Market highs are dangerously alluring

At the beginning of this year, SEBI released a research paper titled 'Analysis of Profit and Loss of Individual Traders dealing in Equity F&O Segment.' The infamous '89%' paper revealed that "89% of the individual traders (i.e. 9 out of 10 individual traders) in equity F&O segment incurred losses, with an average loss of Rs. 1.1 lakh during FY22..."

Now, six months later, we are in a phase of the equity markets which is more dangerous than the last few years have been. All-time highs are exciting while they are happening, but for many new investors, they are essentially a lure which sets them up for future losses. There are many wise sayings about what to do when the markets are crashing. A typical one would be, "I've found that when the market's going down, and you buy ... at some point in the future, you will be happy", said the great investments manager Peter Lynch. Or the more famous "Buy when there's blood in the streets, even if the blood is your own," attributed to the 18th century Baron Rothschild of the Rothschild banking family.

However, the opposite is just as true, but there aren't any pithy quotes about it. What would be the opposite of Peter Lynch's statement? Something like, "I've found that when the market's going up, and you buy ... at some point in the future, you will be unhappy." Is that true? Well, it's not true of everyone but certainly true for a vast majority of investors (traders?) who are new to the markets. It takes hard experience not to fall for the lure of the rising graphs when you are new to it all.

One of the less remarked-upon revelations in SEBI's paper is how young and inexperienced a large proportion of traders are and the bearing it has on the inferences one can draw from this. The paper states that: "Total number of unique individual traders who traded through a sample of top 10 brokers in the equity F&O segment was 45.2 lakhs during FY22, up from 7.1 lakhs during FY19 (significant increase by over 500% in FY22 as compared to FY19), of which 88% were active traders. That's a huge increase but, generally, has been noticed all along. Take that in conjunction with this: During FY22, Individual traders belonging to the age group 30-40 years had the highest share in participation (39%) across all age groups. For younger individual traders (20-30 years), the percentage share of participation went up significantly from 11% during FY19 to 36% during FY22.

So here are three facts that you can put in conjunction. One, 84 per cent of traders had less than three years of experience. Two, 50 per cent of traders were less than 40 years old. Three, 89 per cent of traders made losses. From these facts, you can easily build a mental profile of the typical trader. Now, with the equity markets zooming up, it's again the time when we'll have a larger and larger number of traders heading to the markets. Given the economics of the trading industry, a major proportion will be herded into the derivatives. What will happen in derivatives trading is already quite clear from the analysis in the SEBI paper.

From an individual standpoint, it's quite straightforward - avoid dabbling in derivatives. There's a high chance you'll suffer significant financial loss. Despite the SEBI study suggesting that 10 per cent of traders turn a profit and that every trader believes they're destined to be among that 10 per cent, don't be deceived. This is nothing more than the influence of industry misinformation - don't get caught up in it.

Given the excitement around the market highs, a lot of people are going to do this anyway. The only question is who is smart enough on an individual basis to avoid it. Despite the allure of market peaks, the wisest move at the individual level is to resist the tempting yet deceptive allure of derivatives trading.

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