TEN INDISPENSABLE COMMANDMENTS FOR INVESTMENT

“An investment in knowledge pays the best interest.” Benjamin Franklin

It is often heard that more than 90% of retail traders or investors have been losing money in the stock market. Even highly educated people, who have been doing great in the other fields, lose money when it comes to the stock market. One of the main reasons behind these losses is the lack of knowledge about the investments they make. It’s astonishing that we do a lot of research and bargaining before buying a small power bank but we blindly make huge investments in the stock market, many a time just on the basis of news or hunch.

For serious starters, books are the cheap and best source, to begin with. An experienced and good mentor can also improve your learning curve. Having a sufficient theoretical base, it is the practical knowledge that is going to make you a better trader or investor as you learn from your mistakes. Charlie Munger has wisely said that spend each day trying to be a little wiser than you were when you woke up.

“With a good perspective on history, we can have a better understanding of the past and present, and thus the clear vision of the future.” Carlos Slim Helu

Before investing in any stock or group of stocks, it’s better to run thorough research about the business performed by those companies. You should at the least know the sector they belong to so that you can have an idea about the future aspects of the parent group. Have a little sneak peek into the earnings growth of the company. If historically the company has been showing good growth, similar trends may be anticipated in the future. Also, evaluate the other financial aspects such as Debt to Equity ratio; Price to Earnings ratio (PE); Dividend Yield, etc. Generally, debt-free companies with relatively lower PE ratios are better for investment. Very long term investors should look for, in addition to the above, consistent and high dividend-yielding stock which can generate added returns over a long period of time.

Knowledge about the technical analysis can provide an edge to the investors. You would precisely know the important value zones where institutional investors are interested in buying and selling. Waiting patiently for those levels before taking an entry or exit can save you a lot of time and value.

“I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.” Warren Buffett

As the majority of traders/investors have been losing money in the stock market, it would not be a better idea to trade like any of them. If you want to make money you will have to trade against them. It’s better to buy when the heard is selling in panic and sell when the heard is buying in greed. This is a time-tested method but needs a lot of patience to wait for high probability opportunities. Only the patient ones can make money in the stock market.

“I don’t look to jump over seven-foot bars; I look around for one-foot bars that I can step over.” Warren Buffet

Predicting market tops and bottoms is the most painful thing to do. As markets may remain in a trend or consolidation for much longer than you can expect. Keeping realistic expectations from your investments would not only keep you away from such predictions but also in building your capital. Booking profits at preconceived targets would enhance your win rate and bring confidence in your trading. Remember that preconceived targets for an investor would be much higher than a short-term trader. Some investors like to adopt an open target approach but in that case, they keep on trailing their stop-losses higher, as the price trends up, so that they can catch the whole juicy part of the trade.

“The stock market is filled with individuals who know the price of everything, but the value of nothing.” Phillip Fisher

The stock market is filled with traders who want to become rich overnight. They opt to buy a small-cap stock because they think it’s cheap; they can buy a huge quantity, and there is more room to make profits. This is normally seen in stocks that have historically traded at a much higher price. What investors don’t understand is that the stock has been trending down to such a low price because of a valid reason. The reason perhaps unknown to retail traders but known to well-informed institutional players and insiders. Averaging such a stock would only hurt your portfolio to a greater degree.

“The secret to investing is to figure out the value of something – and then pay a lot less.” Joel Greenblatt

Let us say you want to buy a used car from a seller. You would like to know the information like the price of the new car; the model of the car; condition of engine and tyres; registration details, etc. You would definitely search for that model in the market for a better bargain and then you will make your decision to buy or not.

While investing in stocks you should also collect the perspectives that reveal the intrinsic value of the company. Then you should patiently wait for a better current market price which needs to be lower than the intrinsic value of the stock. Fundamental analysts use various models such as the Dividend Discount Model; Residual Income Model; Discounted Cash Flow Models etc. to calculate the intrinsic value. On the other hand, technical analysts look for oversold and overbought conditions to assess if a stock is cheap or expensive. If a stock is overbought on the charts, it is considered expensive and if is oversold on the charts, it is considered cheap. Although every model has its own limitations yet your decision to buy at a price lower than the intrinsic value would reduce the downside risk compared to a situation when a buy decision is made at a relatively much higher market price.

“It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.” George Soros

An investor needs to assess his financial condition and set the goals accordingly. These goals should not be to double or triple the available capital within a short span of time but to make consistent profits over a long period of time. There is a general rule that on any trade taken, the profit target should be at least double the risk involved. This simply means that you will make double than you can lose on any trade. This simple principle can keep you in-game for a much longer time.

Your returns have a strong relationship with your risk appetite. A high-risk appetite has a potential for higher returns and thus beating inflation. If you are investing in stocks, then it reflects that you already have a higher risk appetite. Parking your money in very low-risk instruments such as fixed deposits won’t beat inflation and thus reduce profit potential or return on investment.

“Wide diversification is only required when investors do not understand what they are doing.” Warren Buffett

If you are investing in stocks, then its neither wise to invest the entire capital in just one or two stocks nor to park it in a group of fifty stocks (for retail traders). The former would be the riskiest bet as chances of bad investment are higher. It may also lead to overtrading due to too much focus on just one stock. Whereas over-diversification may become too complicated and difficult to manage as your limited span of attention may lead to poor returns. On average, a retail trader may diversify in 15-20 well-analyzed companies.

Investors should keep in mind that even a well-diversified portfolio will be at risk if the stocks are from the same sector or extremely correlated. Therefore, it’s prudent to diversify in various sectors which are not highly correlated. At the same time, rebalancing portfolios at suitable intervals would set off the cyclical effects of stocks on them. It would also help in plowing back your profits.

“What can be added to the happiness of a man who is in health, out of debt, and has a clear conscience?” Adam Smith

The long-term financial goal of investors can only be achieved in a debt-free environment. Borrowing money from friends and relatives or redirecting business loans to trading would add both financial as well as psychological pressure to the investors. It is advisable that — only surplus funds should be used for investment purposes; keep emergency funds for the future to keep you away from any debt requirements; and pay all high-interest debts, if any, before you even think of investing in the stock market.

“Investing should be more like watching paint dry or watching grass grow.” Paul Samuelson

Patience is the key to investments. The analysis is important but what ultimately pays is your control on emotions to keep the trade as long as you can, when it is in profit. Generally, investors hold losing trades for a longer period of time than winning trades. Rather it should be the opposite. Traders need to be impatient with losing trades and highly patient with winning trades. Getting emotionally attached to a stock(s) is an indiscipline approach. With this approach, even one or two underperforming stocks may drag down the profits generated from the entire portfolio.