Shares have become a popular investment for ordinary people, often providing higher returns than bank deposits and savings. The rising value of the stocks in recent years has attracted hundreds of thousands of small-scale or retail investors. It became a popular investment for ordinary people, often providing higher returns than bank deposits and savings. This "easy money" attracted individuals to invest substantially in the stock market, which drove up the value of shares further.
There was no significant improvement in economic fundamentals to justify the share price surge, however, but no one dared call for restraint (or it went unheeded) when times were so good. This market has recently seen a bubble collapse similar to the one experienced by US markets in 2009 and 2010. This has left many people wondering what went wrong with the stock exchange. The market experienced a crash when bullish investors forced stock prices to rise well beyond their actual value and created a bubble that burst.
What caused the crash in this market? A sharp increase on the demand side unsupported by fundamental analysis of the stocks being traded lead to incredibly exaggerated prices being paid for stocks that had an actual value of less than half the price per share.
Throughout this roller-coaster ride, the cardinal rule that share prices should reflect the fundamentals of the company was obviously ignored.
Fundamentals means going back to basics - to look at the company's cash flow, assets, debts, and track record, among others. Traders allowing emotions to guide them rather than study of fundamental market indicators created a market in which investors could not see anything but gains in value in the near future. High ratio can be an indicator of healthy economic growth; Ratios reaching extremely high levels should have been a warning sign that stock prices were becoming exaggerated beyond reason. The primary lesson investors in these markets should learn is that allowing emotions to rule one’s decisions can create a falsely inflated market price for shares that are unsupported by the value of the companies they represent.
Another missing element was adequate programmes and education to help individuals make wise investment decisions. Anyone investing in the stock market should be aware of not only the attractive rewards possible, but also the potential risks. They also need tools and skills to assess where, when, and how much to invest, or if in fact they should be investing in the stock market in the first place.
But over the past few months more and more investors have been selling up, amid rumors that large institutional investors had pulled their money out after making large profits. Regulators introduced a circuit breaker mechanism, after concerns that shares were over-valued. The regulators have also taken measures in recent weeks to restrict money supply into the share market after concerns that stocks were overvalued. The move forced big institutional investors to withdraw from the market, triggering panic among individual investors. After sustaining an upward momentum, the stock markets have refused to move upwards and are showing signs of choppiness over the past several months.
These are lessons that growing retail investors and market regulators will have to learn from their current stock market turmoil. As with all major financial markets, the Colombo stock exchange will recover from the recent crash. This may not help the vast number of investors who lost huge amounts of money when the market corrected itself. However, it serves as an example to traders what can happen when emotions rule the day rather than fundamental study and wise investment choices. Risk is an inherent part of investing in stocks. People always dream of making a fortune in the stock market, and many do it, but many other newbie investors have lost everything very quickly because of failing to minimize the risk involved with investing in the stock market.