Why you should fight the trading temptation
Given dismal returns from the stock market and continuing volatility, it won’t be surprising to see investors losing their faith. But this makes little difference to traders, who aren’t too afraid as they get a chance to make money regardless of the market direction.Updated: Jul 05, 2013 21:12 IST
Given dismal returns from the stock market and continuing volatility, it won’t be surprising to see investors losing their faith. But this makes little difference to traders, who aren’t too afraid as they get a chance to make money regardless of the market direction.
Traders not only take daily calls on stock prices moving up but also short sell, which helps them earn profits if stock prices decline. In fact, sharp moves can be very beneficial if a trader’s call is right about the direction of the stock price.
Let’s take Hindustan Unilever Ltd as an example. Some reports said that the stock was expected to fall short on the September-December quarter results on the sales and profit front.
An investor wanting to buy its share would like to wait for the results to be announced to take a call on future earnings and then look at buying. A trader, on the other hand, may want to short sell the stock and gain from declines. The stock fell as much as 7% intra-day on the day the results were announced and finally closed down 4.5%. Traders who had short sold or sold futures at the start of the day would have made a killing then.
Smart investors, who understands markets, may be tempted to enter the trading domain as long-term investing now seems rather confusing and there are chances of profits in the trading business. But remember that trading is not so simple. Even for a smart investor, it’s not enough to just know how to trade and what strategies to play out.
There is a whole new discipline you will have to embrace which may not be in sync with your goals and the kind of risks you are willing to take. Though we would advice you to stay away from trading and keep your faith in long-term investing, if you are still keen on changing your course in the equity market, assess whether you have some basic traits that qualify you as a trader. If you don’t, you better fight that temptation and stay out.
Do you like to run a marathon or a sprint?
While equity investing requires you to be patient, trading is more about timing the market. You may understand this better through a simple analogy that distinguishes between a 100 meter sprint and a marathon runner.
For the marathon runner, whose aim is to keep running for a long distance, stamina is more important than speed. This is akin to an investor, where the holding power and the ability to sustain an investment for the long run is more important than timing.
“Traders need to be very disciplined, otherwise a trade gone wrong can wipe out your principal,” said Kiran Kumar Kavikondala, director, WealthRays Group, a financial planning and broking firm. “You can also make a lot of money, but be prepared to do the research behind it. Many traders sit after market hours to analyse technicals and entry-exit levels.”
On the other hand, a sprint is more about speed and accuracy for those few seconds. In trading, too, you have to be quick about judging market moods and knowing when the sentiment is right for investing in a stock. If you hesitate for too long that trading opportunity might pass you by.
Do you have the ability to take unlimited loss?
Traders don’t restrict themselves to buying stocks, rather they indulge more in futures and options. In case of options, if you are buying, your downside can be limited to the premium paid with the potential of unlimited upside. However, if you sell options or sell stock or index futures, the loss can extend far beyond your expectations. According to SP Tulsian, an independent market analyst, “Short selling is purely speculative.”
Kavikondala adds, “There are many who indulge in day trading and short futures, but they may not understand technicals very well. It’s better to play with a small amount but be ready to lose it all.”
Given the sharp moves in stock prices these days, where even fundamentally strong stocks fall or rise 10-15% in a day, a short sell which goes wrong can cost you dearly. The classic example here is what the Infosys Ltd stock did on the day it announced its third quarter results for FY13 in January 2013.
Most traders were bearish on the stock and either had no positions or were short (sold futures). When results and guidance beat expectations — the stock witnessed a 17% single-day rally — those who had already sold the stock hoping to make money if it declined were caught with heavy losses.
While traders work with strict stop loss prices and reverse their position once those get hit, investors’ emotion is tied into buying stocks and adhering to stop losses may prove harder than expected. And if you are unable to objectively assess the movement in stock prices and stick to stop losses, it’s better not to indulge in trading.
Are you able to assess market sentiments?
In the short-term stock prices get affected not just by valuation but also by investor sentiment and liquidity, which is driving markets currently. Over a period of time, prices are ideally determined on the basis of the earnings ability of a company rather than who’s buying what. The sharp rally and fall doesn’t mean that earnings will be affected so strongly. It’s just a reflection on sentiments that gets altered on a daily basis. According to Tulsian, “In the current situation, it works to remain loyal to 25-30 quality stocks and take profits in short rallies.”
For pure investors this is an orientation which may not be easy to grasp.
What should you do?
Mint Money had earlier published a story about investing when market levels are 6,000 and suggested that if you pick good quality stocks with a visibility for future earnings, then the index levels are not relevant. This will work for you if you are an investor.
“An investor has to focus on a goal-based approach. If there is a financial goal to be achieved in the next 10-15 years, simply invest in equity now. Market levels and present volatility don’t matter,” said Sumeet Vaid, a Mumbai-based financial planner.
Kavikondala says, “A disciplined investor will not worry about timing an exit. Volatility creates confusion. While to a trader it doesn’t matter, investors may get caught.”
He adds that trading is a different animal and if you really want to indulge, use only 5-10% of your surplus funds and be ready to lose everything in the worst-case scenario.
As an investor do what you know best: pick your stocks on the basis of earnings strength and pick good performing equity mutual funds where you can invest regularly. Losing patience in the short term and focusing on trading instead may backfire rather than yield positive results.