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You must have heard that money can be made very easily in the stock market. It is true that it has become very easy to start trading in the stock market. But you have to keep in mind that making trading profitable is hard work.
What is the difference between trading and investing?
I think if you buy and sell shares keeping in mind the time frame (usually short term), then it is trading and not investment. For example, if you buy a house to live in without the intention of selling it, it is an investment. If you buy a house just because the price is attractive so that it can be sold when the price increases, it is called trading.
Countless people have been lured into the markets by dreams of getting rich quick and achieving financial freedom. The ease of getting started with trading adds to this attraction. However the truth is this: less than 1% of active traders make more money than a bank fixed deposit over a 3 year period. While this number seems unusually small, it is, in fact, similar to the success ratio of typical businesses; The only difference is that the ease of entry entices a large number of people to start trading.
I have been a trader for almost 25 years. I have been very fortunate to have had the opportunity to interact with thousands of traders, both before and after starting Zerodha. I felt that as a trader it would be a good idea to interact with all of them and share what I learned from my own successes and failures.
Limiting Defeat – Money and Time
The markets can be incomprehensible longer than you are rich - John Maynard Keynes
Just as not everyone can be successful in a sport, music or business, not everyone can make a profit from trading in the long run. Stock market is like a black hole where you can lose unlimited amount of money if you are not good at trading. If you are a new trader, define a stop loss and set a loss limit – an amount you can afford to lose and a time period you will wait to make a profit.
Put stop loss on every trade as well
Two basic rules when trading: (1) If you don't bet, you can't win. (2) If you lose all your money, you can't bet - Larry Hite
I had the privilege of hosting this podcast with Jack Schwager – author of Market Wizards , a must read for any aspiring trader. I agree with what he says in this talk after interviewing some of the best traders in the world – “You must ensure that you do not lose more than 1% of your trading capital on any single trade”. The bigger your losing trade, the more likely you are to act rashly during or after trading, which can ruin your trading career.
And for those who buy calls or puts, placing a 1% stop is only possible if your option buy trades never exceed 2% to 3% of your trading capital. Remember, buying options without a hedge is almost like buying a lottery ticket. If you had Rs 1 lakh, how much would you spend on buying a lottery ticket?
keep up with the trend
In trading, what is comfortable is rarely profitable. – Robert Arnott
We are tempted to buy stocks whose prices have fallen and sell the ones that are profitable. While this may be a good strategy when investing for the long term, it is not a winning strategy when you trade short term. reduces the chances of Share prices tend to trend, i.e. move up or down in one direction for a long period of time. Going against the trend – Buying a stock that is falling, or selling one that is rising, is a bad trading strategy.
A common opening strategy is to buy stocks that are at their 52-week low. The thought process is that prices that have fallen are bound to bounce back. This is probably one of the worst trading strategies ever. We are all ready to buy whenever there is a discount sale. But while trading, one should buy the stock which is going up and sell the one which is going down.
Doing "average down" is the destruction of Lakshmi
Don't invest more money in loss trading.
When you buy a stock at 100 and buy more when the price falls, say at 90, something else at 85, etc.; Keeping the hope that a bounce will help in recovering the losses faster. Unfortunately, hope is not really a trading strategy. Stock prices tend to trend (up or down for a long period of time), and buying more to average might work a couple of times, but it's usually a money-losing strategy in the long run. By buying more of a declining stock, you are essentially trying to correct a trading mistake that could have been avoided by having a stop loss. To make matters worse, in order to average out a stock, small traders usually sell the stocks where they are making profits (also known as the disposition effect) .
At least when you average on stocks, you can give it time to bounce back. But when you buy stock or index options that have a limited time to expiration, this strategy of averaging is a surefire recipe for disaster.
To trade, one must hold the winners and discard the losers, and not vice versa. I also want to say that averaging is the biggest money killer for small traders. Check out this post on Lessons from the Trade of Yes Bank .
Leverage is a weapon of mass destruction
Money cannot be the goal; Use it as a tool.
Leverage (in futures and options) is trading with more money than you have. It is extremely dangerous in the hands of someone who does not know how to handle it well. While this may lead you to believe that when done right you can make a quick enough profit, if you take on too much leverage, you can end up with a single bad trade. If you talk to an active trader who has stopped trading, the most likely reason is that they traded with too much leverage. If you decide to use leverage, make sure to use it sparingly and only when you are really confident about trading. Still make sure you keep the stop loss!
Using fundamental analysis with technical
Buy on rumours, sell on news.
Many beginner traders begin their journey in the markets by learning fundamental analysis, the most popular strategy being the Price to Earnings (P-E) ratio. While fundamental analysis is a great way to invest for the long term, it is not meant for short term trading. For example, stocks that have a low P-E may maintain that low P-E and go lower for an extended period of time while the share price continues to decline. If you want to use fundamentals, it's best to mix it with some technical analysis (T-A).
T-A is based on the fact that market sentiment shows all (you don't wait for news to buy, you buy when prices go up (rumour) and sell when it goes down ( Usually when there is news)). Most T-A strategies do not allow you to trade against the trend. So if you have decided to buy a low P-E stock by adding to the T-A, you will buy it only when the stock price goes up. For example, if the price is above the 50-day moving average (a simple T-A strategy) – a trading strategy is much more likely to win than simply buying a stock because it has a lower P-E.
Trading the stock price without knowing what the stock is is not a good strategy. Penny stocks (companies with a market cap of less than Rs 100 crore and mostly where there is no real business) are wealth destroyers as well. These stocks are usually manipulated and have a tendency to go up quickly and then come down too quickly without giving you a chance to exit. If fundamental analysis is a part of your trading strategy, then you can avoid such stocks.
Avoid stock tips
Always start from scratch (think through all possible outcomes and be prepared before placing a trade). Professional traders have an exit strategy before every trade. – Robert Kiyosaki
While there are many "advisors" who claim they can give you stock tips that will generate high returns or make you a quick buck, rarely is it easy to make money that way. When trading on a tip, you will not know the reason for entering, and therefore will not really know when to exit, which is the most important part of trading. Most of us are also terrible at using advice, which means that even if you somehow find an advisor who makes good suggestions, you still might not follow through. Either way, it usually only creates problems. Also trading on tips is almost spoon-fed, stunting your learning curve and growth as a trader. More importantly, there are heaps of unsolicited stock tips and SMS "pump and dump" scams circulating on social media., These scammers inflate stock prices by generating hype through tips, only to dump large blocks and profit at the expense of traders who fall prey to them.
Diversification or Diversification
Don't rely on one means.
If you are building an active trading portfolio of stocks, make sure that you do not have more than 10% of your trading capital in any one stock. Ensure that not more than 25% of the portfolio is in any one sector. Although diversification can reduce returns, it also reduces risk. As a beginner trader, the most important thing is to reduce risk in the first few years. Think of it this way: You have to go through 16 years of education before you can find a job. Similarly, you need to give yourself time and opportunity to learn and grow as a trader. But you can get that time only if you have survived trading for a long time, and this is possible only if you reduce the risk as much as possible.
Trading Addiction and Trade Sizing
Sometimes, the best trade is not to trade at all.
It is very easy to get addicted to trading. Most people enter trades simply because there is nothing more interesting or exciting to do. It is very important not to be such a trader. Whenever you feel that trading has taken over your life, take a break. If you are finding it difficult to stop trading completely, reduce your trading size to 1/10th when you know you are only trading out of habit.
By the way, this strategy of changing the trading size depending on the position is called “trade sizing”. Essentially, don't trade with the same volume all the time – make your trades smaller when you have a drawdown or when you're not confident, and place larger bets when you're winning consistently. and are confident about their trades. By placing bets in this way, you increase your chances of finding yourself victorious in trading.
Have alternate income to improve your chances of winning
Confidence is not 'I will make profit from this trade.' The confidence is that 'even if I don't make profit from this trade, it doesn't matter to me'. – Ivan Biazzi
If trading and making money is hard, then making a living from trading is many times harder. Very few succeed under the added pressure of earning from trading to put food on the table. This decision of trading for a living should only be taken if you have a substantial source of income to cover your lifestyle, and have hard stops in place. Even when it's all in your favor, it shouldn't be a decision to be taken lightly. The alternate stream of income can be from a fixed income source, rental income, a salaried job or anything that will reduce the pressure to make a profit on every trade. In my experience meeting countless traders, most of the people who were profitable were also those who had another source of income.
And finally, remember that trading is not life. Trading is an exciting way to generate income. If you are not enjoying it or are constantly losing money, then stop. Don't let bad or missed trades affect your personal life. As they say, opportunities always appear bigger than they come. And remember, there's always another trade; If not in the stock markets, then elsewhere.
If you are a beginner in trading, make sure you learn about trading and investing through Varsity . For those who have been trading for a while, be sure to learn trading psychology through this collection of InnerWorth newsletters. they're amazing. If you have any questions, you can post them on TradingQ&A .