The markets are a brain game (Like Chess or like chasing a cricket match in the second innings) and to win this game, you will need to create a plan. You will need to think before you make a move, measure every move since it will have implications on your next moves and also have a strategy in mind to adapt in case things don’t go according to plan. The most important thing will be to follow the plan religiously and not deviate from the same. What should your plan have
- Objective:- A well – defined objective of return expectations. Just like each cricket chase has a defined target, you will need to define a reasonable expectation of return from your capital. How much capital to be introduced? Rs 25000/- is just an indicative minimum, but depending on one’s strategy one should figure out what is appropriate capital requirement based on one’s style of investing or trading.
- Design a strategy to pick stocks/contracts to trade/invest in
- To win a game, you will need to decide the right mix of players – batsmen, bowlers and all-rounders. Same way, you’ll need to work out a list of stocks, indices, options, etc that work for you in order to achieve your return objectives.
- A clear well defined risk management strategy
- You will need to define a clear risk management strategy. If a bowler is having bad day on the field and is being whacked for runs, he needs to be taken off. Same way, formulate a strategy, how much diversified the portfolio should be and to cut losers and hold on to winners.
- A entry and exit strategy
- Well defined rules when to enter either fundamental factors like results, sales growth etc or technical factors like breakout etc along with clear exit strategy for eg outcome of financial results or price below a moving average etc.
- Design a strategy to pick stocks/contracts to trade/invest in
2. Create a Risk Management System and Preserve your capital
a. Risk Rules: Defining how much to risk or how much to lose on a single trade is the firststep towards risk management. Based on the available trading or investing capital oneshould decide prudent limits one is comfortable losing, this is all the more importantbecause if one knows realistically the loss taking capacity, then trades will be donewithout FEAR of losing, and when fear is not disturbing, one can take decision from themind without any emotions attached. Fear of LOSS is the biggest hurdle in trading andinvesting and the only way to overcome is pre defining the risk rules in the form of losslimits.
b. Size of the Trade: Too often people, either, bet everything on one trade and go broke orbet too little to make any meaning full profits to remain in the business. Both will drivethem off the markets. In the first case there will be too much emotional attachment orthe greed, but when the trade goes against, it will be hard to press exit button and theygo broke because the position was huge. For Trading the right size of trade is such thatwhich limits the losses to 1% or max 2% of the trading capital. On a trading capital of sayRs 1 lac, one can afford to lose max Rs 2000, therefore say for example ACC is trading at1500 and stop loss is identified at 1400, therefore max loss per share would be 100. But2000 is the max loss defined, as per strategy, therefore 2000/100 = 20 share can bepurchased at 1500 entailing a total investment of Rs. 30,000 (1500*20) with max risk atRs. 2000 on this trade. Similarly for investments one should not invest more than 10% ofcapital in any single stock. For capital of Rs. 1 Lac, max Rs. 10,000 can be invested in asingle stock, thereby creating a portfolio of 10 stocks. The above rules are notmathematical rules of exactness, but suggestive and are followed elsewhere as bestpractices in the industry.
c. Exit Strategy: In a war, what will happen if one doesn’t know when and how to comeout of it? In trading one must have an exit strategy, i.e. when to get out and book profitsor losses. Indecision will not help. Some have pre defined profit target of three times riskfor example if risk per trade is assumed at Rs. 2000 then profit will be booked when Rs.6000 profits is achieved. Others have exit strategy when prices fall 10% from the peak,then and only then, a long position will be squared off. Similarly there are different waysof exiting the trade, it is essential to have the exit strategy in place before entering thebattlefield called the stock market.
d. Stop Loss Strategy: 90% of the battle is controlling the losses no matter what strategyone adopts. Portfolio returns often look bad because of a few trades gone wrong wherethe exit stop loss wasn’t defined or triggered. In trading this is even more importantbecause leverage is used. One generally keeps a stop exit when price adversely moves beyond say 2 times Average true range (ATR) or crosses key support or resistance areas.For investing some prrefer to keep stop at 8% of their purchase price. Whatever may bethe strategy it is a must to exit a losing trade. Every time no one is right all the time.
3. Keep Trading (Price) and Investing (Value) separate:
Trading or Investment, both require different set of skills, mental attitude, and divergent rules. In order to be best in the class, one can therefore either be a Trader or an Investor. The important decision making points wherein strategy differs are Stop Loss or hold on, long term or short term, analyzing price or analyzing value, to follow the market or to predict are some of the contrasting and opposite action points which needs to be applied to either investing or trading to the exclusion of each other.
4. Money can be made on both sides – Up and DOWN! :
Markets are not one way up, after bull market, bear market is going to follow, so one should not be biased towards only long trades, selling short should also be done with the same ease. By refusing to sell short one forgoes huge opportunity to make money when the markets are in bear zone. Always remember, money can be made in 2 ways
a. Buying Low and Selling High!
b. Selling High and Buying Low!
5. Discipline – The silent secret:
The hardest thing in the financial markets is the ability to consistently execute the plan with the iron fist discipline, but which rarely happens and that is why results are so poor. It is said majority of the people do not make money, because people lack discipline. It’s just like control over self all the time which is really hard, similarly remaining disciplined all the time is the most important ingredient for success. Whoever does it has the riches.
6. Manage your Emotions and Expectations:
Trading and Investing are essentially interlinked with human emotions. It the human being that makes the decision but the emotions act as a gatekeeper which filters out decisions. It is sometimes said the battle is not out there on the street, but it is inside one’s own mind. So to be successful trader or investor one needs to understand one’s own temperament, whether he/his is patient or impatient, fearful or fearless, slow decision maker or fast decision maker, emotional or unemotional etc, identifying one’s psychological makeup and then selecting the style which suits, would lead one to a sustained success in trading and investing.
7. Don’t listen too much to forecasters or advisers! They only fill your ears, not your wallets:
Any money making skills has to be self acquired , no one can forever depend on others, that they will make money for them. Similarly by depending on forecasters one constantly postpones efforts to self learn the art of making money through hard work and self study. There is no substitute for self acquired knowledge and experience.
8. Like in all other forms of trading, keep your costs low!
The economics of profit is simple, reduce costs, profits will automatically increase, other things remaining same. The flat fees of Rs. 20/- per executed order shall entail almost 90% of savings in the brokerage costs. Whether Rs. 10000 or 1Cr trade, it’s the same flat Rs. 20/-. This may seem irrational but it is possible because of advent of technology, businesses are now becoming digital driving down their cost of operations dramatically. The flat fee brokers like SAMCO are just passing on the benefits of cost reduction at their end which every trader and investor must avail off in order to reduce costs and increase profits dramatically.
9. Go with the trend:
It is far more difficult to swim against the flow of the river, but very easy to flow with it. Similarly once the phase of the market is identified bull or bear, then one should trade or invest in that direction. Also, it is not necessary to trade compulsively all the time. More trading doesn’t mean more return. In fact, there goes a saying by Mr. Warren Buffett, “As investor motion increases, return decreases”. Sometimes if there is no clear trend in the markets, it might be better to be a spectator than be a compulsory speculator.
10. Keep it Simple:
Like many things in life, simple and uncomplicated things are more effective, similarly in trading or investing, the strategy should be simple and easily understood. The rules of entry exit, the risk management policies, discipline to stick to the plan and the ability to control emotions are the key to success. There is no other rocket science to success in the markets.