Margin Trading , and its relation to PE

As many of the readers know, we are neither interested nor are we willing to advice anyone to actively pursue trading. That said the topic of the post shall come across as a contradiction to what we have followed, and would like to follow in the future. 

A closer look, and after going through the article might help you better understand our stand and our fixation on the topic and its importance on ones investment decision ( especially in India, as the topic is drawn onto from data on Indian Indices) 

What you shall see below is a comparison between two graphs, which on a simultaneous basis seem to have increased significantly all of a sudden, followed by a sudden crash. Why is it that this graph is important in particular, and why one needs to pay attention to it ? How will this help one in his or her investment decisions , as well as timing ( which in itself is a tricky part at times can come in handy if one has looked around for all the pitfalls that come along with investing in the stock markets) 

Without further wait , we shall look at the graphs first and then give our explanation.

Margin Data


Nifty Nse Pe

The first graph shows margin trading in Lakhs Rs, and the other one shows the trailing PE for the index. The margin data is much shorter which starts from 2005, and has been updated to Jan 2012, as compared to NIFTY PE which starts around 2001, and is complied to the Jan 2012 the latest day. 

One striking thing, that calls for ones attention is the significant overlap in each of the graphs patterns. While this shall come as no surprise, increase in margin trading followed by increase in PE ( aka prices increasing higher than earnings ) eventually results into prices rising to levels which are not sustainable in the long run and are eventually followed by crash in the prices.

Now why does one needs to be aware of the absolute level , as well as the relative significance the variables have on each other ? Well it is quite intuitive, if PE is going high and so is margin what is the reason for the price increases ? Increase in earnings or a speculative excess in the markets ? 

Henceforth, before and while investing in the market it is always necessary to make sure what are the averages, at what level you are getting in and what is the time one should get out of the market ? 

As the saying goes, we buy cheap and sell dear. To follow the saying, one should know before investing if they are buying cheap or not. 

Before we end this post, we forgot to mention one thing the long run PE of Nifty is around 18 (approx.) So every time keep an eye out for the levels.

If you have any further questions or are looking for data please contact us at info@valueeinvestor.com

DISCLAIMER: Anything on the website , including this post and or anything is not to be taken as an investment advice. Our sole purpose is to share our knowledge on an educational open forum basis. That is open for discussion, and is to be part of a learning process. Anything taken otherwise is at the readers own risk. We take no responsibility for any loss experienced in the markets, or otherwise in any ways. Please consult or financial advisor before investing in the markets.