Hello people, welcome to the latest issue of Mind over markets by Varsity. We were facing some issues with Revue, so we switched to Substack.
In this issue of the Varsity newsletter:
The most common way people lose money
How to file your taxes
Understanding a bull call spread
Understanding inflation
Integrated financial modeling: Risk premium & tax shield
Next Time You Get a Hot Tip…Beware
The one common piece of advice from experienced traders and investors is that making money in the markets is hard. The first modern stock exchange started 400+ years ago, and this has been the same advice since then. But despite this, people come into the markets every day thinking they can get rich quickly. We keep hearing from traders and investors about how they lost money by trading based on stock tips from random people or by sharing their trading account login details with people who promise extraordinary returns.
It’s sad that something as basic as this has to be said, but please don’t trade based on stocks tips from “experts” and “gurus” or share your account details with unauthorized advisors.
Let’s start with stock tips. One of the biggest reasons why people start trading or investing is because of greed. They would’ve heard about their friends making a lot of money in a short span of time, or they would’ve seen some ridiculous P&L screenshots on social media. People rarely ask themselves if it’s really this easy to make money in the markets. They directly skip to the part where they start trading and investing without even a basic understanding of the markets.
A lot of new traders and investors start by trading and investing based on tips and recommendations on business news channels, business news websites, social media, and WhatsApp. Predictably, this always ends in tears. Some people, once they lose money, seek out “experts” and “gurus” who make it seem like they make more money in one month than Jim Simmons in a year. Again, they rarely question if someone is so good at making money, why would they sell stock tips instead of making money? This, too, rarely works out. These are the same people who often say the stock market is a scam.
Even if you want to trade based on tips, the least you can do is actually measure their performance. Track the calls the tipsters make and measure the accuracy. A lot of people have calculated this, and there’s also been a lot of academic research. In almost all cases, the rate of failure is around 60-70%—this is worse than a coin toss. So you would be better off buying something by flipping a Coin. The best thing you can do is to invest in mutual funds and ETFs. Even if you want to be a trader, maybe experiment with a small amount of money rather than going all in.
The other issue we keep hearing about from investors is how they lost money by sharing their trading account login details. A lot of people believe fraudsters who promise extraordinary returns and share their login details. Once the fraudsters have access to the trading accounts, they trade penny stocks and illiquid options, cause intentional losses and move the money. We’ve warned investors numerous times:
For the three billionth time, please don’t trade and invest based on random tips or share your account details with unregistered advisors. There was also a short but brilliant Innerworth post on the topic.
But for each person who has gotten rich acting on a hot tip, there are probably fifty who have been burned when it failed to materialize. And there are twenty-five more losers who acted on the tip, only to see the stock react in an unexpected way. We’ve all seen stocks fall on ostensibly good earnings news, and rise when the news seemed outright bearish. Take note of these occasions, for they are not so uncommon as you might think. And to be sure, tally up the tips that turned out to be winners, for that’s the best way to build up resistance to the gambling fever that sometimes possesses us when some alleged insider has a secret to share.
Don’t forget to file your income tax returns
Nobody likes thinking about taxes, let alone having to file them. But it’s part of the journey when you’re a trader. It’s important to file your taxes, regardless of whether you made a profit or loss. A lot of people assume that just because they’ve made losses, it’s not necessary to file taxes, but that’s a mistake. We also understand that filing your taxes can seem complicated, so we’ve built reports on Console to make this as easy as possible. Here are all the reports to help you file your taxes: Zerodha tax reports.
Varsity video series
Directional naked option trades are always risky. The better way to trade options is via spreads, where both the risk and reward are predefined. In the 13th video of the Options module, we look at one such popular strategy—the bull call spread.
Varsity Bytes
Inflation is one of those things we keep hearing about, but don’t really understand well. The common explanation of inflation you would’ve read about is something along the lines of a cup of coffee used to cost Rs X 5 years ago, and it costs Y today. There’s nothing wrong with this basic explanation, but there’s more to inflation. Given that inflation affects your returns, as a trader and an investor, it’s important to understand some of the nuances. In this video, Karthik gives you a quick explanation of what’s inflation and the various actions that governments and central banks take to control it.
Latest chapters on Varsity
Most financial modelers add back interest directly to PAT to arrive at FCFF without factoring in the tax shield. Check this chapter to understand why you need to factor in for taxes.
Valuation (Part 3) - Risk Premium & Tax Shield – Varsity by Zerodha
That’s all for this issue, and thank you for reading. Please do share and spread the word If you liked this issue.
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Valueble words Sir....very much needy to new traders