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| Reacting to rumours |
| Devangshu Datta / New Delhi Oct 25, 2009, 00:44 IST |
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Rumours or khabar in India tend to surface days or even weeks before the event. This allows one to have a good trading strategy
The latest mega-scandal on Wall Street involves several people of subcontinental origin. The insider trading charges against hedge fund Galleon targets stars like Raj Rajrathnam, Rajeev Goyal, and Anil Kumar. Even the government prosecutor, Prett Bharara, is of Asian origin. Galleon has been quite active in India and Rajrathnam, Goyal and Kumar are all well-known here. Sebi has responded by placing the hedge fund on the watch-list.
One can't delve into the substance of the charges. Nor is this a forum for arguing about the sociological implications of the Desi Vs Desi aspects. But the incident did trigger some thoughts about insider trading.
Every investor seeks an “edge”. Big traders and arbitrageurs can use pure technology. Given fast computers and more bandwidth, an “arb” can slice larger margins. Some well-heeled institutional players skate on the edge of shady practice by placing opposed buy-sell (net zero) orders, and number-crunching market response to get an idea of depth and velocity.
There are also “network effects”. In an environment where everybody knows each other or has a low degree of separation, information will always leak. India is such an environment. It has high network effects due to its tightly-knit business communities and its relatively few upmarket educational institutions with strong alumni associations.
The network effect is even more apparent in the Far East, in Japan, Taiwan and Korea, where a few closely held groups call the shots. It is less apparent in the US and Europe with its many power centres and a multitude of widely-held, professionally managed companies.
Some network effects are inevitable anywhere. They are even healthy. Old school ties, professional connections and family alliances foster trust in environments where contractual enforcement through legal recourse is difficult. There is nothing wrong with an MBA in company A comparing bonuses with a batch-mate in Company B. If they choose to switch jobs, or buy shares, as a result of such conversations, there is little any regulator can, or should, do.
However, Indian traders go a long way beyond mere network effects and well into the realm of ‘Khabar’. Almost every punter trades on khabar. Many rumours are absolute rubbish. Some consist of rehashed conspiracy theories based on garbled information in the public domain. Some are pure gold so the quality of the rumours obviously makes a difference to returns.
In every case, a strong rumour (whether well-founded or not) results in unusual price-volume patterns occurring before the news is officially in the public domain. One way of finding stocks with khabar, is running data-analysis that highlights sudden volume expansions and unnatural price movements. If there is no apparent explanation for extra volatility, ask around about “khabar” on the stock.
Of course, if the rumour is not well-founded, or it has been floated deliberately by a sharpster (this happens with depressing regularity), an entry could cause disaster. But ever so often, you will also find a stock where there are rumours with genuine substance and there, you can make a killing. One signal can be actual reported traders by insiders or heavy institutional action.
An ability to judge the quality of rumours is therefore, among the best assets an Indian trader can possess. It is less important for an investor, who can apply more normal methods of finding businesses with good long-term prospects.
How does on judge quality of rumour? It's a subject that is very rarely talked about and it's not taught in financial economics courses. However, media professionals do develop methods of chasing rumours down. Unfortunately, very few media professionals are financial whiz kids so, they may not always realise the financial implications of rumour-analysis.
A large network of contacts help in rumour analysis (as well as in rumour-mongering). A basic knowledge about the business in question – at least enough to judge if the rumour is at all credible – is essential. Beyond being credible, one also needs to dispassionately study the pros and cons. Favourable or not? Here again, a large network helps.
In my experience, rumours in India tend to surface days, or even weeks before an actual event. That offers ample time to find the khabar, investigate it and put a trading strategy in place if it seems credible. But very few traders actually seem interested in going through the hard work involved.
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