In the volatile world of stock markets, risk management is the defining trait that separates long-term winners from short-lived speculators. Zerodha Founder and CEO Nithin Kamath reiterated this in a LinkedIn post on Monday and stated that managing risk effectively is crucial, especially in times of uncertainty when “fear takes over and having an objective mindset”.
Drawing from a old podcast featuring legendary trader Jerry Parker, also the Chairman of Chesapeake Capital, Kamath shared key insights on risk management and trading psychology.
Live to play another day
A fundamental rule of trading is knowing when to cut losses and preserve capital. “This is a Turtle Rule. That when you have a drawdown, you reduce your positions twice as fast as the drawdown. So, if you’re down 10%, you should reduce your positions by 20% and so on. And that’s a different day when we were trading really large, very few markets, very short-term. But I think it still kind of applies that you want to have that one rule that always works. It’s always going to work. It’s going to keep you from losing too much. And that is just to reduce your positions and live to play another day,” Kamath posted.
Cut your losses, let winners ride
Human psychology often contradicts successful trading strategies. Kamath shared Parker’s observation that traders tend to hold onto losing positions, hoping they will recover, while prematurely exiting winning trades out of fear of losing profits. This emotional bias leads to compounding losses and stunted gains.
Instead, Parker suggests reversing this mindset — be fearful when in a losing trade and hopeful when in a winning one. A well-placed trade with strong momentum should be allowed to grow, while losses should be cut early to prevent them from ballooning.
Avoid over-trading and stick to the system
One of the biggest mistakes traders make is over-trading—entering too many positions or trading outside their strategy. Parker recalled that most of his trading anxiety stemmed from not following his system religiously. “The markets I can kind of get over, I can turn it into a game, I love the game. I love playing and I love competing. But, yeah, that’s the two most important things. And I got that from Rich. I asked him, like, one day, what’s the two biggest mistakes we make? Or what are the biggest mistakes we’re going to make? And he’s like, oh, over trading and not following your system.”
Kamath’s observations come amidst a prolonged market downturn. The Nifty index has endured five consecutive months of decline, marking its longest-ever losing streak and is currently 17% below its all-time high of 26,277.35. Although the market showed a slight rebound with a 0.5% gain on Monday, uncertainty remains high.