Investing is as much as an art as a science and every person must consider his risk to reward ratio before getting into the stock market.
“Cut your losses short and let your winners run” – This sage advice has been doing the rounds in the stock market since years. The general practice among investors is selling stocks after a small gain only to watch them head higher or holding a stock with small losses only to see them worsen. However, unless investors and traders take certain amount of calculated risks, making money in the share market would be difficult. Hence, avoiding losses should not be the aim but it should be minimizing them.
And the first thing that comes to one’s mind to minimize losses is to place a stoploss. Stoploss is the only way to minimize losses but actually it is the most common element in multiple small losses because more often it gets hit and then the price moves in the original anticipated direction. Generally, stops are triggered and then the prices move, thus traders lick their losses every time although they are small in number but becomes huge overtime. But that doesn’t mean that stoplosses should not be kept instead they should be far and scientific. The correct way to reduce losses is to manage risks effectively.
Here are 5 ways to minimize losses in the stock market:
1) Traders should have a portfolio of 5 to 6 trades such that even if 1 or 2 stoplosses are hit, they are still able to make money in the other open positions. On the other hand, investors can choose 10 stocks from different sectors and each stock should be a leader in its respective sector. This diversification will enable minimizing losses because if a few stocks perform badly, at least the others will even out the underperformances.
2) Basic historical fundamentals should be checked at least once before investing for that matter even for trading. For example, Kingfisher Airlines is one such stock which never made profits in the past several years and had a growing debt on its books. Such companies which give red signals should be avoided as there is a higher probability of losses than gains unless there is news of a turnaround by restructuring, change in management or several other factors.
3) Traders and investors should form teams of like-minded people such that they can effectively filter out promising trades as a team and the negative emotions and mistakes are kept under check if they operate in teams. Similarly, an investor may take the help of an advisor for investment opinions.
4) Investors and traders must not panic and make extempore reactions to negative or positive news. Short-term noise muse be disregarded, and investments must be made solely on the qualitative and quantitative aspects and not in haste. Example, Nestle India had undergone extreme panic in 2015 and the stock fell from Rs 7000 levels to Rs 5500 when there was a ban on the Maggi noodles due to the presence of lead and monosodium glutamate beyond the permissible limit. However, that led to the fall in the stock price as prima facie, but people forgot that great companies eventually have the capabilities to put their house in order sooner than what people expect. The stock price since then has double to Rs 11000 currently.
5) Avoid leverage. In other words take manageable trading positions such that rational thinking ability of mind is not corroded with fear because in a state of fear no rational decision making can happen.
Investors and traders must follow these 5 points as a thumb rule for investing or trading. Patience is the key as wealth cannot be made in a day. Investing is as much as an art as a science, and every person must consider his risk to reward ratio before getting into the stock market. Stoploss is a basic requirement which cannot be neglected and must be placed far off and scientifically so that it is not hit before the stock is about to turnaround. Only when investors and traders follow discipline can they minimize their losses and make huge profits.
(By Jimeet Modi, Founder & CEO at Samco Securities)