Sunday, April 11, 2010

Prerequisites of investment decision at stock market

Investment decisions at secondary stock market require some basic prerequisites such as analysis of market indices and company fundamentals, stock selection and portfolio risk management. Unfortunately, recent downward trends of Bangladeshi stock market following a bull run indicates that investors should have better knowledge about trading and precautions towards initial investment, especially at the fluctuating secondary market. Market price of different shares on the DSE has experienced 'random walk' due to market anomalies in prices as well as return distortions. Evidently, the aftermath of this slowdown manifests itself in all of its dimensions, which have alarming economic consequences on investment climate including losses of market capitalisation.

In fact, stock markets of Bangladesh (DSE and CSE) run below the international standards in terms of its structure, regulations, surveillance and overall monitoring systems. Some investment friendly rules thrust market capitalisation though market suffers for the shortage of good shares. Moreover, inadequate rules and regulations of regulatory bodies for short-term control over market mechanism negatively affect share market. In the meantime, information asymmetry also exists due to the deficient monitoring and supervision. And hence, a downward trend makes investment environment vulnerable to thousand of retail investors.

Another decisive factor such as lack of market transparency, short-selling, insider trading and behavioral biases of the investors distort the market efficiency that also leads to unstable situation.

Generally, in a distorted market, share pricing depends on what people expect rather than discounted value of expected future dividends, which generates a stock bubble. Notwithstanding, the ultimate effects of the bubble have widespread negative consequences on all outstanding shares of the market.

Under the circumstances, initial investors should take some precautionary actions to save his/her investment. The first thing is the time when investors enter into stock markets. Some investors make their decisions while market indices such as DGEN are growing over a short period of time. In such cases within a few weeks, prices settle down automatically and they lose their invested amounts. This is due to the fact that they invest on the basis of misleading information spread by market manipulators. Against this backdrop, selection of brokerage firm is another crucial step to entering at the share market.

The second important criterion is the complete understanding of actual statistics as regard to company's share fundamentals. It includes basic understanding on cash flow statement, category of share, profit after tax, net asset value (NAV), earning per share (EPS), price earning ratio (PER), issued dividend, market to book value ratio, regularity of annual general meetings (AGM), margin call ratio, forced sale and other market-timing indicators. Some times high market to book value ratio overestimates the financial value that gives a wrong price signal to the marginal investors which actually overvalued by illegal share exchange activities (alleged manipulations) of market speculators. It is often suggested that price-earning ratio of over 20 of any share is risky for investment, but in the recent bull it reached around 70 for some specific shares.

During investment an investor might consider the following specific aspects: total amount of investment, risk bearing capacity, risk-return analysis, risk diversification, better portfolio management considering profit rule, time horizon for the speculative and fundamental gain. For the starters, detection of market asymmetry may be difficult. Occasionally, stock markets can be responsive to macroeconomic indicators and domestic price shocks. As risk and return are related to each other, expectation of quick speculative gain on low category share causes investment risky either lowering the investment or losses of total amount.

Regulatory bodies has arranged basic courses on share exchange and trading operation periodically. Interested investor should attend to understand expert opinion about the market structure, opportunities and threads.

Actually, there is no trusted formula to predict the possible changes of a stock market because some economic and non-economic factors frequently affect the market prices. Though comparing market performance to a benchmark statistics will be a vital policy imperative, but the foremost criterion while someone invest at secondary share market is that the investors has to act rationally correlating the current market information with predicted future investment environment. This is the way which subsequently increases competency under risky market environment and ability to accommodate with price variability and thereby reduces the investment risks.

(The writer is a programme associate at the Centre for Policy Dialogue. Views and opinions expressed in the article are of the writer himself. He can be reached at. e-mail:

Source: The Financial Express, 11 April 2010.