Some basic precautions you need to take in the stock markets

Trading and investing in the equity markets has an element of risk to it. Equities can be volatile and therefore profits and losses are part of the investing and trading game. You often get to hear about risk management and at the core of managing risk lies the basic precautions you take while buying and selling stocks in the stock market. Here is a list of precautions you need to take while trading in the stock markets. These precautions are not a strategy to make profits but these are precautionary steps for your market risk management.

Timing the market is much more complex than you can imagine

Quite often, traders believe that the easiest way to make money is to buy low and sell high. The problem is not with the through process but with the practicality of the idea. Practically, even the experienced traders and investors have found it hard to time the market consistently. Concentrate more on quality of stocks purchased rather than concentrating on trying to time the market. It is very hard to consistently buy low and sell high. The best approach is to buy into good stocks / companies and hold for the long run. Time works better than timing in the stock markets.

Don’t try to recover your losses by overtrading in the market

This is another cardinal blunder a lot of investors commit. When they make losses they try to outsmart the market by trading aggressively. In the process you only deepen your losses in the market. So trade to a plan and a certain strategy! Your overtrading has cost implications in terms of transaction costs and also tax implications. Never trade in panic as you are likely to be on the wrong side.

Keep a stop loss and adhere to it as a discipline

A stop loss is like an insurance against market volatility. Whether you trade long or short, you keep stop loss to protect your position when the market moves against you. Remember, that stop loss is a discipline and has to be adhered to. This means two things. Firstly, stop loss must be part of your trade initiation. Don’t wait for market movement to put a stop loss. Secondly, when the stop loss is approaching, don’t entertain second thoughts about averaging your position. That defeats the purpose of a stop loss.

Booking profits is also a discipline when the market moves in your favour

Profits can be realized only when you sell your positions and that is why regular booking of profits becomes critical. That explains why profit booking is so important. Even after the target is achieved, traders often try to retain that stock hoping that it will move further. There are two ways to approach this kind of a situation. Firstly, once you decided profit booking level is reached, you must not hold on unless you have a very strong reason. In case, you have reasons to believe the stock price can go further up, use trailing stop losses. Even when you keep trailing stop losses, there is an opportunity cost involved.

There is nothing like a risk-free trade in the capital markets

There is nothing like a risk-free trade and hence there is nothing like loss-free trading. All investment products are subject to volatility and risk under certain conditions. Equity indices can correct due to domestic or global triggers. Stocks can correct due to financial or non-financial challenges faced by the company or sector. Bonds can see volatility due to interest rate movements and due to credit quality issues. Trading in currencies also carries the risk of dollar volatility and Indian macros. All these risks get factored into your returns.

How you respond in the market is more important than how you react

When you think through before acting it is a response and when you act by instinct it is a reaction. In markets you must respond rather than reacting. This may be easier said than done when there is panic in the market, but that is an important quality you learn. When you panic in the markets, you subsidize the other trader who does not panic. A cool head will help you to take rational and well thought-through decisions. Panic makes you irrational and forces you to make wrong decisions. It is better to keep a cool head and respond tactically to market situations rather than to react by instinct.

Listen to the experts but be your own analyst

In the stock markets, there is no shortage of advice. There are SMS calls, WhatsApp forwards and there are experts on TV channels. While you can take inputs from these sources, there are two things to remember. Firstly, strictly adhere to broker research as most of the WhatsApp forwards may not be in your interest. Secondly, be your own trader or investor. Use your own discretion and judgement before taking an investment decision.

The famous trader, Jesse Livermore, used to say that there is no bull side and bear side but only the right side in the markets. Try to be on the right side of the markets as far as possible.