We have, in general heard of a large number of successful investors who have made lot of money by investing right over long periods of time. However we rarely hear of very successful traders. Some of the successful ones have done very well but that has been out of discipline and taking positions that they can afford to take.
Historically I have not been a very good trader myself as I have focussed on long term investing and have found it easier to pick out long term winners. However over the last few years I have also been trading and out of my empirical experience the key features to be successful in trading are the follows.
- Every trader needs to put a limit or value on the amount of trading that he or she will do per call. Now trading being very different from investing requires that emotions or long term view of a stock or commodity not being attached to a trading position. Since that is the perspective with which one starts operating I normally recommend that every trading position should be take with an equal value. What this essentially means is that you are totally taking out any biases from your trading position. For example for the long run one might be more positive on ICICI Bank rather than Reliance Industries. As such in the investment book one should buy more of ICICI and less of Reliance. However when one is trading on the two the positions should be equal.
- Now once a position has been taken Trading requires one to be disciplined on the STOP LOSS most of all. The reasons for this are that Trading essentially is impact by several short term factors which Long Term Investing can ignore. An example of this was seen last week when RBI unexpectedly cut interest rates. This created a huge rally in interest rate sensitive stocks. Now as a Trader if this event led to your stop loss getting triggered then please honour that stop loss. The other factor here is that even a very successful Trader will atmost have 70-75% of right calls. Now if there are disciplined stop loss levels which are adhered to then in a majority of cases you are making money and overall will make money. Stop Loss levels in trading normally should be a fraction of the Profit Booking levels. As such if a trading position is taken at Rs 100 and the profit booking level is 120 then the Stop Loss has to be 95 and not 80. The logic here is simple; in trading you will go wrong several times due to unexpected events. These could be domestic, international, macro or micro. Under the circumstances it’s important that you exit the losing positions fast and ride the profit.
- So then how to operate on the profit side. Even on profits discipline is required. The reasons for this are simple. In the stock markets the more the price moves up the more confident are market participants on the direction of the move. Here again a trader needs to keep emotions away. Take the profits when they come. In some circumstances where you really do not want to do that and want to try to ride the move further it’s important to have a trailing stop loss. For example if a stock was bought at Rs 100 with a target of Rs 120 and the price moves above Rs 120 very fast and reaches Rs 125 then the trader needs to keep a trailing stop loss at Rs 120. Now if the stock rises further then it is great. However if the move falters that original profit level of Rs 120 is protected.
- Do not try to recover the losses by taking excessive risks; Now there will be lot of circumstances where a few trading calls would have gone wrong one after the other. This can happen in both trending markets (where calls are taken against the trend) and whipsawing markets (where the trend keeps on changing). In these circumstances when a trader has made losses one after the other the tendency is to take bigger positions, higher risk to immediately recover the losses. However this is the worst thing to do. It’s best to step back in such a situation, let things settle down and come back to trading with discipline.
- Profits made out of trading ideally should not be used to increase the quantum of trading positions but ideally to deploy the profits in longer term investments which will grow over time. I have seen several traders who have done well in short periods of time, increased their trading and as a result not only lost out the profits but also gone into losses. If your networth increases over a period of time the quantum of trading can be increased but with the same discipline which was there earlier.
I will now conclude this piece by adding that most of the people who ask questions from me or come for advice tend to veer towards doing more trading. Under the circumstances it’s difficult for me to build up discipline in everyone. As such the above mentioned rules could be helpful. Ideally the money deployed towards trading should be a smaller part versus that deployed in long term investing where, with the right picks it’s difficult to go wrong. For the trader the following saying is most relevant
When facts change, I change my mind . What do you do sir? – J M Keynes