Tuesday, June 30, 2009

Why You Should Sit Tight to Make Big Money from Your Bets?

sitting tight on your trades to make big profitsImage Source

Many successful traders or investors in history have done this. Many traders still continue to sit tight and make big money from their bets. Sitting tight is the single most important thing that can make or break a stock trader’s portfolio in the long run. But it is more dependent on the type of strategies a trader uses than on any trader in general.

What Does Sitting Tight Mean?

Sitting tight is a term most popularly used in stock trading by successful traders. Because you can be certain to become successful if you employ sitting tight principle in your own trading! It refers to holding the stock patiently no matter how violent the stock may be moving till it makes the anticipated move in the desired direction.

It is much like its literal meaning. Let us say you are sitting in a vehicle and the vehicle is moving on a rough terrain. Then whether you sit tight or not determines how your experience of the journey will be. Those who sit tight will stay there till they reach their destination without leaving the vehicle or getting hurt. Same is true in stock trading. Just sit tight when your stocks are making you feel uncomfortable.

Any Trader can Sit Tight

Sitting tight can be applied for any time frame. It applies to short term traders, intra day traders and long term traders as well. It does not matter what amount of time you should sit tight, there is always a situation when the stock behaves unexpectedly but you are expected to sit tight.

Importance of Sitting Tight on Your Trades

Sitting tight can make a big difference on the long run. This is because often the biggest gains in stocks can be made by sitting tight on your bets. Immediately after you buy a stock it may either, just fall below your buy price prompting you to sell with stop loss or sell because it is just waiting above the stop loss and wasting time, or it might have moved up sharply and down violently though it shows good profit from buy price. In all these situations, there is an opportunity in sitting tight.

It may not necessarily be true all of the time. But often the stocks tend to move in trends, that is, they continue with the same trend and repeat the moves that they did earlier. For this reason sitting tight makes the big difference between a successful trader and a trader who just makes it above the break-even barrier.

Sometimes institutional investors or some smart high networth investors try to play games with the retail investors. It is easy to for them to play for a while because they have huge money to play with. They can risk a little for game play while testing your trading attitude. Recently Sebi announced plans to allow Indian Brokerage firms to use their software based trading. This was despised by these institutional investors as they can't know now whether it is a retail trader or a software that they are competing with on the other side.

Successful stock traders like Jesse Livermore have explained the importance of sitting tight in trading stocks. Even after knowing its importance we tend to forget it or violate it for some reason. But focusing on its long term importance one can make a habit of sitting tight on the right bets and make the best out of a trade.

Don’t Be Mislead into Holding Stock as Sitting Tight!

There is a difference between sitting tight and holding the stock. Sitting tight does not just refer to the act of holding a stock without selling it. Sitting applies to only situations where you should hold your breath and do not sell immediately till the stock makes anticipated move. So there is a plan in your trade and an expected result when sitting tight. You will hold the stock till it does what you expect it to do.

In holding a stock there may not be a plan. You may be just holding it for no reason other than hope. Most of the times the average stock trader decides to hold a stock only when it falls below their buy price. He/she does not get the courage to book the loss, when it is small, and expects it to turn around and close it without loss. It may or may not happen. Most of the times the stocks move in the same trend. Hence as the stock falls further and further, these traders hold it for eternity making the loss bigger and bigger!

But sitting tight in no way comes close to this act of drowning in a falling stock. In fact holding the stock in a falling market is opposite of sitting tight. Relatively we can view it like this: not waiting till the stock makes its bottom is sitting tight on you cash in a bear market trend. We should clearly distinguish before trading stocks as well as even while trading stocks. Most importantly you should be able to clearly assess the type of situation you are in and if you are already in loss cut short with stop loss, close the trade, or plan for second stop loss there is still an opportunity for the stock to make a move. Never take a third chance.

As the stocks continue in a trend, you will also need to sit tight for long term trading beyond one cycle. Long term stocks move ahead in jumps. It gives a big return if more than one jump is captured in a single trade. This is where you need to sit tight. It enables you to get an extra margin over trading expenses and also increases the profitability per trade. This ensures long term success of stock trader as only few such trades are needed which compound that return into massive gains over a period of time.

Depends on Your Trading Strategy

Sitting tight is not just for any stock trader. It has to be applied to certain types of strategies. Knowing them well makes a big difference too. For certain types of strategies there may not be a need to sit tight.

Some traders’ strategy is to trade that part of the stocks’ movement that is certain when applied a particular rule of entry or exit. This can be for short selling or buying stocks. They exit quickly after the stock makes that certain move upon entering. In fact here if you keep watching the stock, the stock will hit the high and wipe out the gains quickly. There the stock will sit tight before making another move up or down. As the margins of profit per trade are low for these traders, they do not waste time sitting tight.

Hence the profit potential per trade must be considered strictly when deciding to sit tight on a bet. The trade should generally be of a long swing type be it short term or long term. The expected price range potential should be very high. Even in day trading, stocks can make moves successively again and again on certain days. These days are not very rare for particular stocks. But on average they are rare. Hence a stock, that makes such moves on some day, may make only part of such move on normal days. Here it becomes difficult to separate it. So you will have to check the pattern, assess it and decide to sit tight within the day or over a few days.

Generally Good on Long Term Trades

Sometimes in day trading, immediately after you make an entry the stock might just become range bound into a tiny range. The volume may dry down. But you should weigh the trade-off between the value of your trading time and the odds of the stock moving right. Then only sitting tight here can make a difference. Of course profit potential over expenses must make it worth sitting tight. Unless otherwise you should restrict this habit to the long term trading only.

Sitting Tight can Change Your Portfolio Forever

Note the strategy you are trading with, the situation at hand when you are in a stock, and decide whether it is right to sit tight. When done properly sitting tight can grab all the opportunity that you have ever wanted to capture in a stock. It results in a long lasting satisfaction and experiences to share as you sat tight when the stock moved violently!

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Sunday, June 28, 2009

Should You Trade in Liquid Stocks or Illiquid Stocks?

Should you trade in liquid or illiquid stocks?Image Source

Liquidity is an important property of a stock. It is in fact not just for stocks but for any asset that can be traded with money. Many people trade stocks without ever knowing about this property of their stocks. For a professional stock trader, who trades with strong trading principles, liquidity becomes one of the major properties to consider in his/her trading. Continue reading to learn more about its importance as well as what is liquidity if you did not know.

What is Liquidity?

Liquidity is a popular term in finance but I did not know it until last year. Even though I heard about it and its importance in the first ever seminar I heard when Anand Agarwal (from Hyderabad) presented about investing and risk, I did not quite understand it at that time. As I started trading on my own, and learning new lessons at one point of time I could quite understand the right meaning of this in relation to my own trading.

Liquidity of an asset is defined as the ability to sell or buy it quickly in the market without affecting its price. You must have heard that a stock will rise when it is bought and will rise when it is sold. In reality if you think again you will note that there is a seller for every buyer and a buyer for every seller. Then how come you can say that the stock is only bought or sold?

The fact is not whether the stock is just bought or sold that determines its movement. It is the change in value of the stock in the mind of buyer or seller willing to transact the stock at any time. At any point of time there will be orders for sell above current market price and orders for buy below it. If buyers want to buy the stock at any rate immediately, what should they do? They should just rise their order price, then immediately it will match against the sellers’ prices and gets executed.

How Does Liquidity Play Role in the Stock Market Movements?

When too many buyers behave in the same way then the stock starts showing a definite movement in the upward direction. This is the reason why the stock moves with buy or sell actions not just by their simple meaning but due to as described above.

That means stock moves when you make a transaction aggressively by changing your order to get executed quickly. This is only when you do not find enough number of stocks with the matching opposite orders. But what if you find? Then the stock price does not move in the up direction if you buying. In other words the stock appears stable.

Now to make sure that the stock makes some move at all times, we need to have liquidity. That is there should be buyers and sellers constantly trying to match their orders. No matter who trades them and how many trade these stocks, the point is to have very little impact of your trade on the price of the stock. Even if you sell your stocks in huge volume, it should regain its earlier price in a very short time (in seconds).

So Liquid Stocks Regain Their Shape

That is how liquidity works. You must have noted the relative stability of the big companies and especially the large caps mentioned in the stock exchange indices like Sensex for BSE or Nifty for NSE. This is because of their high liquidity. Liquidity, if you take literally ,also tells that the asset is more like a liquid in which you can quickly put your hand, pull something out and it still retains its shape after a little time. If it is like a solid, then whatever small piece you add or take from it creates a mark or change in its shape that remains like that for the rest of the time. Illiquid stocks behave like that. If you traded them, you can see the impact of your trade for a long time to be noticed by the Securities Exchange Commission.

Hence liquidity is referred to as the ability to trade an asset without altering its price. In reality different stocks have different amounts of liquidity. For that reason their daily movement ranges and the volume of transactions too differ.

Those stocks are highly liquid which are traded heavily with huge number of transactions per second compared to any other stock. With these stocks you can get in quickly for the price that you see as the CMP (current market price) at that time. You can also get out of the stock quickly for the price you see as CMP. In less liquid stocks it is not possible to do so easily. In other words liquidity determines how many shares you can transact at any given time in a given stock.

Liquidity Gives a Safety Edge for a Trader

Liquidity thus gives you flexibility to play the game easily. So it is safer to invest or trade those stocks that are highly liquid or traded heavily than otherwise because you can get in and out of them pretty fast. Examples of these stocks are many in Nasdaq as 100s of millions of shares get traded on them. For ex, Apple, Nasdaq Index QQQQQQ, QualComm, Texas Instruments, Cisco, Microsoft, etc. On the National Stock Exchange in India, the stocks in Nifty like ICICI Bank, HDFC Bank, Reliance, RNRL, etc are highly liquid. In general, NSE is more liquid than BSE.

Now you must have already understood how liquidity can be used. If you are a stock trader (or share trader), then you should go for highly liquid stocks. Especially if you are going for short term trading or intra day trading. When you do short term trading, you should be able to get in at the price you want to get in and also trade with the same number of shares that you would have done with long term trading. The reason is that regardless of short term or long term trading, a stock can give the same amount of return. You got to do long term compulsorily when liquidity is less.

Hence short term traders bet relatively large money in a short period of time. To absorb their impact and not to affect the stock price movements we need to select those stocks whose daily traded volume is very high. At the end of the day somebody has to absorb your moves right :). For example, for day traders or short term traders, many stocks on Nasdaq and RNRL, Reliance, JPAssociates, DLF, Adlabsfilm, etc. on NSE are right type of stocks.

But it does not necessarily be vise versa for the long term traders. I had explained the difference between long term trading and short term trading and when to use them in an earlier article. The long term traders often target stocks that may not necessarily have good liquidity. For example in the year 2007, the top 20 stocks that gave highest returns as much as 2000% in a year are the stocks that have low liquidity. It happens like all of the time.

Illiquid Stocks Too Are Important, But Play Carefully

This does not mean that you can not trade them. Many people get turned off for low volume and ignore them thinking there may be some scam involved. That is wrong. There is a professional way of trading these stocks. And institutional investors always employ such tactics to get in and get out of any stocks easily and quickly without draining out the stock or skyrocketing it. In fact institutional investors trade with a big deal of money that they mostly settle with highly liquid stocks like Infosys and Reliance. Just check the fund allocation into stocks of any mutual fund and you will find this.

With low liquid stocks, you should never consider short term trading. You should only do long term but with a proper strategy in deciding the number of shares to trade. You can also buy the stock not in one trade, but in several at different times in different order for the same or closely similar prices. It takes time for these trades to get executed as there may not be much activity on that stock.

Similarly while getting out as well, it can become extremely dangerous with illiquid stocks. You may want to get out at certain price but as you start reducing the exposure you will see that the next lowest buy order is at a huge gap. Either you need to have enough patience to wait till it gets executed (it often does) or lose money in the process. As the margins of profit for short term trades are less than that for long term trades in illiquid trades, it is never a good idea to trade illiquid stocks for the short term.

In many cases the right time to decide to sell is when the trend of the stock reverses and by then the illiquid stock too becomes very liquid due to the hype and attention it had accumulated over time. And if you do not get out then, it will become illiquid again as the stock falls. Then you can never get out with a reasonable profit from it.

Liquidity Changes with Market Trends

Note that not all stocks can be just separated as liquid and illiquid stocks. Each stock has a certain level of liquidity. Hence you should understand this level of liquidity of a stock from its daily volume of transactions. Often this becomes highest during bull markets or at the peak price of a stock.

Once you know about liquidity, now you should consider it while creating the list of stocks to trade for short term and long term separately. Sometimes you should add some stocks or remove some from the list as the liquidity of stocks can vary depending on the type of investors that trade it from time to time.

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Friday, June 26, 2009

The Importance of Plan for Your Trading

It is important to have plan for your tradingImage Source

What is the simple thing that separates professional stock traders from novice traders? Are you a trader who trades stocks by the instinct? Or do you trade with a plan? You need to have a plan for your trades from the entry into a position till its exit. Having a plan does the same help for trading stocks as it does for any other profession.

Many traders start trading stocks because it looks like as if it holds some luck for them. Some traders understand that it is not a gambling casino but still continue trading by the instinct. Even the traders who are active and have some experience of past trades still end up doing a lot of trades without any proper plan.

Novice Traders Don’t Have a Plan

Trading stocks without prior study or preparations is what makes it an instinct based trading. For novice traders it is very natural to just jump into a stock that has just made some gain compared to other stocks. They do not even think of the stock making a reversal in the next moment.

Only after several failed trades do many stock traders understand the importance of a plan before executing a trade. Many learn it the hard way. Some traders actually do not bring in a full change in their trading habits. Sometimes they trade well as with their plans. But in between they keep doing trades without prior plans.

With Practice I Learned to Plan

When I started trading since two and a half years back, I too used to trade just like that. In fact I was not a very novice, unorganized trader. But I had studied a little about stock markets and stock price movements before opening my trading account. I had created a list of stocks which I can trade and used to track them well before I started trading. Even after all this I couldn’t control the urge to enter a stock just after logging into my trading account.

It is not when starting trading first time or logging into my trading account. Whenever I close a trade by selling existing stock, for whatever tiny profit that came from my luck, I immediately wanted to put the money to use in some stock. I never used to give rest for it. I think this is the same case for you as well at one point in your trading life. We just don’t get over this thinking of keeping money always at work.

Some trades resulted in profits whether small or big. But some ended down in loss. But I never booked loss initially until my first big loss. It was just part of a powerful bull market that we had for the past years and hence it did not matter. The stocks always bounced back and I used to quickly close the stock after it crossed a little above my buying price. Then again I used to put in some other stock without any plan.

After several trades and few months of time has passed, I started analyzing the progress. I was surprised to see the way my portfolio is growing relative to the market indices. Sensex was making 5% gain every month. But my portfolio was making only 2% and that too with multiple trades, diversified and so on. So I thought there is something wrong. I need to change my trading habits.

No Plan - No Progress

Later as I started looking for best ways to trade and make full out of opportunities, I found several experts’ articles on the internet. Sometimes I searched for books and read them. Though I couldn’t find a perfect book or the books did not match my then wavelength, I noticed that almost all books and experts emphasized the importance of a plan in your trading. They used to say, “It does not matter what you trade and how you trade and so on. If you have some plan for your trading that is all that is needed. You will certainly be on the right path soon.”

Trading without any plan is like a kite flying without being controlled by a rope. It is a complete waste of time and money. The worst still is that many people do not get over this urge to trade without plan. Though they do some trades with plan, they still do some trades by the instinct. It is almost like a habit that we need to unlearn. We can overcome this through practice.

It is only after learning my lessons from losses, not small but big big ones, that I had consciously added planning into my trading. I almost made it a habit. Because of this now I can control no matter what kind of stock you show me today. I can very easily imagine the consequences of entering a trade right now without a prior plan.

All You Need is a Plan, Rest will be Taken Care

If you are reading this article it means that you are consciously trying to improve your trading. Just take a step ahead and start thinking seriously about your past trades and future trades. Answer these questions to yourself before every trade:
What went wrong and what went right?
What can I do better this time?
What stocks should I trade?
What kind of stocks should I track and when should I enter any of them?
Why I should not jump into the next trade?
Can I give my money some rest?
Do I know that I can make a lot better profits even with money engaged in less amount of time?

As you answer these questions you will get out of old habit and start planning your next entry to make it at the best time. You will soon inculcate a habit of trading with a plan. What it takes is an initial effort to change your trading constantly. After few trades, you will automatically change both because of a new habit and also because of the results from these trades.

Next time make trades only with a plan. It does not matter who you are and what you know. It does not matter what kind of plan it is. As long as you have some plan, I can assure you that you are going to become a better trader!

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Wednesday, June 24, 2009

How to Cope with an Unexpected Massive Loss And Emerge Again as Professional Stock Trader?

how to cope with massive unexpected loss in your stock tradingImage Source

Every stock trader must have faced an unexpected massive loss at one time or another in his/her trading. When that happens to you, your heart will break down. A massive sudden loss pierces a deep hole in your heart. Especially for the effect the loss has in terms of money, it creates a unique feeling that can only be experienced than described. Often this results in a trader either packing back to their original profession or going beyond to explore their opportunity to emerge again as professional stock traders.

Every Trader Gets Their Chance to Lose Big

I had such an experience very early in my trading. Though that first time big loss is not really big compared to my present standards, it was a big deal at that time. It had a huge impact on the state of my mind at that time. Though I felt I did a bad thing by booking that loss at that time, later I had realized that in fact had helped me learn to cope with such unexpected losses which came to me from time to time.

The case of a sudden unexpected loss is not something new in the stock trading. It happens for any trader. It can happen at any time, in any cycle, in any year. Many traders have gone broke in the history just because of such sudden turn-arounds. Sometimes these events, in fact, triggered the longest bear markets like the one we are facing now and the one during great depression of the 1930s.

Why Massive Loss is a Problem?

What we should realize from such times is that it is not the end of the game. It in fact is a part of the multifarious scenarios that stock market presents to its participants from time to time. Much like a massive loss, the stock market also gives, sometimes, a massive run away profit. But we tend to forget such things and remember only massive loss situations.

The other reason why people get caught up with this sudden loss and completely lose their mind for it, is that they miss the opportunity of run away of profit when the market gives. Stock market plays a fair game with its participants though it does not behave in certain patterns that are obvious to the ordinary. But it is the participants’ failure to not fully capture the profit side but end up drowning on the losing side.

The reason for not taking complete advantage of the profit side is because of the temptation to take profits early. People fail to call the top at the right time. You need to capture top at exactly the peak point. You can catch when the next top is lower than the all time top. That definitely signals a reversal atleast in the medium term time frame. Meanwhile you could go for next good bet.

It is Not Always Unexpected

It is not only missing the profit advantage that burns the portfolio of the stock trader, but also not taking precautions to cut losses with stop loss limits. Remember every big loss starts with a small loss that you can easily cut. You may say that nothing can be done if it is a sudden loss.. But even in the last year’s violent movements of Sensex on Jan 22 and 23, the markets did not really make unexpected sudden jerks. They were steadily and everyday consecutively falling since reaching the topmost point of 21.4k and next top most point after that at 20.7k.

The consecutive falls and the second lower top formation were enough to convince any trader to reduce his/her exposure as much as possible. And that is what I had precisely done. Nevertheless for a new trader who had never experienced a massive loss like I did early in my own trading, it would be definitely hard to take this action. It is easy to see why they would end up in a massive loss.

For this reason, and also for a reason that even after learning all the trading principle there comes a time when you end up making a massive loss for whatever cause, it is important to learn to cope with such a scenario.

Your Trading Does Not End with This

A massive loss is not the end of the world. Most of the times it is perceived to be so. That is why we need to first prepare ourselves not to think like that. Remember nothing happens in your stock trading without giving you an opportunity to learn a lesson. Here too there is a strong and important lesson to learn.

Though the massive loss may come unexpectedly, from my experience I have always seen that it immediately presents an amazing and easy opportunity to make a massive gain in the next few days. Sometimes the sudden unexpected downside of a stock does not continue on the next day when I had placed stop loss order to close the position if it were to continue.

Better Sides of a Massive Loss

Whether it is last year January on Dalal Street or the year 1929 on Wall Street, there were immediate magnificent rallies that created history in the next few days. And most importantly these were easy to capture because the whole market was sympathetic of losers. The buyers are coming in just to show their sympathy without a second thought. That presented an opportunity of a life time for a trader who can trade at the edge. This is when you should actually leverage because the rally appears too certain.

It is also a time when you get to know who are the people that really give support to you during bad times. You will find your true friends who try to understand and feel your pain. You will also get to know people who start talking low about you because you made a “loss”. There will also be people who gossip behind you and possibly you can get to know them as well.

Once you go through such bad times, you will see that you will build good virtues like humility and shatter egoism. You will also have the choice to become strong enough to prepare for such a catastrophe if it were to repeat again. This time you will plan alternate support systems so that you will not go broke overnight. You will realize the importance of helping friends, relatives etc. so that they come to help during these times.

The turn of the century trader Jesse Livermore had gone broke several times and gained riches again and again because there were people who trusted his ability to make gains from the market. Can you think of such a luxury in your life too?

Faith can Save You From a Massive Loss

One last thing that you should note when coping with massive loss is faith. Faith is a basic fact of our life. We cannot live even for a moment without it. Catastrophes, natural calamities or disasters can happen at any time and there is no way we can predict them. No matter how much our science advances, we still feel like a baby in front of the destructive power of nature.

The room you live in may collapse. There can be earthquake in the next moment. If we think of these things everyday, then how can we continue our daily lives? But despite knowing all these things we still continue our life without fear. This is all because of faith. A faith that these do not happen now. They may happen sometime but we don’t know when. And there is no guarantee that they happen or do not happen. But we maintain our faith that these are things that rarely happen and nothing to worry now.

Same faith should be applied in your situation too. When you encounter a sudden massive loss, do not lose hope. Have faith that you can start again. May be this will not happen again to you which means that the path from here is golden.

Expand Your Horizon to See a New Future

Many people, who end up with such massive loss in their first few trades only, really lose faith in the markets. I have practically seen many such people in my life. They go back to their life never to come back again. Partly I feel that it is their unfortunate situation to enter at the wrong time. But partly I also feel that it is their mistake not to try to explore if this is everyday scene or if there is a future beyond this.

Losing big in the beginning when you bet small is much better than losing big later on in the game, when your betting size has increased. Come out of the fear of a big loss and realize that there can be many like you. Treat this as an opportunity to know yourself better and your relationships. Prepare with alternative ways to tackle such a situation in the future. When you do this, you will definitely emerge again as a professional stock trader!

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Monday, June 22, 2009

Apply Speed Breakers (Stop Losses) for Your Losing Stocks

stop loss for your stock trading is like speed breaker for your drivingImage Source

If we were to take the perspective of skill, the stock trading is much like driving a vehicle. You learn stock trading with practice much like you learn driving your car or bike. But to avoid accidents there is one thing that you cannot do easily on your own. And speed breakers are placed on public roads especially for this reason. When it comes to stock trading, it is a stop loss that works like a speed breaker for your losing stock.

A stop loss is a single most important thing in the life of a stock trader. Without it he/she is certain to drown in the bloodbaths that happen every now and then in the stock markets. Every best book I read about stock trading, every successful trader I found through my search, had always emphasized the importance of a stop loss for the long term success of a stock trader.

You Should Never Forget Stop-Loss

Even after knowing its importance it is very natural that traders ignore it once in a while. And when the hell breaks lose, which is not uncommon in the markets, the heart of the trader also breaks down. To forget to put a stop loss is a big mistake even if done only once in a while.

Stock traders develop successful trading skills with practice. Stock trading is much like any other activity. But it distinguishes itself due to the extreme risks involved as well as extreme pleasure it can give to the trader. It is much like the dangerous sports of skiing, trekking etc. People learn these things through practice much like a driver learns driving from driving his/her own car after coming out of a driving school.

Speed Breakers Avoid Accidents

You can learn to drive well with practice. But accidents still happen not because you forgot to drive well, but because a vehicle came opposite to you even when you are on your normal speed. Generally when crossing junctions, most accidents tend to happen. This is because at the junction an opposite vehicle can unexpectedly in a short span of time. And there is always a reaction time on the part of the driver that limits his/her ability to avoid accidents in such situations.

For this reason, at junctions, speed breakers are placed. These speed breakers make the driver slow down automatically because otherwise his/her vehicle is going to be damaged if continued in the same speed.

Even though we know that it is at the junctions that there is a good chance for accidents, and thus we think that we can slow down, still in reality people do not slow down most of the time. This is because the risk of accident is not certain. There is less probability for unexpected event of vehicle coming opposite. But when it does the risk is very high for the life of the driver. Hence to automatically avoid such situations, speed breakers are placed.

Stop Loss Cuts Losses Short

Similarly when it comes to your losing trades, you too should apply the rule of stop loss. Stop loss means to cut the losses when they are short. Remember every big loss first starts as small loss that you have the chance to limit. But it is hard to apply this rule because when a trade turns around unexpectedly we just can’t give up easily. We do not feel like taking a loss right now. So we let it slide giving it a chance to turn around again.

The stock may or may not turn around. Sometimes it may come back and give you expected rewards. That is what leads you to learn bad lessons. But remember that most of the time a bet gone bad, continues to get worse no matter how much you hope it will turn around.

Stop loss orders do a great help here by getting executed automatically when the stock price goes below a certain price if you have bought the stock. Sometimes we think that we will actively observe the market and sell it if it really goes down the stop loss limit price. But you should not do this. When a trade went wrong, you are most likely to be caught by emotions than by logic. Hence you should not believe in yourself. It takes sometime to get over this. Hence always apply automatic stop loss order.

Stop Loss is a Controllable Loss

You will certainly make a loss with this but it is a fixed amount that is within your control. Sometimes the thought of selling the stock for a lesser price than the current price does not let you apply the stop loss. In such times you should think about how worse it can get if you do not apply stop loss now. What if the stock falls by ten times more than the amount of loss you get by stop loss? Once you think about this, your focus changes.

To help even further, think about using that money for the next good bet. Stop the loss in this stock and go for the next best stock. Remember when you are following strong trading principles, you are most likely to win 2 out of 3 bets. If you close the current bet and gain on the next bet, then won’t you be more than happy?

Think about it during such situations. There is never a lost opportunity in the stock market. Stock market is like a blue ocean. There are always next good bets to trade. Get over the feelings of the bet gone wrong and apply the stop loss strictly.

Habit Makes Stop Losses Automatic

To make things even better build a habit to apply stop loss orders immediately after entering a stock. Many successful traders do this as a habit. This in fact works like a speed breaker for a driver on the road, because the stop loss now is much like an automatic one that is already placed without your conscious influence.

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Saturday, June 20, 2009

Learn to Take Lessons from Your Losing Trades

take lessons from every trade for consistencyImage Source

What makes the difference between an experienced trader and a novice trader? Is experience just about passing time with one stock trade after another? Or is there something smart that a trader should do before he/she can be considered an experienced trader? Well, the answer to all of these questions lies with the ability of the stock trader to take lessons from his/her losing trades.

Many stock traders trade stocks just by the urge. They are not disciplined in their trading. Their plans of trading transactions are not organized. The moment is enough to catch their instinct and execute a trade. Well, not all traders are like this. But there are certainly different levels of traders who are smart in their trading.

How to Determine if Someone is an Experienced Trader?

The different levels of trading expertise come from two different aspects. One is the amount of time a trader has spent trading in his/her life. The other is the qualitative lessons that the trader has taken from his/her losing trades. To truly call yourself an experienced trader it is not just time that is important but also the lessons that you learned from each trade and applied for future trades.

Never let your trades just go away in the sands of time. There is always a lesson to learn either new or the same old lesson but with a different perspective from every trade that you execute throughout your life as a stock trader.

The successful stock traders are made by their consistency of making right bets. And this is possible not with inherent skills or something but with the persistent will of take lessons from seemingly simple things and applying them to avoid catastrophes in the future.

You Did the Same Mistake Again, Right?

How many times can you remember doing the same mistake that you did in your first trades? For my case, I had spent my initial months of trading just without any plan or discipline. But at the same time I was looking for information from expert traders that must have left some information on the internet. Though nobody gave the exact information that I was looking for, everybody spoke about the importance of a plan for your trading. Without a plan you can be sure to leave all your money in the markets at some time.

It is not just an organized planning that makes best trades but it is the lessons learned from old trades that lets you trade right consistently. Remember consistency is the key to long term success in your trading. If you cannot even try to improve consistency then you should better close your trading accounts right now.

How to Learn Lessons from Your Stock Trading?

The best way to learn lessons from your trades is to note them down in your trading journal. Earlier I have written about this in Why You Should Keep a Trading Journal to Track Your Trades? There is enough info. to learn the importance of it. The most important and direct advantage you gain from this is the ability to learn lessons by yourself without help from anybody else. You can truly shape yourself as an expert stock trader whose bets hardly go wrong by taking note of every trade on your journey in the stock market.

When you are noting down your trades, you should make sure that it is easy to recover the information related to the reason for entry, price, profit/loss, quantity, reason for chosen quantity, exit plan, reason for exit, etc. The key is to keep it simple. The best tool to use can be a spreadsheet where you can make different columns for each of the key points related to a trade and add each stock trades chronologically with each row.

Noting it on a computer makes it easy to edit and keep clean, also able to add more columns later. But a real note book can also be helpful in a different way. Choose something comfortable to you.

Be Careful About Misleading Lessons!

You can also learn lessons from profitable trades. But the lessons you learn from these can sometimes be misleading. Even the lessons from losing trades can be misleading because for unexpected reasons you might end up in closing a trade with loss. But perhaps it could have been closed with a stoploss as it was a good bet went wrong due to trend reversal of the market. Then how do you resolve this problem?

It is simple. Remember as I mentioned earlier, the stock market is like a stochastic process. It does not vary just in samples of time but also in samples of stocks and circumstances. There is randomness to it. But you can gain powerful conclusions when you increase the sample sizes as done in statistical analyses of random variables.

Similarly to learn best lessons from your past trades, you should take lessons based on the number of such instances. If a bad trade happened only one time and not repeated as much time as other bad trades, when repeated with similar conditions, that does not have any lesson to learn other than that it is part of the random nature of reality. But if you find that some type of your behavior in executing an entry or exit a trade is consistently resulting in bad bets, then there is good lesson to learn from it. Learn not to repeat those conditions for future trades.

Mine is an Evaluated Trading Experience

Even though I have a trading experience in time of only two years, I consider that I have good experience in trading that I can help others with my principles. This is because my trading expertise does not come just by the time I had traded and the number of trades in the two years but from the evaluated experience I got from learning lessons from past trades.

I have seen many fellow traders both online and offline who just don’t get over certain mistakes. I had even advised them to start a trading journal. Even though they bite their tongue every time they repeat a mistake they never consciously tried to learn some lessons from losing trades. That is what has separated me from such traders.

There are also people who are elder than me and advised not to go for trading. They themselves don’t have much to offer in the form of lessons than telling the same old lessons like diversify, go long term etc. This is because though they have experience of years, they don’t have lessons learned from their trades. Their trading just goes much in the same way as their life just moves on.

I don’t want to offend such people, but my intention is to highlight the importance of seemingly simple thing as noting down your actions. If you are in a different profession, don’t you maintain a dairy or something similar to note down what you accomplished, planned or lessons learned from the day or week or month’s work? Same holds true for the stock trading as well.

Learn Constantly for Long Term Success

It is never too late to learn stock trading principles. Knowing the importance of right principles thoroughly from all perspectives, even if few, helps improve the consistency of your next trades. Remember the success in stock trading comes from the consistency of right bets. And that happens only by constant learning.

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Thursday, June 18, 2009

Your Loss Does Not Necessarily Mean Somebody’s Gain

Your Loss Does not Necessarily Mean Somebody’s GainImage Source

Whenever stock markets start falling like hell, people start questioning who is making gains now? I practically met lot of people who just can’t get over this myth. They always think somebody must be gaining if you are making a loss. “Oh.. So many traders are losing money.. Then someone must be making big money..”. You should note that a loss for a person does not necessarily imply a gain for a different person when it comes to trading stocks.

When you make a loss in the stock market, it is most likely that there are several other traders that are also making losses. That is the nature of the stock markets. Otherwise it would have been no different from a gambling casino.

In Gambling Your Loss is Somebody’s Gain

In gambling there is always some one that makes money when you make a loss. Or some one loses money if you were to make a gain. There is no inflow of money for the system other than from the participants. The fact of the matter is that gambling is designed to profit only the casino owners in the long run. There may be one or two gamblers that make money once in a while but most of the time most of the gamblers end up losing though a fixed amount of money. Too many losing gamblers add money to the casino which helps it take breath everyday.

The stock market is never like a gambling casino. In fact it is perfectly legal, mathematical and logical type of system. Its money does not just come from investors or stock traders. The stock traders add money and take away money. But on the overall money is pumped into the system externally by the companies listed on the exchanges. I had given elaborate explanations about these things already in the earlier article titled: Someone Loses When Someone Gains: Do You Have This Belief about Stock Markets?

Nobody Need to Gain When You Make a Loss

Let me get straight to the point of this article though it sounds similar to the other one. You should never think that when you end up in a loss there is somebody making a gain out of it. There is nothing like conservation of money or something like that for the stock markets. In Physics you must have known about the principle of conservation of energy but there is no principle of conservation of money in the discipline of stock trading.

The True Reality of Stock Markets

What really works in the stock market is this: Everyone makes profits during certain period of time and everyone makes losses during another period of time. These cycles continue one after another in the name of bull market and bear market phases. These are like the inspiration and expiration related to the lungs of human body.

But on the overall which dominates in the long run is determined by the state of the economy. Remember stock markets always reflect the economy. They run parallel with it. So if there is a net development in the economy which may be backed by outsourcing or industrical growth or agricultural growth. Whatever may be the reason, the stock market certainly reflects that as average net gains. That is what is most spoken by your brokerage agents as the long term gains of stock markets who persuade you to trade stocks.

Who Gains When Your House Burns?

Now if there were to be a catastrophe, natural calamity or any kind of man made or non man made destruction, for example, it will definitely influence the stock markets because the economy is now going to be affected. This will have a negative impact meaning there will be losses for everyone. May I now ask who is gaining here?

If you still wonder that there is always someone gaining, let me quote an example that a famous MoneyControl Boarder with name Kalidas used to quote often – “Who is gaining when your house is on fire?”. There is a destruction of your assets when your house goes under fire. You are definitely losing. But tell me who is going to gain from it?

Well, nobody. You can burn the currency notes in your pocket and who is gaining from it? There are, of course, instances when someone gains, for example, a pickpocketer taking away your money. But you should also know that there are instances when nobody gains. Fortunately there can also be instances when nobody loses while some are making gains from the stock market.

Stock Trading is Not So Simple

You can now note that the stock market is not as simple as it looks for the uninitiated. Stock trading is like any other discipline. It has its own rules and principles. You need to take a step ahead and learn them to differentiate yourself from the rest of the crowd. Don’t just go by pre-assumptions that you brought from your other professions. It really takes a smart mind to understand the game of stock trading.

If You Just Made a Loss…

So next time when you make a loss or find that the markets are frustrating you with everyday losses continuously, just remember this truth: stock markets run on a cyclical basis. There are times when everyone makes gains while no one loses. There are also times when everyone makes losses while no one gains.

What remains on the net is decided by the net developments in the economy of the location where the listed companies operate. Decide your next moves accordingly. To avoid pain from the losses, consider stock trading for long run. That expands your horizons and gives confidence about the future.

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Tuesday, June 16, 2009

Averaging the Buy Price to Minimize Risk: A Common Mistake of Stock Traders

This is something that almost every trader or investor does in his own trading at one point of time or another. I did this myself several times and had to learn the bitter lesson before stopping it. There are several bad consequences that averaging the buy price results in. Typically we tend to think that the risk in a falling stock will be minimized if we buy more quantity of the same stock at lower prices because that brings down our average buy price.

averaging the buy price to minimize risk in stocksImage Source

My Personal Experience with Averaging Buy Price

Let me explain the situation with an example so that even if you haven’t done this before you can learn to avoid it in the future. There is a stock called CMC that I bought two years back when it was flying high. I missed its ride all of the time because I never tracked it before. It was just the time when I learned about chart patterns of stocks that make new highs and keep going higher.

The common of such stock chart patterns is the cup and handle pattern. It is nothing but the chart of the stock’s historical price movement looks like a cup (stretched U shapre) and after the top of the cup continues the same price for some more time to form the handle shape. This is found commonly in many stocks that make such exotic moves in a range trading market. The pattern lasts about 4-8 months only.

Having learned somewhere that following these patterns will help us take advantage of biggest gains the stock can in only a short period of time (about 2-3 months), I had set out to apply this in my own trading. As I started looking for such stocks studying their charts at bseindia.com, I found that this stock was just doing that. Please note that this stock was already in the list of some stocks that I used to track regularly. Otherwise I would have caught even better ones probably.

The chart of CMC has just confirmed that it fit the cup and handle pattern. But what I missed to see was that it was already in the process of making its dramatic expected move upwards. I should have found it a little earlier. Or I should have waited for more time. Thinking that these stocks repeat such movements again and again, I just entered it at 1300 when it was falling from its high of 1500.

The next day it fell down again and then it continued slide everyday. One day after touching 1150 (which I guessed rightly out of gut feeling), it made a quick bounce till only 1250. It stayed there for quite a time when I grabbed more in 2:1 ratio of existing stock to bring down the average buy price. I bought it at 1180. The average came down to 1225.

Unfortunately the stock did not make any more upmove other than going till 1265. I felt that if I close the trade at 1250 I would just close it without loss after adjusting for brokerage charges. I thought it was such a stock that I can wait even it were to fall further for some time.

Just look at this situation. My bet had gone wrong in the first place. I did a good thing to first guess the reversal or bouncing point and bought in 2:1 ratio. But I did not close the trade to avoid loss but rather desired for little more. Unfortunately I did not realize how I would feel when it slides further. It sure slid from there till 1050.

You should have guessed it right this time. I thought of averaging it further by buying more at this price. But I did not do because already it was a heavyweight in my postfolio swinging it the whole postfolio everyday. I realized that now there is no diversification. There does not seem to be hope of it coming back to atleast 1200.

Actually just at the same time, I was also trading a different stock Jet Airways that I bought based on the same chart pattern. At that time it was trying a deal to buy Air Sahara which is a competitor. Luckily I bought this one at a relatively less price (612) after it had fallen from its high of 675. It slid later all the way down to 550 but that did not shake me as much as CMC did. When I closed this it was at 735 just below the highest value it made of 745.

I couldn’t get the same thing with CMC. Because I had made a profit on a similar stock, I felt it too would show its move soon. I was missing to see why this along with others in the same industry is falling at the same time. By the time I realized this it was too late. The stock started falling further and swallowed all the profits I made earlier with the right bets. At last I made the decision to close the stock.

But I did not close it in haste. Because I had such experience before in a different stock. I learned a lesson from those earlier wrong gone bets that immediately after I sold them they made a little move up that would have offset some of the losses. So I waited as the stock bounced again.

A Bad Closing!

Unexpectedly the stock bounced all the way upto 1650 in only three days of time. I was wonderstruck and did not understand all this. I was thinking that the stock was doing another cup and handle pattern. The next day it fell down to 1450 again. Then to 1350 and so on. I just watched it thinking that I can sell it again in its next move.

As the fate would have it, it fell down below 1100. This gave me such a bad feeling because I felt like a toy in the hands of the stock that is moving on its own without any sense. I did not understand what I was missing. Eventually I closed the stock when it made its last bounce at 1125. The stock this time went all the way down to 900.

Lessons from This Mistake

The biggest lesson I had learned from this is that averaging did not bring my loss down. In percentage terms, yes it did. But as percentage of loss on my total portfolio value, it had done worse. I would have had a lot lesser loss had I instead sold at the same price I bought for averaging.

It was plainly simple. Don’t put good money in the bad stock. Let it slide. Cut your losses if possible. Or wait for a small bounce and close the trade. But don’t add to the bleeding. It results in a wound that is exaggerated by the first aid.

The other lessons too are important to consider. I was not able to stick to my plans all of the time. I was changing plans with each transaction or each time the stock made a reversal move. When it made a bounce I was thinking about selling it for a little higher price. When it was falling down further, I felt I could have closed it just a day before. Then I make plan to sell it if just goes above from there by 2%.

When it eventually made a run away completely unexpected, I was wonderstuck when I had to be quick to run away with the gold that was somehow thrown at me. I realized that apart from heavy influence the averaging effect can have on our portfolio, when combined with our discipline in trading, the matter only got worse.

Had I thought in the same way at the time I finally closed the trade, I would have seen a big hole in my portfolio. Atleast in the end I closed it in a smart way. But it left a bad feeling because I held the stock for 6 months without any returns but only considerable loss that wiped out the gains made by two other successful trades which took only 45 days. I couldn’t bet on anymore stocks during the rest of the time because I was heavily bought in the name of averaging.

Avoiding Averaging Helps Later Trades

I had learned a good lesson from this. From then on whenever my bets went wrong, I had either cut the losses short or held my breath but never added more money into it. Why put good money for the bad? This principle really helped me as I made the biggest strides by betting on the next good bets like RNRL, ELECON ENGG, GMRINFRA, and so on. At the same time I had seen some trading friends who couldn’t move fast in pace with me because they still had some bets that they made worse with averaging.

When a stock goes in unexpected direction, just hold yourself. Control the urge to turn it around by thinking about how worse it can get if the stock goes down further. The only way it can get better is if the stock makes a turn around. But then of course you will definitely feel that averaging would help you make much more.

The reality is not so simple. Most of the times a stock that goes wrong, continues to do so. Just because you saw some cases where this was not true, and also found the reason that averaging will give more advantage if the stock turned around, does not mean you should risk too much every time. This is like a double edged sword. The risk or reward increases once you increase the exposure to the same stock.

If the stock were to turn around, then you would certainly be able to find a different stock that would also make its best move. The key is to avoid regrets. If you cut the loss short it gives you a good feeling which helps you spot next best opportunity. It often happens that once you have a bad experience in a certain stock, you will continue to have more of it if you do more with the same stock. I believe that you too can find similar instances if you go and look into your trading journals!

Averaging is a Mathematical Illusion…

Note that averaging is only a mathematical illusion. You must have known the visual illusion created by certain pictures. Similarly when you do not see some details as to what will happen in the future, how it influences your portfolio etc, this illusion can continue to deteriorate your portfolio while still giving you a false feeling of security.

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Sunday, June 14, 2009

Is Long Term Trading Better than Short Term Trading?

I am sure this question must have occurred to many traders whether they are new to trading stocks or not. I cannot really say long term trading is better than short term trading or vice versa. Because there are times when both are good and there are times when only either of them is better. But nevertheless to maximize the returns from your stock trading you need to definitely learn which one is better at which timeframe.

is long term trading better than short term trading? , S&P 500 historical chart from 1950Image Source

The three basic things that happen with these two types of trading are the three types of market behavior. Stock markets can move strongly in a particular trend whether up or down. Other times they also make moves much similar to swinging. These swings form range trading patterns but they can range from months, years to decades as well. History very well proves this pattern. But it can be noted that the range trading pattern is what markets spend most of their time while the biggest movements happen in a relatively short and concentrated period of time whether up or down.

Only depending on the type of stock market movement can we determine which type of trading is best to do. A trader who bets only on one type will not be able to succeed consistently. And remember that it is the consistency of the right bets that makes a successful stock trader.

Strong Trends or Current Trends

There are times in the stock market that are most noted in history. For example, as per the current economy scenario the stock market slides of the last year are now noted in history to be the sharpest ever falls. These become popular because they do not happen every now and then. That is not consecutively for a significant period of time to move the market swiftly in a particular direction.

These times are associated with the powerful economic development or economic depression. Either way they make the market move suddenly and continuously in the same trend. The trend can be either up or down and depending on that they will be bull markets or bear markets. But you should note that these strong trends happen only for a short period of time even in a bull or bear market period.

When such trends occur, it does not matter which type of trading you choose. Both long term and short term trading offer equal potential for returns. I cannot really judge which is the best in these times because I found enough evidence to get the highest returns from stocks held for sufficiently long time for many months or trading stocks on short term that are making swift moves one after another in only a week’s period of time.

For example, there are stocks that gave as much return as 1800% within a year during strong trend. During the same time, if we try to accumulate the gains when made with short term trading of stocks that move one after another, there were enough opportunities to make similar gains. Though I could not take advantage of this myself, I had learned that it can be taken. Not many traders find this fact.

Also notable is the compounding effect of short term trades that make their returns comparable to one long term trade’s returns. Trading in strong trends is like rowing boat along the direction of current. It is very easy to do!

Trend Reversal Periods or Uncertain Trends

I think there is no need to give an example for this type of situation. This is because the last year’s market movements were a perfect example for this. When the markets started reversing their major trend in the last year from bullish to bearish, they did not do that overnight. There was a lot of time for uncertainty which made many traders make big losses well before the market made its biggest crashes in the September-October months.

It is true that markets made overnight falls like they did during January 22nd and 23rd. But the days after that they did make violent moves in the opposite direction. There was plenty of opportunity during that time but only with the right approach.

The right approach during these times is to do short term trading. You cannot make a long term bet because there is no certainty of the trend for more than a week or a month. But you may think that there is a risk with short term trading. As I explained earlier about the difference in risks between investing and trading, similar pattern holds here too.

The short term risk is obvious and makes you to be alert. The long term risk being non-obvious at the moment, can make you go broke in the end with a wrong bet. Especially it goes wrong during uncertain period. If you are still doubtful about this, go check your trading journals and observe the reasons for the mistakes during these periods of stock markets.

Most of the Time or Normal Period

I couldn’t get the right term for this timeframe where the markets spend most of their time. It in fact consists of periods where small bull and bear markets come and go. It also consists of times when stock markets move in a range but in a relatively longer period of time. Overall if the stock market average returns are calculated, they will turn out to be a big zero or even negative for a short term trader.

This is how stocks move most of the time. If you use traditional principles of investing without active involvement you will end up losing money after adjusting for inflation.

You might have heard that stock market returns beat any fixed income investments over the long term. Let me tell you that it is not true. It is actually dependent on the time frame chosen for this calculation. When the markets are considered during their strongest trending periods, their returns or losses outrun any other type of investments. But when these are considered during their normal periods, they underperform any other type of investment. They can even end up in loss.

But during these times both short term and long term trading can give returns. But that depends only on the specific stocks traded. If you diversify and then do short or long term it does not matter, the returns will get cancelled. You should go with only stock specific approach. And note the fact that you have to do this for more time your trading life. But more over the best returns come from long term trading during this period.

Actually I need to give a paradigm about long term trading. It does not have to do with the decades of period that you hold a stock. It has to do with the stock specific behavior which is identifiable unlike in a powerful bull market.

In a powerful bull market trend, almost every dumb stock makes noise. But during that time everything can give profits. During normal market periods, there will be only few stocks that make their consistent movements almost like spirals moving upwards or downwards. These stocks make their movements not just for a short time like a week or a month but continuously repeat the trend for many months or over a year.

The advantage for long term trading during these periods is that it is easy to identify such stocks. Just go and look for stocks listed in the 52 week highs or all time highs section of market statistics. Historically many stocks have made their golden periods in a relatively short period of time but still long enough for long term trading.

Long Term Trading is Not Long Term Investing!

Don’t confuse this with long term investing. People go for long term investing essentially to capture the benefit of long term trading but at a reduced effort on their part. By betting during the whole period of the stock movement, they are certain to catch that golden period as well.

But the stock market is not about betting with certainty. You should be able to handle uncertainty by learning stock specific patterns to deserve higher and consistent returns. If you go with long term investing, all you will get is a big return but without another chance before a trend reversal. If you rather go with long term trading, though you will get slightly lesser return, you will have the time saved for next long term trade. It is anyway easy to identify those next good bets. You will gain more here because of the compounding effect. What is good when compounding is missing from your finance?

One important thing that should be noted here is that long term trading cannot be applicable to institutional investors. It is because of their size of funds involved. Though they buy or sell stocks over a long period of time, they can only do long term investments without making losses to their portfolios. This is one area where an individual investor has an edge over institutional investors.

Another thing I should mention is that there is a genuine long term investing that gives high returns not because you are capturing a stock’s long period but because the sector or industry or the company itself performed well for that long period of time. For example, the infrastructure boom in the current Indian markets. But still these returns do not come anywhere close to long term trades of individual investors. But they are big enough for those with rich money that cannot be traded easily in the market!

There is Nothing Like Long Term Trading Better than Short Term Trading…

Now you know what is the best type of trading you should do in a given period of time. There is nothing like “long term trading is better than short term trading”. Of both, I liked the long term trading for the long lasting good feeling it creates, huge returns from compounding effect and at the same time not requiring as much effort as the short term trading. But the time should be suitable for that. Identify the market movement trends and take the right approach in your stock trading.

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Friday, June 12, 2009

Is Investing in Stocks Better than Trading Stocks?

Investing and trading are not really two sides of a coin as many people think. They are not opposite things. The only difference in my view is the risk a trader takes for a given trade that determines whether they are investing or trading in stocks. Many people easily fall into the belief that investing is better than trading. Let me shatter this myth in this article and show why the contrary is actually true.

is investing in stocks better than trading stocks?Image Source

Investing is a One Time Shot

Investing appears to an outsider to be similar to gambling. But to the investor it is not really so. Though it shares a lot of similarities with gambling and many so-called investors practically gamble with the markets, there is an aspect that makes these people slightly different from gamblers.

Investing is like a one time bet or one time shot. You will make it or break all in your only one attempt. For this reason investors study the markets and stocks and their background companies, economy in general before making their bets. Though this is time consuming task and also full of domain knowledge, this is what makes the investor’s bets better than gambling. Any trade done without a plan or reason is just gambling and returns from that can be attributed to plain luck.

Investing and Trading Both Help Each Other and the Economy

Investing money does not necessarily go into stocks. It can go directly into the business of the companies if not stocks. Even the stock market investments start for a company by investing directly for the growth of the company though initial public offers. Hence investing is more closer to contributing to the economic or industrial activity. It has a direct impact on the companies.

Trading is indirect. It is not a waste thing as many people think, who like to be called as investors. Without traders there cannot be a market as we see everyday. Traders make the bloodline for the market and keep it flowing everyday for the functioning of the markets.

If traders are not there then it will be a hard time for investors. The long term investors from large institutions need enough volume on any day to make a position into stock. Traders help build the momentum or volume for the day so that these investors can buy the stock easily without putting orders lower and lower with every transaction. It is basically the liquidity that traders contribute everyday to the markets.

Liquidity is important for not just stock markets but any business. Even if the economy is not good, enough liquidity can temporarily create rallies and sustain a short term bull market as we see today. Liquidity implies that it will be easy to get in and out of stocks with ease and without moving the price of the stock very much. Highly liquid stocks can be bought in thousands or even millions on single day. This is all due to the presence of traders who generally concentrate popular companies’ stocks.

That is how investors and traders work to create a stock market as we see today. No matter how old or new the technology is there were always traders and investors in the history of stock exchanges. Both contribute not just to create a market but in fact to help the turn-arounds or major growth phases of listed companies in the country.

I saw many people who think that stock market is like a casino and traders and investors are like gamblers without really contributing anything to the society. That is not true. In fact it is a part of our modern culture. It plays a great role in helping the economy and works like a virtual money lender which has more flexibility than banks or finance corporations.

Most of the people who start trading stocks, slowly start their bias towards investors. They think that investing is better than trading because they do not realize that trading is also like any other discipline. It is not just trading even investing does require same kind of study and effort on the part of the market participant as does their other businesses.

Investing is Not Low Risk Option But Trading is!

People tend to move towards investing because they think of the timeframes involved without bothering about how risk changes in the overall equation. There is a general feeling that investing involves low risk where it is exact opposite. Also people flock to investing because it gives them lot of free time to concentrate on their daily business. This is because they do their job only to certain extent as much as their current knowledge tells and get convinced there itself.

In fact investing is far more riskier than trading. It is because you do not have stop loss protections. I saw many traders who call their trades as investments when the trade turns into a loss. Instead of taking the loss they change their mind and plans, to let the stock do whatever it wants. They give more time for it thinking it will recover in a “long period of time”. Hence they name it as long term investment.

It is amazing how people shift their thoughts so easily when it comes to trading stocks. They also shift their identities as a trader to investor without much trouble. But the fact is that all big losses first start with initial small loss. A trader cuts them short and books them. An investor lets it become bigger and bigger until finally selling the stock when it just starts a turn around. How many times can you remember doing this in your own experience? I think many times unless you are learning your lessons.

Such is the risk involved with investing. You may now point out that same will hold true when it comes to making profits. By holding the investment long enough the investor stands to gain bigger. Let me tell that the reality is quite different. The stock can behave like that but not the investor. There are several reasons for this.

First of all many investors book profits soon because they can’t have an idea when to close the trade. That too they do it more often during uptrends much like they let the losses increase during downtrends. If an investor is sitting tight to hold the stock during uptrend it is much like the quality of a trader who does the same thing but with more certainty. Because the trader lets the market gives its signal while the investor looks for things that indirectly affect the market. These indirect things many times go out of phase and make the investor lose sight of the best price to get out of the position.

Investing is Not Necessarily Long Term

But there is another little catch here. Apart from the uncertainty of exiting that investors face, they also face the problem in time dimension. People think that investing is good because it is about long term. In fact the long time means either long term gambling or long term trading.

The stocks in reality make their biggest moves in only a short period of time. You can check all of stock markets histories. You will find that stocks spend a lot of time moving here and there. But only a part of the time they spend moving straight in one direction. It is only long term traders that get to catch this portion and make the best killing if not the maximum possible made by those bought at the bottom. Generally those who buy at the bottom fail to call the top at the right time.

The Reality of Long or Short Term When a Stock Moves…

The stocks move in a short period of time with all intermediate trends concentrated in that same time frame. Investors think that by capturing a stock for all its life time will increase the chances of grabbing its golden period of rising. That is actually gambling in the time dimension. Because you may be studying the stock and its company but leaving the timing for luck. Even the most successful investor Warren Buffet made the right timing for his entries and exits. All the principles will go into the ash if timing is not taken care.

Trading is Superset of Investing!

Don’t judge investing and trading based on false beliefs shaped by your trades that went bad. Learn lessons from them. Just take a step ahead and look at the reality. Trading offers more flexibilities than investing. Trading does not only have to be about day trading. It is like a superset of investing when it comes to the time and effort involved!!

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