Rakesh Pandey, a senior executive with a marketing firm cannot comprehend the investment analysis his relationship manager sends. A year ago, a large infrastructure company was mentioned as a ?buy? and now the same reason is used to justify a ?sell?. Nothing has changed much since then, the company at that point in time did not have earnings visibility and the report predicted that it would not have it till 2010. So by that reason, the earnings forecast held, then what suddenly changed the mindset. The firm was set to be a bet for the long term, the next three years, and even after one year, the research outfit chooses to downgrade the company.

Pandey is probably one of the few who is beginning to reckon that the many of these analyses have come a cropper. There are just too many conflicting views that are floating around, all thrown into the pond by the media, brokers, fund managers, financial advisors or their own banks.

?Two things are infinite: the universe and human stupidity; and I’m not sure about the universe,? were the famous lines of Albert Einstein. With every financial report one reads these days, especially those which have accurately broken down the current economic mess, they seem to echo the great man’s words.

Funnily, another saying that comes to mind on reading some of the solutions to the current mess, seem to echo Sam Levenson’s words, when he said, ?It’s so simple to be wise. Just think of something stupid to say and say the opposite.? As a fund manager with a boutique wealth management firm jocularly says, ?When the research outfits say ‘buy’ it means ‘buy’ from us, we are selling.?

In such a case where nothing makes sense, and the markets seem to be following an irrational pattern and therefore looking at things from a psychological or a behavioural perspective may actually prove fruitful.

Now, if one can predict the pattern that such irrationality or stupidity follows, one can stand to make huge gains, in a market like the current one.

The left-digit effect

The left-digit effect basically stems from the fact that most human beings around the world read numbers and letters from the left to right. While Urdu and certain Arabic scripts letters are read from right to left, in numbers, they continue to be read from left to right. When we see the number 399 and 400, in our minds, since we read the digit 3 first in the former and the digit 4 first in the latter, we mentally believe 399 to be much lower than 400, and not just one number away.

While lots of research has been done in this field over the years, one of the most recent studies in this genre was carried out by the University of Indiana, when they explored whether there was a ?left-digit effect?, in stock prices. Utpal Bhattacharya, Craig W Holden and Stacey E Jacobsen, jointly conducted this study and then published their book, ‘Penny Wise, Dollar Foolish: the Left-Digit Effect in Security Trading’.

Here they pointed out that since people read numbers from left to right, consumer marketers long ago discovered that if your products price ends in 99 or 49 or 199 for that matter, instead of 100, 50 or 200, consumers seem more inclined to purchase them. One of the first companies to use this to good effect in India was Bata who began pricing slippers and shoes at say Rs 29.99 or Rs 199 to boost sales.

Even the Indian dollar stores, which had made a foray into the Indian retail segment, priced their items at Rs 49, Rs 99 or a maximum of Rs 199 and were hugely popular due to this. While this may seem silly while reading, the fact remains that whether we like it or not, in aggregate, people behave as though Rs 199 is a whole lot cheaper than Rs 200 than just the one buck it actually is.

During the research carried out into the left digit effect, it was found that after analysing 100 million trades made on the Nasdaq exchange, they discovered that the exact same phenomenon was at work when people buy stocks, expanding the theory from consumer goods to the stock market as well. They realised on an average, ?buy? orders outnumbered ?sell? orders by 12% over the period of the study.

However, when the stock prices were ending in 99, the ?buy? orders outnumbered the ?sell? orders by a whopping 66%. This is over five times the average. This was by far the most popular price point at which people sought to buy stocks. On the other hand, the least preferred price points to buy a stock was 01, where there were only 0.83 buy orders for every 1 sell order. This clearly showed the investor preference for certain numbers and aversion to others.

The second-most popular price point for investors to buy shares was 49; and the second most popular at which to sell was, ironically 51, once again showing investors having the ?left digit effect? for in reality the difference between the two points is only 2, and barely enough to constitute a major change in the stock value.

This is mainly due to the fact that the human race, has certain structural difficulties getting over our natural tendency to read numbers from left to right. However, this may not necessarily be a bad thing, since it does open investment possibilities for those who can find ways to exploit those structural difficulties. Using such generic flaws as an advantage, to one’s hopefully now more controlled and informed minds, while may seem an obscure way to have read a market movement, it is not all together baseless, and when most models fail to see a trend or reason, giving the esoteric a shot, may not be that bad an idea.

And this holds in the Indian context as well. There are these ‘psychological’ or ‘sentimental’ barriers created by the trading community and these are widely announced all over. The fact to beware is that while these barriers exist and they keep changing as news and announcements unfold, it is best to stick to your trading plan and book profits or cut losses at the limits set by you.

Herd mentality

Indians by nature are known to strongly believe in the safety of numbers concept, say several experts. If everyone is doing something it must be okay if not the correct and done thing to do, a sadly common notion we face. This phenomenon seems to hold true for all people. It is more to do with the emotional quotient rather than the intelligence quotient, says a behavioural finance expert.

Such a situation is mainly due to our insecurities to do something different, that could make us stand out and be the recipient of disbelieving stares from our friends and neighbours. What will this relative think? What face would we show in society? Common questions, which are the fear of people across all classes in our society, force them together in this herd mentality.

Investing, especially in the markets, is no different from the other areas where herd mentality rules the roost. And in India, there are several examples. Morgan Stanley mutual fund, when was launched in the early nineties, saw serpentine queues being lined up to collect application forms. After all, they were the first overseas mutual fund to make a foray on the Indian soil and the foreigners could not go wrong. The subsequent flopping of the fund meant that the ‘bias’ was created for overseas funds and it took several years to wipe out that image.

Similar was the case with IT stocks in 2001. Several of them got phenomenal valuations for no earnings visibility of their own and now are languishing. One obviously cannot forget the ‘K10’ stocks during that time. Investors were sold securities just because they were the favourite of one Ketan Parikh.

Yet today, the people willing to break out of the general consensus are fewer than ever, for even though staying with the pack got them burnt, the self belief to break away from it is yet to be strengthened enough.

When investing in the stock markets one of the key issues with the herd mentality is, investors do not judge and value a company and its stock prices themselves before making an investment. The stock price of the company and how we treat that stock is often governed more by how others value it.

These others comprise of the herd who, either out of some expert advice, rumour, panic, fear or lack of understanding of investing in general, do what the other is doing. The biggest problem with such a situation is that, when things are going well and everybody is making money in the market, it is all hunky dory, as the entire groups of people take their share of the profits. However, if things are not going well, or if some people within the group have made bad decisions, which others have blindly followed, then the entire herd of investors gets hurt.

Most traders, investors, stock enthusiasts and even newbie’s in the market, would have read about investing philosophies by the greats Benjamin Graham or Warren Buffett. They all believed in value investing and usually going against the market tide by selling when others are buying and buying when others are selling. Their success rate is proof of their understanding of market sentiments and movements based on the herd mentality. After learning from these investors who liberally share their thoughts, reasoning and success formulae, we all feel that one should do the same things when investing in stocks.

Yet, when it comes down to doing it, few investors amongst the thousands have ever stood against the tide and reaped the true benefits of value investing. The situation of too many sheep and too few shepherds, which exists in the Indian stock market, offer investors a chance to even today make money in this market.

One can acquire value for money shares, as well as understated and under-priced great stocks, which could make a portfolio in the longer run. All one needs to do now is overcome ones own mental fear and stop following the herd that got you burnt before, and start believing in yourself and your instincts.

Greed and fear

?A shrewd man has to arrange his interests in order of importance and deal with them one by one; but often our greed upsets this order and makes us run after so many things at once that through over-anxiety to obtain the trivial, we miss the most important,? once said Fran?ois de la Rochefoucauld, French author of maxims and memoirs, (1613-1680).

Two other driving factors of our markets these days, which are again as unrelated to a trend analysis, financial model or market forecast as can be, are greed and fear. These two round up the main heuristics present in our current markets, which have not only been see-sawing but are also being heavily controlled by retail investors these days, who account for almost Rs 2,500 crore worth of daily trading, way more then FII’s and institutional buyers both. This helps explain why the markets seem to be so out of sync and patternless lately, for most of our retail investors in reality are traders.

The main difference between a trader and investor, as most of us know, is the former is more a punter or speculator in the market, looking to make quick money by the daily or weekly movements, and the latter is a long-term buyer of stocks, with a timeline of 3-5 years.

Now, when it comes to traders, the driving force for most of them is greed. Hence, wherever they feel a stock price will rise or fall, and they can make money on the movement, they will invest into that company, irrespective of its fundamentals or soundness. No traditional investment logic is applied here for it is more a gamble taken on particular stocks, and with herd mentality within the trading community too prevalent as ever, one sees erratic and unexplainable stock price movements.

Be it the recent bounce back of the Satyam stocks when the company had no management, or the movement of our markets in the opposite directions of our global counterparts, or even the stock prices of companies moving randomly during the result season, as though the results declared were not even read or considered into the equation.

All these points lead to the fact that a traders market, as is predominantly operational today, functions purely on speculation and greed. Understanding these driving forces of our markets today, not only explain the minimal up and down movements we see daily, but also help us understand what the psyche behind certain movements are. Once one has a grip of this, one can always use this knowledge to their advantage, and either buy stocks or short them, depending on the reading one gets out of each price movement. The advantage for the prudent here is, with greed being a driving force in a market, people often tend to lean towards stupidity, often pushing their luck in ridiculous endeavours, be it by supporting an unstable company or trying to hike up the price of a newly listed company or badly fallen stock price. In such instances one can almost be certain the pattern to follow would be a sudden unexplained price rise, followed by a massive drop in stock value, and depending on which wave one chooses to ride, there is always an opportunity present.

For after all, as Elbert Hubbard said, (The Note Book, 1927) ?The greatest mistake you can make in life is to be continually fearing you will make one.? Fear, too is a big psychological factor plaguing our markets today. Fear, both in the form of investors and traders, though more crucial in the case of investors. Currently, the market, while many believe and rightly so may not have bottomed out completely, neither is it a true reflection of the economic growth, conditions or potential of our country.

The market has been hovering around the 9,000 range for a while now, not at its bottom and no way near its true value. In such a case, every investment guru and serious investor is of the opinion that the markets offer a lot of high value stocks at runaway prices. However, almost no one seems to be keen on buying and holding on to these future blue-chip Indian companies from the investing world, and the reason for this is fear. Having been let down by many of these companies during the dramatic fall of our markets, most investors are not willing to take a long-term view of things and start investing again, not with FII’s being net sellers and the global economic factors still unfavourable.

Also, many investors, having fallen prey to greed during the previous market boom and instead of sticking to their plans or goals and booking profits, have ended up losing most of their wealth, and are now more wary than ever of the markets.

This is the psychological reason or an insight on investor behaviour, which explains why many investors today are not willing to jump into the foray and buy the good stocks available at attractive prices.

It is not that the Indian companies are bad or unfit, but the Indian investors whose mind is still either wary with fear, greedy with anticipation waiting for the markets to fall to its lowest and hoping they can jump in at that precise time and no other or is not yet willing to walk alone, waiting for the herd of investors, institutional investors or FII’s to make some move first. These are the points clouding many an investor’s mind right now and whether one may consider them silly, illogical or baseless; they do go to show the market is not completely random. It may not follow any prediction based on a financial model, but it does follow investor sentiments, psyche and behaviour, and hence understanding and being able to read these, may be ones biggest asset while dealing with the volatile Indian stock markets.