InvestorQ : Can we say that percentage success in stock calls are largely misleading?
Tisha Malhotra made post

Can we say that percentage success in stock calls are largely misleading?

3 years ago

While you cannot say that success percentage does not work at all times, you need to be clear that there are circumstances when the success percentage has very limited application. Why is that so? Firstly, cost of trading is a major culprit. Most success percentages do not consider the cost of trading. If you add up brokerage, STT, service tax, stamp duty and the liquidity premium, a few percentage points get chopped off from the stated returns. Over a period of time, the cost of trading really adds up. Ideally, you should also add the taxes paid by you on your profits because that is what will give you a real picture of what the investor will eventually take home.

Any return measure that ignores risk has limited value. Return percent is a mathematical measure and does not typically consider risk. There is a risk of liquidity, a risk of cyclical downturn and the risk of valuations. These risks, when they manifest, can make a vast difference to your actual return vis-à-vis the stated returns. The problem with risk is that they can make the difference between loss and profits. Take the case of Dewan Housing. The stock is down from Rs.650 to Rs.250 and the trader or investor would have never got the time to consider an entry or exit in the stock.

More often than not, traders become their own enemies. When a broker gives a call and investors rush to buy that stock, the resultant liquidity surge pushes the price up. This will ensure that you will buy well above the stated price, or sell well below the stated price. The return percent does not consider this. That is where impact cost comes in handy. You need to focus on stocks where the impact cost is as low as possible.

There is a practical side to the argument. Every trader and investor operates with finite capital. If you give 3 calls spread through the day, I can probably play on all of them. But if you give me 10 calls in the morning, then it does not really make sense. Resources and mental capital make a lot of difference. Let me explain. If the analyst gives 10 calls in a day, the investor may not have the resources to keep so many positions open. When you pick and choose, your returns can differ substantially from stated returns. This is a common problem for investors.

A trader or an investor, at the end of the day, is a human being and not a machine. If you give a buy call in a weak market the investor may not be willing to buy as his psychology dictates otherwise. Similarly, even with your best intentions few traders would have been willing to sell Yes Bank at higher levels. They have their own fears, their prejudices and their own preferences. It would be ridiculous to expect that a person will be able to overcome all these emotions and execute the calls given by an analyst. It just doesn’t work. You cannot just mechanically give a call and expect that to represent percentage returns. It does not work that way.

Even with your best of intentions, a return percent sheet can never simulate a real trading environment. In real trading there are capital constraints so you have stop losses; you have profit targets, margin calls and requests for MTM margins. It is much easier to talk about stop losses and targets but in the real market, there is many a slip between the cup and the lip. Stop losses may not get triggered due to lack of liquidity. Profit targets may just be missed by a whisker. These are all practical problems.