My latest at Yahoo: Tips about the Tipsters.

With a market as strong as this, there is no surprise that people are looking out for tips in the stock market, and “advisory” services are tickling everyone’s email boxes with promises of “100% guaranteed return in one month” and such. The modus operandi is simple: a service where you pay every month to receive stock tips by SMS or email, with some others promising to even directly trade in your account.

There is no dismissing such services off-hand, because of multiple reasons:

  • Short Term focus: people love to look at the markets in the very short term (which is where these services thrive). Many services only offer “intraday” trading – that is, you enter and exit in the same day.
  • Lack of time or effort: Trading is a skill that needs education, but it is quite a lot more attractive to use someone else’s effort if the output is just “buy this”.
  • The apparent success: Some of these services are actually quite good at least for a while, and some others offer the chance to learn from trades. Success is attractive, regardless of how it’s packaged.

Some of these advisory services come at no cost (usually from brokers or on TV or media) and I’ve heard of others that cost Rs. 20,000 per month. The real cost, though, is the damage you might inflict on your portfolio by listening to them without proper due diligence; so what should you really look out for?

Time, Intensity or Direction – Never all three.

Like astrology, the art of predicting stock movements has to do with word-play. You will find people say something like this:

  • “The market looks like it will fall in the next week”
  • “Fertilizer stocks seem to be ready for a 10% upside move”
  • “ICICI Bank has setup a large move within the next week”

Every trade – especially in the short term – needs a time period (who wants to wait 2 years for a 10% move), the scale or intensity (what’s the point of a 0.5% move) and the direction (buy or sell?). Without all three, there is no real trade – and you’ll see that the above statements lack one of the three vital elements. Yet, they create an illusion of foresight.

Also if you were to call these “advisors”, they will take the nature of “See, I was right”, by pointing that the market did fall a little bit before rising, that fertilizer stocks will see 10% in the next five years, or that ICICI bank moved 3%. In all honesty, I have made such open-ended statements as well, so assume I live in a glass house.

(Technically you could trade #3 above with stock options, but that’s an entirely different discussion)

Entries and no Exits

Imagine you’re told to buy a share at 105, and it goes to 108 before dropping to 92, all within a single day. The “advisor” claims a 3% profit on the trade because it went to 108 – and what you see in your portfolio is a 10% loss!

Many advisory services tell you what to buy and benchmark that against the highest price the stock traded at after the recommendation – which is fairly stupid because you will never see that kind of return, and also because any recommendation will prove to be “profitable” in this way (unless the stock chooses that exact moment to retrace and lose everything, in which case you will only lose nothing).

Many on TV now provide a stock view with a “stop-loss” – that is, a point at which you should exit the trade at any cost. Yet, if a stock hits the stop-loss and then reverse back they may tell you that you should have waited. That’s the equivalent of saying “jump” to a sky-diver and after a while, “Oh, wait”.

The other problem is they never tell you how much money to allocate. You might think this is not such a big problem – you could put in say 10% of your money per trade. But some of them have about 100 “open” recommendations at any given time, which defeats the purpose – yet others do just one or two trades per day (would you really risk 50% of your capital per trade?).

Highlight Only Winning Trades

Some such services tell you in emails how some of their picks performed. Obviously they will tell you that Jet Airways went up 10%, which (surprise!) was a “buy” call. That though, is only part of the story -they never highlight losing trades. What matters is how much you would make in total, overall, if you bought everything they mentioned. If one stock went up 10% and nine others lost 2% each, you’re net-negative.

Front running

Certain advisors tell you to buy a stock, while selling it from their portfolio instead. SEBI has, in the past, chastised certain TV personalities for this behavior, but this kind of activity continues at various levels. Would you trust an advisor who trades in the stocks he advises you to buy? But then, if he thought it was a good stock, why wouldn’t he buy anyway?

You can’t be sure that advice you get for free is more like free beer or free speech.

The Rest

Would you trust the guarantee of a person if you can’t enforce it? There’s no real point of a guaranteed return unless it is legally valid.

Slippage and transaction costs eat substantial parts of returns, especially in short term trades. Slippage refers to the difference between your buying price and the price at which the ‘recommendation’ came – usually because other subscribers also put in their buy orders. Together with transaction costs, if your slippage takes away more than half the trade profit, you’re in a losing game.

Unrealistic result demonstrations – of over 40% per year – require serious due diligence. In the US, trading advisors who run managed money products will report their trades so you can see complete history of how trades have worked, usually at a third-party site. In India, no such service exists, so you can’t get a transparent parallel ranking of advisors or even Portfolio Management Service (PMS) Products (which go one step ahead and actually trade your money). But regardless, you can ask for details like a complete equity curve (including ups and downs, marked to market daily), the largest down-side – called a “drawdown” – that they have seen, and an audited account which they have advised. I suspect all of this will not be forthcoming; and they might just want to focus on less diligent customers, otherwise known as suckers.

Lastly of course, you have to ask yourself – if someone’s giving you tips that make so much, why wouldn’t they try to make that much for themselves? The answer usually lies in capital – they don’t have enough starting money to make a reasonable living trading, but in many cases, it’s just that they are happier advising, because they can’t or don’t want to handle the gut-wrenching volatility.

Of course, in the end, if the idea isn’t really to make money but for the thrill of the game, consider only paying as much as you would pay for a roller-coaster ride, only longer and more scary. But for those with serious money at stake, it’s time to take more informed decisions about those who inform you about their decisions.

 

Now, tell them about it: