Play by the rules of the game

Many people enter the equity market thinking that they would make a quick buck riding on some news or momentum without having a time horizon in mind. However,once the stock they invested in starts sliding,they tend to keep increasing their time horizon and refrain from cutting losses. It is dangerous to buy “stocks in news” without regard to fundamentals.

Typically picking up a ‘tip’ and buying without any information is a common mistake many investors end up making. The stock market has seen excesses in the past where stock prices are whipped up in frenzy by ‘operators’ after planting news about the growth prospects of the company. Castles get built in the air and an atmosphere of belief is created and it is too late before an unsuspecting investor figures out the truth about the company.

Identify the type

Every individual while entering the market has to determine the exposure s/he is willing to take and the time horizon s/he would like to invest that money for.

Many entrants into stock markets are not clear of their risk appetite and the time they expect to be in the market. “Rather than taking a disciplined approach to investing or trading,many times individuals are looking to make a fast buck from the market and this approach lands them into deep trouble as there is no such thing as a free lunch,especially in the stock market,” says Sandeep Nayak,ED & CEO,Centrum Broking.

Equity trading

A trader has a short term horizon where each purchase may be an intra-day trade where the transaction is squared off and profit or loss booked by the end of the day.

A trader uses the help of technical analysis tools to identify the trend in the stock price and it is necessary to determine the price upside (or downside) one is playing for and determine a stop loss level. One must recognise that technical analysis is not a perfect science and is known to fail one at crucial times. It is therefore necessary to identify a stop loss strategy and recognise pattern failures and accept them and book losses.

“A trader or momentum player needs to decide a stop loss level upfront before entering the trade. There is no hard and fast rule and the stop loss is a matter of risk appetite. A rule of thumb a trader may follow is that the stop loss should be less than a third of the gain one is aiming for. For example,if a trader buys a stock with an expected gain of Rs 6 then an opposing movement in stock price of Rs 2 should be his or her stop loss,” adds Nayak.

Momentum player

A momentum player identifies an underlying trend in the price of a security and rides the trend as long as it is profitable and the time horizon could be a few days to a few months depending on how long the trend lasts. “As a momentum player,an investor invests on the assumption that a company is ‘hot’. Typical streaks do not last beyond 5-10 per cent,” says Sandeep Tyagi,MD and CEO,Estee Advisors. Traders and momentum players trade on both sides of the market i.e. long and short side both depending on whether the outlook for the market or stock is bullish or bearish.

The “trend is your friend” strategy is best adopted by these players with two key things to be kept in mind — stop loss must be strictly followed without fail and exposures kept under control — keep taking money off the table when you are winning.

“A common mistake made by most of the traders is increasing exposures by ploughing back trading profits leading to large exposures which can lead to higher losses when the market whipsaws contrary to expectation. About 90 per cent of the traders/momentum players end up losing money as they mix emotions and let their ego influence their buy/sell decisions. Exiting timely is extremely important to make money,” suggests G Maran,executive director,Unifi Capital.

Investor

An investor is in the stock market with a long-term horizon intent on capital appreciation. The dividend yield is also a relevant consideration but largely an investor is in the game for a reward through handsome capital appreciation.

According to the experts,an investor is likely to get best results following a buy and hold strategy with a horizon of three years and above. Identifying the right companies to invest is a great challenge faced by an investor.

Understanding the fundamentals of the company,judging the quality/competence of the management and the corporate governance standards followed by them require expert guidance and a good quality advisor or wealth manager is a handy help in this process of stock selection and investment.

“A good company tends to grow at 15-20 per cent. The market volatility is about 25 per cent. So your holding period should be at least 2 years in simplistic terms. The stop losses should be decided when the losses are more than the market volatility (so if the market is down 5 per cent and your pick is down 10 per cent,net loss of 5 per cent is what should determine that you exit),” adds Tyagi.

An investor needs to spend adequate time tracking the performance of portfolio. It is necessary to review each company one holds in the portfolio and ensure that the rationale for purchase still exists. Company performance is available on a quarterly basis and researchers put out updates on the company after each result and explain the variations in performance.

A prudent investor would do well to at least review portfolio every quarter and take a call in conjunction with an advisor/wealth manager on the prospects of the stocks.

But before that,do identify whether you are a trader,momentum player or an investor and play by the rules,for that should be the first step when investing in stocks.