Despite the continued slump in the Pakistani stock market since the summer of 2017, which has seen the KSE-100 index drop from a peak index value of almost 53,000 points to around 34,000 points (at the time of this article being written), the market continues to exhibit ample money-making potential, especially for active trading.
Investing and trading basically differ predominantly in terms of their respective time horizons; that is, investments generally refer to holding an asset and/or security for a relatively longer period of time in a bid to build wealth gradually, whereas trading refers to more active participation – buying and selling assets and/or securities far more frequently, with the goal of generating faster returns.
However, for countless traders, over the years, this dream of generating faster returns has turned deeply problematic very quickly – so much so, that fewer than 1% of all active traders make more money on the stock markets than they would have had they instead opted to invest in a 3-year fixed deposit scheme with a commercial bank. Such damning statistics, coupled with the added appeal due to the ease of starting out make trading an especially risky way of generating a regular income stream.
Nevertheless, equipped with almost 70 years of trading and advisory experience, KASB Securities brings you a few golden rules of trading to ensure that you always give yourself the best opportunity to make the most profitable trades.
Know your resources and your limits
The stock market can put a cruel drain on one’s life savings if emotions are allowed to lead the way. Therefore, to combat the allure of potentially earning back more than you have already lost, set yourself a concrete bottom-line in terms of both: the amount of money you can afford to lose, and the amount of time you can wait for a trade to turn profitable.
Stick to a stop loss for each individual trade
Emotions become increasingly more involved as the loss incurred on a trade increases, and so increases the likelihood of you acting irrationally. Nip that problem in the bud by exercising a strict loss minimization strategy on each trade by not letting yourself hold an asset more in hope than in expectation. Have a stop loss point in mind from the very beginning, and stick to it religiously.
Go with the flow
It is fair comment that the most comfortable trades are usually not the most profitable ones; but given that share prices tend to move in one general direction (either up or down) for lengthy periods of time before they can break the trend, it is not advisable for traders with shorter tolerance thresholds to buy stocks whose prices are on the decline and commit to a waiting game that they cannot afford. So, if your trading activities are time-bound, buy when the share prices are going up, and sell when they are decreasing.
Do not average down
Leading from the previous point, we have seen many traders give into the temptation of buying more of a plummeting stock as its value decreases, in the hope of winning big when the trend eventually reverts. Although, once in a blue moon the gamble may pay off but it is generally a money-losing strategy closely linked with the human disposition for denial. The failure to accept that you initiated a bad trade in a timely fashion, may end up costing you more money if you let hope and emotions disregard the stop losses you had earlier set out for yourself.
Trade (almost exclusively) with your own money
Yes, leveraged bets have scripted many major successes but unfortunately, for every success story there are hundreds of bankruptcies that have come about as a direct result of people trading with money that they did not have in the first place. A single bad trade can render you insolvent if you are not careful with leverage. If you absolutely must use leverage, use it only very sparingly when a win is all but assured and continue to follow the stop loss strategy religiously.
Supplement fundamentals with technical analysis
As stated earlier, the market trends may persist for longer than a trader can wait for them to break. Fundamental analysis may reflect that a company’s stock is currently undervalued, driving you to purchase it in bulk, tying up most of your trading capital in a single trade. However, without having a technical aspect to your analysis you may underestimate the timeframe that the stock will remain undervalued for.
Technical analysis is founded in the notion that markets account for everything and as such, share prices are reflective of all underlying factors; this reiterates the point about going with the flow – in that, you buy on rumor (when the stock is in high demand) and sell on news (as the prices start to fall). That said, technical analysis does not render fundamental analysis moot at all. If anything, fundamental analysis helps traders steer clear of easily manipulated penny stocks.
Try not to trade on stock tips
The problem with trading on tips is that the supposed ‘advisors’, themselves, are not equipped to definitively tell you the reason behind purchasing a particular company’s stock, which by extension means that you would be in the dark with regards to when to sell. Often times, there are ‘pump and dump’ scams behind these supposed ‘tips’, which aim to generate enough unsubstantiated price momentum for the scammers to quickly sell-off large blocks of that particular stock, making a small fortune at the expense of several ill-informed traders.
Maintain a well-diversified portfolio
It might be a clichéd phrase, but it bears repeating: Do not put all your eggs in one basket.
No more than 10% of your trading capital should be tied up in one stock, and no more than 25% in a single sector. This might lower returns in the short-run but it holds true especially for less experienced traders – in that, if you do not diversify and get too greedy too soon, you might not have a long-enough trading career to learn from your mistakes. Lowering risk should be the prime objective for a novice trader, as it is far more likely to allow you the opportunity to learn from your mistakes. Just as a batsman gets more confident at the crease with each delivery he faces, so will you with your trades. The important bit is to see off the tricky period, and allow yourself the opportunity to get the lay of the land.
Do not be compulsive when it comes to trading. If you are disappointed at registering a loss on the market, do not rush back in a bid to quickly recover your money. We are humans after all, and we are not always in the best frame of mind to make wise financial decisions. Therefore, especially when there is so much to lose, do not shy away from taking a break every once in a while. Furthermore, no batsman can hit every ball out of the park, and there is no shame in running singles (here I go again with the cricket analogy). All of which is to say, do not feel pressured into trading at maximum capacity all of the time. Bet-sizing – altering the size of your trades based off of the market conditions and other factors, is a very good strategy and will likely help your chances in long-run.
Have different income streams
Remember how we talked about diversifying your portfolio a little while back? Well, the same applies to your life and livelihood: do not let the stock market be your sole occupation. As important as it is to leave your emotions behind when you are running trades, the truth is that the human psyche cannot be ever fully discounted. We make the best decisions when we are secure in the knowledge that the stakes are not exceedingly high. So maybe don’t quit your 9-to-5 job just yet. It is great that you want to enter the stock market as a trader but remember a supplementary source of income can greatly reduce the pressure you would likely put on yourself to generate a profit on every single trade, and without that pressure eating away at you, you will not only make better trading decisions but also keep your stress levels in check.