Jul 21, 2018

Playing Chess OR Trading Markets, One Must

Playing Chess OR Trading Markets, One Must

·         Focus on the process
·         Keep their fears and anxieties in check
·         Not worry about unseen threats they can’t control
·         Understand the nuances of conflict
·         Enter their decisions somewhere between “instinct and reason”
·         Not defy the lessons of history

A game of chess is pure. It is a free market with a level playing field and a product of spontaneous action, not human design. Unfortunately, one cannot say the same in reference to the markets.



Stoploss and averaging are concepts that a regular trader knows very well. Stoploss is a price level where the trader ‘stops losing’ in any trade. While averaging out or averaging down is if not opposite of it but falls way on the other side of the meaning of stoploss. It means to increase the trade size when the trade is in loss. For example, trade X has bought 1000 shares at price of Rs.100 and, the stock falls to 95; he had decided to make maximum loss of 5000 and so he exists at 95. Here 95 was stoploss. Now if X decides to buy more 1000 or certain quantity at this declined price or at a little more lower price of 90 for example then he is said to be ‘averaging’ his position.
Averaging is considered to be one of the top five trading mistakes. And (to keep) stoploss is considered to be one of the top 5 important requisitions for successful trading.
So, thus these both are concepts in trading. But in investing there is this presumption that you do not require stoploss. Yes, averaging out is seen among many investor. Averaging out is employed many times as part of their basic investing strategy or as a contingency. However, it is a fact that no investor buys a stock imagining that it is going to come down 50% or more, as averaging at decline of at least 25% or more is only prudent. You can see how, stoploss concept is rejected simply when investor opts to keep the strategy of averaging in his arsenal of tools of success in investment. We have explained 3 stages of investing in another article. This practice comes at the stage of managing investments. We will not call it new investment. When you have bought 1000 shares of X Ltd at 100 and buy 1000 or so more at say, 70 or 50. Now your average or cost price on all 2000 shares is not 100 but 70 or whatever.
Are we in favour of averaging? Of course yes. We believe it to be one of the most important concepts to be considered and used by investors for success in investing world and gaining good returns. Does this have pit falls, yes it does. In fact Watrren Buffett, the legendary investor, has said, you should not invest in a stock, which you cannot buy or will not want to buy when it may decline 50%. Same advice has been given in his lessons buy Indian value investing master late Shri Parag Parikh in his teachings. There are many ways to look at this concept. First is that you make sure that whatever you is you are buying at cheap prices or at good value. There is a good margin of safety. And even after that for any reason the price of it declines you should be willing (not compulsory) to buy it more. This states your confidence in your original purchase and also brings down your average buy cost, making it perhaps a further cheap buy. So now also you will probably need smaller rise to make money if you are looking at capital appreciation through rise in stock prices. See, averaging or buying more shares when your already invested share falls is not kind of compulsion, if you are not averaging out it doesn’t mean that your purchase is not cheap or you do not anymore have confidence in your investment into that company. You may just not choose to buy it more simply because you do not want to hold more than the number of shares you already have due to variety of reasons like the limitation of your capital, your overall sectoral or portfolio strategies and so on. You also have to do your research again in case any fundamental or other vital change has happened which itself demanded the stock price to come down to adjust to new lower valuations due to the development. In that case, you have to reconsider averaging out your investment in that stock or decide to average on further decline only when your average purchase costs becomes reasonably cheap.
I think we mostly discussed about averaging and not stoploss, it may seem. But we did. Stoploss, in our opinion is not a concept in investing. It may be for huge fund managers or hedge funds and so on. But for retail guys like you and me. Following the averaging strategy is better than following stoploss strategy. They are not strategies per se, but approaches. Yes, if you device them calculatively into your investment planning then they become important parts and parcel of it. See, the huge funds have to cut losses, they have to show quarterly profits, sometimes they bet big on speculative stocks and growth stocks with steep valuations. So they know when they have baught at 50 PE, and if its coming down they get out at 35 PE, because they are sure that now its going to get worth 20 PE or something. So, they hit the sell button and get out of the investment position. Another thing to keep in mind here is that with huge funds, they have trading and investing concepts all blurred up mostly. We are not talking about long only and long term funds. All other funds are aimed at profits. If they are making good money they get out. And may be buy again. So logically concept of stoploss seems to fit in their investing strategy. But for retail guys like us, its best to enter an investment with complete prudence and good valuations etc.along with readiness to average at lower levels (unless ofcourse, you are investing like them hedge funds for short term or for a targeted return only and have predecided to get out of the particular stock in case of a fall of so and so percentage. But in that case we don’t call it pure investing or long term investing. We should know it by short term trading. That is the right word. As it is not either pure trading nor pure investing). The whole base is that you can not put stoploss while investing because you are buying the stock with full cash and not in margin and you are buying it for longer duration and it is not for intraday or till next expiry. These are technical reasons apart from the basic arguments of value investing. Many of you will say what if a company, when we invested say, before some months is no longer worth investing and the fundamentals have changed and so on. Do we still hold it or exit at some so called stoploss and save the rest of capital?. Yes and no. Because you should have thought it out before investing. Why did you buy such stock and at such rate. See, 80 pc of time unless it is a market meltdown or recession, stocks do perform well and if your company is doing well it is unlikely that it is going down from the price of you investment even after that price is a good bargain price. Also as an investor you have to keep one thing in mind which is that over the short period the price of a stock just like a commodity is driven by demand and supply rule. But over the long term it is driven buy demand-supply rule and valuations. Here we are pointing out at the stock price where it reaches over the period of years after building bases in technical terminology and not the price range it gyrates over the period of days or months and doesn’t stabilize there. Now coming back to the point. If you have to exit because some of your stock is down and out and the firm is not going to recover or the sector has seen a huge fundamental shift towards worst then you got to do what you got to do. For e.g if you had Kodak, or some stock of satyam computer at reasonable price valuations, you had to exit at loss, making it a stoploss. But again like we said, if you predetermine all possible variations and follow prudent value investing rules and stick to the plan which ever you have made, you will likely not require to get puzzled with use of concept of stoploss in your investment ventures.
So, now you understand clearly, the concepts of stoploss and averaging in investing. The bottom-line is that you got to have a clear understanding of both and a very clear determination as to what are your approaches in regard with your investments, weather its pure investing or if some stocks you have bought is for short term without prudent investment valuations and you will exit it if it goes down certain points and so on. There is not much written or explained so far regarding these two concepts in investment arena. But knowledge of the same seems very necessary looking at the effects it can leave on your long term return on investments.