An alert investor/trader would know intuitively when the markets are nearing a peak or about to form a significant bottom. For instance, I would know that the market is about to form a long-term top when my sedate, academically oriented neighbour would start waylaying his friends to share his latest stock market triumphs. Since watching the antics of neighbours is not always this fruitful, here are a few other pointers that can be monitored by novice investors to scent out a peak or a trough.
New fund offerings (NFOs) from mutual funds always pick up steam close to market peaks. When investors are bombarded with a plethora of schemes with themes that outdo each other in vagueness, it is a sure sign of trouble. The reason why the NFOs cluster near the market peaks is simple.
As more and more investors watch their neighbours flaunting the wealth that they have made in the stock markets, the feeling of being left-out grows. Since many new entrants prefer taking their first step in to the world of stocks through mutual funds, the demand for mutual funds grows. A case in point is the way Reliance Equity Fund creating history by collecting over Rs 5,000 crore in March 2006, just after the markets buckled under in May 2006.
Another indication of an overheating market is an increase in the number of initial public offerings (IPOs). The quality of these IPOs and the valuations would further signal if the promoters are exploiting the investor optimism. The IPO boom just before the Harshad Mehta scam broke out in 1992 is an unforgettable phase in our stock markets’ history. Investors went berserk over the deluge of public issues in this period. The third indicator that we want to dwell on is the rally in long-forgotten stocks and penny stocks. Any-time you see the dud stock in your portfolio that has not budged an inch over the last five years, being recommended by an ‘expert’, you can know that a crash is around the corner.
The above-mentioned are the signals of over heated markets. The reverse would be true near market troughs. Investor apathy would make fund managers and promoters postpone their public offerings. There would be no takers for even bluechip stocks leave alone penny stocks.