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 take/sell shares keeping in mind the time frame (usually short duration), 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 simply because the price is attractive so that it can be sold when the price rises, it is called trading.
Countless people have been lured to the markets by dreams of getting rich quickly and achieving financial freedom. The ease of getting started with trading adds to this allure. The truth though is this: less than 1% of active traders make more money than bank fixed deposits over a period of 3 years. While this number seems unusually small, it is, in fact, similar to the success ratio for 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 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 the lessons learned from my own successes and failures.
Defining the Limit – Money and Time
Markets can remain ignorant longer than you prosper – John Maynard Keynes
Just as not everyone can be successful in a sport, music or business, not everyone can profit from trading in the long run. Stock market is like a black hole where if you are not good at trading then you can lose unlimited amount of money. If you are a new trader then define stop loss and set loss limit – an amount you can afford to lose and a time period for which you will wait to make profit.
Put a 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 Height
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 conversation after interviewing some of the best traders in the world – “You should make sure that you don’t lose more than 1% of your traded capital on any trade”. The bigger your trade losses, the more likely you are to act irrationally 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 have one lakh rupees, 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 attracted to buy stocks whose prices have fallen and sell those that are expensive. While this can be a good strategy when investing for the long term, it can be a win-win when you trade short term. reduces the likelihood of Share prices tend to be trending, ie move up or down in one direction for a long period of time. Going Against the Trend – Buying a falling stock, 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 lows. 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 going on. But while trading, one should buy the stock which is going up and sell the one which is going down.
To “average down” is the destruction of lakshmi
do not invest more money in loss trades.
when you buy a stock at 100 and buy more when the price falls, such as at 90, something else at 85, etc.; expecting that a bounce will help in faster recovery of losses. unfortunately, hope is not really a trading strategy. stock prices tend to trend (up or down for the long term), and buying more to average out might work a couple of times, but it’s usually a money-losing strategy in the long run. by buying more of a falling stock, you are essentially trying to correct a trading mistake that could have been avoided by having a stop loss. worse still, short traders usually sell stocks where they are making profits ( also known as the disposition effect ) to average out a stock.
at least when you average over stocks, you can give it time to bounce. but when you buy stock or index options that have a limited time to expiration, this averaging strategy is a sure recipe for disaster.
in order to trade, one must capture the winners and remove the losers, and not vice versa. i would also like to say that averaging is the biggest money maker for small traders. check out this post on lessons from trading in yes bank .
Leverage is a weapon of mass destruction
Money cannot be the goal; Use it as a tool.
Leverage (in futures and options) means trading with more money than you have at hand. It is extremely dangerous in the hands of someone who doesn’t know how to handle it well. While this can give you confidence that you can make substantial profits quickly if done right, if you take too much leverage, you could end up in the same bad trade. If you talk to an active trader who has stopped trading, it is most likely that they traded with too much leverage. If you decide to use leverage, make sure to use it sparingly and only if 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 for short term trading. For example, stocks that have a low P-E may maintain that low P-E and remain low 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 the market price shows everything (you don’t wait for the news to buy, you buy when the price goes up (rumor) and sell when it goes down) Usually when there is news)). Most T-A strategies do not let you trade against the trend. So if you have decided to buy a low P-E stock by adding to the T-A, you will only buy it 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 sharply and then down sharply without giving you a chance to exit. If fundamental analysis is a part of your trading strategy, you can avoid such stocks.
Avoid Stock Tips
Always start from the beginning (think of all possible outcomes and be prepared before trading). Professional traders have an exit strategy before every trade. – Robert Kiyosaki
While there are many “advisors” who claim that they can give you stock tips that will generate high returns or make you earn money quickly, they rarely end up with easy money like this. When trading on the tip, you will not know the reason to enter, and therefore will not know exactly when to exit, which is the most important part of trading. Most of us are also terrible at using advice, which means that if you somehow find a mentor who makes good suggestions, you still may not follow through. Either way, it usually only creates difficulties. Furthermore trading on TIPS is almost spoon-fed, your learning curve and growth as a trader stalls. More importantly, there are heaps of unsolicited stock tips and s-m-s “pump and dump” scams spread on social media., These scammers inflate the stock price by generating hype through tips, only to dump those large blocks and profit at the expense of the traders who fall prey to it.
Diversification or diversification
Don’t depend on one tool.
If you are building an active trading portfolio of stocks, ensure that you do not have more than 10% of your trading capital in any one stock. Make sure that no 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 are left 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 become addicted to trading. Most people enter trades simply because there is nothing more interesting or exciting to do. It is very important not to become such a trader. Whenever you feel like 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 just trading out of habit.
By the way, this strategy of changing the size of the trade depending on the position is called “trade sizing”. Essentially, don’t trade with the same volume all the time – shorten your trades when you have a drawdown (stop making money) or when you’re not sure, and place bigger bets when you’re consistently winning and are confident about their trades. By measuring bets like this, you increase your chances of winning yourself in trading.
Have alternative income to improve your chances of winning
Confidence is not ‘I will profit from this trade’. Confidence that ‘even if I don’t profit from this trade, I won’t mind’. – Ivan Biazzi
If trading and making money is difficult, then making a living from trading is manifold. Very few succeed under the added pressure of earning money from trading to put food on the table. This decision of trading for a living should be taken only 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. Alternative income streams can be from a fixed income source, rental income, a salaried job or anything that will reduce the pressure on each trade to make a profit. 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, stop it. Don’t let bad or missed trades affect your personal life. As they say, opportunities always look bigger as they pass. And remember, there is always another trade; If not in the stock markets, then elsewhere.
If you are just getting started with trading, make sure you learn about trading and investing through Varsity . For those trading for a while, learning trading psychology through this collection of InnerWorth newsletters is a must. they’re amazing. If you have any questions you can post them on TradingQ&A .
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