By Gatuyu J.
On Friday 1 September 2017, shortly after the Supreme Court pronounced its verdict on the petition on presidential election, trading at the Nairobi Securities Exchange (NSE) experienced a large intra-day trading price swing, causing a temporary trading halt.
The last time trading was halted due to the index going below the permissible levels was in late 2007, on the heat of post election violence. The event has left market enthusiast wondering. In this post, we shall explain the triggers of market apocalypse.
The Black Monday and the Black Tuesday
The Tuesday of October 29, 1929 is a bad day. There at Dow Jones, there was panic trading. The rapid fire sale of stocks led to the largest one-day price drops in stock market history. The consequence was the great depression of 1930.
We now call it the Black Tuesday. Such an event would occur again in Monday October 19, 1987, when there was a worldwide market crushes. They have called it the the Black Monday.
Behavioral economics and efficient markets
There are contrasting views on why the markets would experience huge price swings. Even the Nobel Prize Committee grappled with the issue in the year 2013, when they awarded the prize to Eugene Fama and Professor Robert Shiller
Eugene Fama formulated the efficient Capital Market hypothesis. He argues that markets are perfect, factor in all information and cannot be manipulated. You cannot beat the market.
Robert Shiller disagrees, arguing that markets are marked by human behavior, more specifically by what he called “irrational exuberance” of traders. Shiller’s theory has led to the rise of discipline that is behavioral economics.
This journal respects Eugene Fama and his efficient markets hypothesis. But we agrees with Prof Shiller “irrational exuberance” theory.
Individuals just make decisions depending on the prospect of gain or loss, the prospect theory. Full stop. For people are in the market to increase value and maximize wealth.
Paper losses and paper gains
So that yesterday, the NSE experienced its own taste of irrational exuberance, leading to huge disposal of stocks by investors, triggered by electoral outcome uncertainty, leading to market hemorrhage.
Our press has reported investors lost over Ksh 50 Billion. Cockamamie, there were no losses. These were just PAPER losses. One would experience actual loses only after a realization event, that is disposal of shares. Dips and ups are usual in market trade gyration.
The market signalling
But there is aspect of contagion in the markets. When one counter is in demand, there is a rally to acquire stocks in that counter. Equally, when there is a rally to sell, everybody just want to sell that counter.
There is element of sheepfold in market trading. Its an issue of market signalling. If this is not checked, it would result to market crash especially in rapid fire panic selling.
To prevent such scenario, the following mechanisms are applied in regulating the markets. We take those for Kenya.
One, the NSE trading rules require that when the NSE 20 share index plummets by over 5%, it be taken as an indicator of negative market signalling and an adverse trading contagion. In that case, trading is usually suspended.
Note: The NSE 20 Share index are 20 selected stocks of supposedly stable companies to measure the performance of the entire market.
Two, the price of any stock can only move up or down in a single trading by only ten percent. These are called the price ceilings and the price floors.
For example, Company Y trades at Ksh 10. This means the maximum it can move in a single day is ksh 11 and the lowest is Ksh 9.
Fortunately, the NSE experienced a correction, and it is expected normal trading will be experienced on Monday.
When is the best time to invest? Anytime. But the secret to value gain from the market, is not necessarily speculative timing of buying, but appropriate portfolio diversification. The market timers are just gamblers. The market has a way of proving them wrong. Where to invest? In an issuer with solid business model and right “fundamentals”