Hey You! Don't Trade The Budget

Major events, such as an impending budget or monetary policy often create identity crises for those who dabble in the stock markets. Purported investors suddenly morph into traders, and traders ditch their carefully curated trading plans in favor of 'playing' the event. More often than not, best laid plans to trade the news don't work out as expected. A damp squib is the most likely result, but in quite a few instances, serious portfolio losses have been incurred from this habit as well.

Broking houses, ably supported by some media channels, go on to release a plethora of short term 'budget' trading calls or bets, cashing in on the hype to shore up their trading volumes and revenues. A very large segment of investors and traders burn their fingers by succumbing to the lure of short term profits.

How markets function - the short and long of it
One of the most famous quotes attributed to the venerable Ben Graham is that "in the short term, markets function like a voting machine, and in the long term, they function like a weighing machine". In other words, short term price movements are largely driven by opinion, while long term price movements by facts.

The stock market comprises of lakhs of different players, each with their own distinct character. Some are long term investors, some speculators, some hedgers, and some arbitrageurs.

In the short run, price action drives markets. Contrary to what technical analysis skeptics will tell you, key support and resistance levels do exist; and momentum indicators, read properly, can actually tell a compelling story about the near-term direction of where markets are headed. These 'price actions' are independent of any upcoming news or event, as they already factor in consensus opinion ("votes") about the event itself.

Also, worth noting is the fact that it's not the news itself, but rather, the expectation of the news that influences short term market movement. Sometimes, these expectations get factored into the current market price well in advance (weeks, even months), and these speculators square off their positions after the actual event takes place. This leads to those oft observed confounding "market falls, despite good outcomes" - or vice versa, for that matter.

Even seasoned traders sometimes fall into the trap of abandoning their well-drafted trading plans by attempting to 'predict' the outcome of an event. Trading, already fraught with risk and imbued with low probabilities of success, thereby takes on an even more perilous shape during these times. Experienced traders would do well to rather continue trading based on their tried and tested price action based strategies, irrespective of the upcoming event.

Alongside traders, investors who buy stocks just ahead of, or immediately following an event such as the budget also suffer their share of pain - especially when they do so with the wrong mindset, and a short-term horizon of 3 to 18 months. Global factors, unforeseen risks, or simply delayed earnings growth could push down stock prices across the board in shorter time frames - even fundamentally good stocks take a beating when selling is rampant. Therefore, "investors" who are playing the budget by taking short term calls are likely to wind up a disillusioned lot.

So, what should a stock market investor do now?

Sit tight, and wait for the budget to be announced. True, you may miss a little bit of the ride in some stocks, but it'll be well worth it when you factor in the risk you'll be circumventing. Rather than speculate on budget outcomes, why not wait for the actual outcomes to come to the fore?

Freed from the burden of guesswork, you can now focus your analysis on the impact that the budget might have on core fundamentals of sectors and companies. For instance: has there been a thrust into low cost housing? Has defense capex been lent a fillip? Will the budget proposals boost fertilisers and agrochemicals? Is there anything in it for banks?

In a top down manner, you can work on on picking fundamentally sound companies within each impacted sector, that will likely benefit from the budget proposals - perhaps not immediately, but eventually.

Stock prices are servile to earnings in the long run. If any of the budget proposals are poised to generate serious medium to long term EPS growth for a company, it becomes a worthwhile pick from a three to five-year horizon.

Wait until the budget is announced, and then make rational investment decisions. If you miss a bit of the ride, don't fret - the journey to stock marketing investing success involves many more stops.