A couple of days ago, I participated in a short discussion on a TV channel that somehow turned to the topic of whether equity investors should be treated like little children or not. Obviously, this is not about chocolates and ice creams but rather about whether equity investors need to be shielded from the consequences of their own actions.
With SEBI having announced a new set of measures which will eventually eliminate margin trading in the cash segment of the equity markets, we have seen a parade of talking heads from the traditional brokerage industry making statements that criticise this move. Mostly, they have said that it will reduce the trading that retail investors are able to carry out, it will affect price discovery, liquidity and of course it will affect business volumes for offline brokers.
All of which is probably true, but not the most important factor which should drive such a decision. The fact of the matter is that, as SEBI itself has recognised, there is a huge boom in recent months of equities trading by retail investors, both new investors and older ones. A couple of weeks ago, I'd mentioned, in a different context, an interview with the SEBI Chairman that this newspaper had published. In that interview, Mr Tyagi had expressed alarm at this boom in retail investors' activity on the equity markets. No doubt, the current measure to tamp down on margin trading is part of the regulator's response to the same phenomena, even though it's something that has apparently been in the works for some time.
Personally, I believe that there are two separate issues here. One of equity investing and equity trading itself, and the other of leverage. After a quarter century of interacting with investors, I have come to believe that for the vast majority of those who try to make money from directly trading or investing in equities, there is no substitute for personally learning from hard and bitter experience. Note that I put myself in this category too.
No matter how much theory you learn, unless you make some bad decisions and then suffer because of that, you do not get a feel for what investing is all about. In this sense, all of us who are investors are like children. There's no substitute for children playing by themselves and getting hurt and learning what to do and (more importantly) what not to do. The excessive parental obsession with safety from serious harm nowadays means that children grow up without having faced any adverse situation. As a result many of them hit adversity quite late in life and are less ready to cope with it.
In the investing context, what that means is that volatility and losses are necessary to learn, but not so much of them that you are faced with ruin and just stop investing altogether.
That suggests the right balance between excessive regulation and not enough. Clamping down on the leverage that retail traders can use is the right approach to take. Amplifying profits using money borrowed effortlessly from the brokers is a great way of luring new investors. Who does not like profits to become bigger? The answer to that non-rhetorical question is those who realise that amplification of losses is just as likely. Inevitably that point hits and leveraged traders get wiped out. Those who are not leveraged suffer losses, but generally only modestly. Enough to learn but not enough to be out of the game altogether.
That points the way to what the regulations should aim for. Almost everyone who starts off in the equity markets makes a beginning by being a short-term trader. Then there is a natural progression to making some bad decisions, suffering some losses and learning the better way of doing it all.
That's the natural path to learning, provided you are not short-circuited by investing on borrowed money.