date but then the price of the apartment fell to 80 thousand. Will your friend execute the contract? of course no. Why would he buy it from you for 100 thousand riyals while it is in the market at 80. So he lost the 10,000 he paid you for the contract. This contract is binding on you, while your friend can choose.

 

- But if the price of the apartment rose to 150 thousand riyals at the time of maturity, it certainly will implement the contract, and give you 100 thousand riyals and take the apartment, and thus achieved a profit of 40 thousand riyals, which is about 150 thousand riyals less the implementation price and the price of the guarantee (110 Thousand riyals). In fact, it is a bet between you and the real estate market. This is exactly what happened in the case of Baosteel.

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The control of the inexperienced market .. Excessive confidence
 

The witness from the Bausteel case is that 90% of the purchase orders and 94% of the demand for the Baosteel contract came from new investors who accounted for 93% of the total number of traders. They were crazy about the contract.

 

- This situation caused the fear of many experienced institutions and individual investors, most of whom were quick to liquidate their positions in those contracts after they noticed the rush of newcomers to the contract during the first week of trading. 0.9% specifically).

 

Many empirical studies indicate that those who enter large numbers into equity markets and cause their behavior to create bubbles, most of them play back in the market after being caught in the fire of the bubble, and usually does not occur another bubble only after the emergence of a new generation did not experience the experience, Once the market is ready to buy shares overpriced.


- A note that explains to some extent the behaviour of the two inexperienced experiences, noted by a research published by Joseph Bonaparte, associate professor at the University of Colorado in Denver in August 2017, that young investors with little experience often tend to over-confidence themselves while still taking their first steps in Stock market.

 

- By contrast, the same research indicates that the world's largest investors who have been in the market for more than 20 years as their experience has become less confident and more sceptical in the market.

 

- Most suffer from this situation, are experienced value investors, who find themselves unable to move the illogical market. In such fits, the last thing that might move the share price is its financial fundamentals. Therefore, most of them in such cases retreat back, because they are aware of the seriousness of their participation in the market of all its foundations is not measurable.

 

- In an environment like this, experienced speculators begin to set up traps for those rushing to the market looking for wealth and losing money, which may have been the price of a home sold by the owner to share what I believe is a guaranteed game. But after the market fires, he comes out of it irreversibly, believing that the stock is only a monument, but in fact, he was the victim of his behaviour and his impulse.

 

- The inexperienced investor does not in itself represent any problem. In all markets, there is a little, average and many experiences. There is no market for all experts, but the problem arises when the few experts are the most numerous in the market, and this often happens only if there is In terms of market rules.

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The importance of information in the stock market
 

- In fact, the inexperienced source of risk is that their investment decisions have nothing to do with the fundamentals of companies, but rather are based on the advice of relatives and friends and information spread on the forums, and at best rely on previous pricing patterns.

 

- What these people do not realize is that in a market like the stock market, there is nothing more precious than information, and the information always has a price, no one will give it to you for free. The person who shares with you on the forum tips on stocks, if he is sure of them and their profitability for what he gave you.

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- Three final words:
 The first of the modern market:
 Equity is one of the most important capital development tools available today, and success does not require more than patience, perseverance, popular decision-making, and confidence that the company's fundamentals will sooner or later be reflected in its share price.

 

- Avoid speculation at least initially, because it is a very risky game, and I know that stock prices are not always bullish. The drop is part of the game and it is very possible to take you down to the bottom or below the bottom if you are using a big lever. Most important of all is to educate yourself financially and learn how to read financial statements of companies.

 

- The second word is for experienced value investors:
 "I'll tell you how to be rich, be afraid when others are greedy, and be greedy when others are afraid."

- Finally,
 The saddest thing about these bubbles is the retirees, the widows and other low-income people who liquidate their savings and sell their homes or other assets to enter the stock market and have illogical perceptions of the size of expected returns. Unfortunately, they may lose everything.

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Source of article
argaam.com/en/article/articledetail/id/554869

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