Stock trading? What are your rules?- PROCESS IN INVESTING

(This appeared in the Deccan Chronicle- July 20th, 2015)

Many of us buy shares without having a ‘goal’ in mind. Do we invest because we like the company and want to own the shares as long as possible, participating in the company’s growth? Or do we own the shares, watching the price every day, hoping to make a quick buck? Nothing wrong with either so long as we know what our reasons for buying are.

The second type of buying, where we hope to make a quick buck, often does not work out the way we thought it would. When we are a short term buyer and seller of shares, we do not give too much thought to the company, its fundamentals or its prospects. More often than not, this kind of buying is based on our pet theories or from newsletters or tipsheets etc. Or it could be because we heard a one minute talk on the television set and decided to buy.

It is important to have a process when we indulge in short term trading.  The process should answer the following questions:

i)              Why have I bought this share?

ii)             What do I expect? What is the price target?

iii)           How long do I have to wait for this?

iv)           If the price falls, what do I do?

v)             What if the price does not move and my time of holding is coming to an end?

vi)           Do I buy my entire allocation for the stock in one lot? If not, then do I buy more if it falls? Do I buy more if it rises?

vii)          Can I sell the quantity I buy without moving the price much? In other words, what is the trading volumes?

Often, I have seen people buying for a quick churn and becoming long term investors even as the share price keeps dropping over years. This is real erosion of wealth.

It is useful to have a set of rules before we execute our short term trade ideas. A simple framework could have rules like these:

a)    My total corpus kept aside for short term trading is , Rs.__ lakh;

b)   Of this, the maximum in a single scrip will not be more than Rs.__;

c)    My maximum holding period is ___ days;

d)   My aim is to get a 20% return in this trade;

e)    I WILL sell earlier if the price either rises by ___ or falls by ____;

f)     I will NOT have more than five positions outstanding at any one time:

g)    I may buy half my limit in one go;

h)   I will NOT fall in love or attachment with any stock from this basket;

i)     I DO NOT need the money allocated to this activity;

j)     I do not hurt if I lose money.

You can keep adding or subtracting from those rules. The idea is that short term speculation should not be a random activity. Have a process. It is likely that you may lose most of your money over time. Or you may get lucky and make some money. The idea behind having a process is to help you be aware of the situation and not go in to panic or worry.

Also, keep a track of why you bought each share, on whose reco, whether you did any additional work to confirm etc.  Of course, I do not have anything to say to those who follow technical analyses or charts, since they have their own process to follow. But they too could do well to have a system and process in place.

I do not expect you to make a big fortune out of this. The probability is that half the trades could go wrong. The idea behind a system and a compulsory exit is to ensure that you do not keep ‘averaging’ or ‘chasing’  and get shut out.  The key is to analyse each mistake and learn from them. Respect the process and it will reward you in more ways than one.

R Balakrishnan

(balakrishnanr@gmail.com)

DC- July 14^th, 2015