Different analysts use different models for predicting the tops and bottoms of markets, ranging from simple to very complex ones. I too use some data to determine the mood of the markets, however in my case it’s pretty simple and most of you reading this too can use the same. I basically look at the participation of Retail investors in the stock market. Somehow, the same works every time for me and I further look at the valuations of the junk stocks (when junk stocks start hitting upper circuits, one should get cautious) to draw a more refined conclusion. The stock valuations become overstretched when the retail participation is very high, while the stocks quote at extremely low valuations (even the good ones) when the Retail participation is low and this is what we are going through at present.
Though without knowing the actions of each other, Retail investors act in a very similar manner and as they say retail investors follow the herd. As per the data available with me, Retail participation (contribution towards the total turnover) was at it’s peak in Oct-Nov’10, while at present their participation in stock market’s is @ 5 year lows.
Most of you reading this must have observed that the volumes are pretty low these days in stocks and people are talking about Gold, Silver etc while completely shunning stock investment. Well, it’s pretty obvious that people are talking about Gold, Silver because both the commodities were registering new highs till a few weeks back and as is always the case Retail investors enter any asset class only at the peak and shun the same at throwaway valuations, when they should actually be participating. The fact that we’re programmed to do exactly what we shouldn’t do shows in the returns we earn.
I would like to put down a very interesting quote from Doug Ramsey. It says a lot about Retail investors. The same is as below:
One of the surest things to lure back the retail investor is higher stock prices.