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Top 5 Faulty Stock Trading Practices [Finance Friday]

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The negative rub-off of housing finance scam in India and sovereign debt issues in Europe is being clearly felt by the equity markets. Indian stock markets have corrected almost 10% from its peaks over the last 1 month. In fact, the correction has been so dramatic and broad-based that almost all the stocks, including those in pronounced up trends, have plunged into deep red.

Under such circumstances, the long-term investors can stem their paper losses by holding on to their portfolio of stocks even during this steep correction, but the real hit is taken by the trading community who trade with a short-term perspective.

At this juncture of jittery market sentiment, we decided to dig deep into ‘Faulty trading Practices and Emotional Decisions’ that can lead to grave losses to the traders and consequently losing their self-confidence and urge to withdraw from trading completely as a knee-jerk reaction.

Stock Trading Practices

Trading without Stop Loss

Before starting with this point, my question to the traders is, “has anybody succeeded by trading without a stop loss for a prolonged period?” The answer to this is a clear ‘No’.

I always exit my trade between 1-2% when it doesn’t go my way. I also have a stop loss for the worst case scenario of about 5% from my entry point. Moreover, I think some pros don’t use stop loss when they enter, but they do have a provision for a mental stop where a trade is proven wrong. Otherwise you’re just holding on to the hope and leaving the rest to destiny.

Of course, you can always exit a trade even before your stop loss gets triggered if the situation so demands; that’s not an issue. But, having a stop loss in place is the most important part of the trade.

In short, stop loss orders are great insurance policies that cost you nothing and save you a fortune. Unless you plan to hold a stock for longer duration, you should consider using them to protect your moolah from draining you further deep into losses.

Excessive Trading

One policy that I follow religiously for my daily trades is to avoid ‘excessive’ trading. For example, I have a daily target of earning Rs.500 from my intra-day trades. If this target is achieved in the first 15 minutes of trade itself, I close my trading terminal and make myself busy with some other work to stave off from excessive trading.

The Reason: The winners are convinced that they will ride it all the way to the top and invariably give much or all their gains back to the casino if they overtrade.

In fact, the urge to overtrade is especially felt in case of traders that are reeling under losses. Despite the fact that odds favor the losing trades on a given day, traders are almost always desperate to recoup their losses.

Moreover, large and frequent short-term trades will also increase the administrative and brokerage costs. These types of trades have the potential to interfere with the efficient management of the trading expenses, including various taxes, and returns.

Compulsive Trading

How many of you are compulsive traders? Traders who are compulsive look for trading thrills, while telling themselves they are doing it to make a profit. It is nothing but a rush of adrenalin powered by impulsively market timing based on the emotional response to news events, sharp market fluctuations or simply for the thrill of the trade itself.

You might get over compulsive about trying to anticipate everything that might go wrong. You may fruitlessly try to develop an action plan for every scenario. Compulsive trading is an overpowering need and an urge to gamble; and it becomes a problem when a person engages in it on a regular basis.

Moreover, even excessive trading is a part of a broader compulsive trading disorder; wherein a trader returns to trade after losing money with a compulsive urge to get even.

Trading without a Plan

A systematic trading is a mechanical set of rules covering entry and exit orders based on pre-established and predefined plans. On the other hand, a discretionary trader relies on his judgment and can employ any number of subjective analyses to form his trading decisions.

A core trading strategy based on a pre-determined set of rules combines risk-management along with logical decision-making; while excluding emotional factor attached with your trade. A disciplined trader cares only about keeping the system he is sure in.

Systematic traders design systems that focus on staying in alignment with the underlying trend. When it comes to risk management, systematic traders also focus on price rather than noise or herd mentality.

Without a trading plan, you’ll not be able to determine whether you’re headed in the right direction. You’ll have a framework to measure your trading performance that you can monitor continually.

Withdrawal from Trading

Complete withdrawal from trading is a state of mentality where a trader has accepted defeat either on account of lack of knowledge or destiny not favouring him in his trading career. It is the last thing that a trader would want. Usually, this stage of depression is reached once a trader experiences huge losses on account of unsuccessful trades.

At this stage, a trader needs to weigh the pros and cons of his past trading practices and beliefs based on which he used to trade and account for the failures. If he runs away from trading, it would be tough for him to find his feet back on the trading terminal at a later period.

Analyse the short-comings of your trading system, your emotional involvement and fear of failure; and make necessary amendments in your trading strategies in such a manner that you can overcome erroneous actions and not repeat them again.

The best thing that can happen to a human being is his ability to correct his mistakes and not as much of achieving success; as success is only the end result. But, if the process to the ultimate goal is refined and simplistic, the success is always here to stay.

As I am writing this post, I am already done with my trades for the day in the first hour of the market opening itself. So, writing this article helps me to remain away from ‘Excessive’ trading. Smile

  1. Akash Sharma says

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  2. Madhav Shivpuri says

    Hi Viral,

    Nice tips for a trader/ short-term investor. As a long term investor, I am try my best to sit tight when market fluctuates and the prices fall even if the fundamentals of a company or macro environment has not changed.

    I think the market is currently inundated with individuals in their 20s and 30s trying to make a short term profit by picking up tips from ‘experts’. I personally think we should not encourage such attitudes for the simple reason that it does not involve the individual’s understanding of the company/ business, but one is betting with their Rupees. So I would argue that financial education should be the way to go instead of finding alternative ways to cut one’s losses.

    1. Viral says

      Madhav,

      I understand the point you’re trying to specify above. And, in fact, I quite agree with you as well. But, there’s other side to the story as well; gimme a chance to explain in a bit detail as follows:

      Just like a huge water-bodies such as sea has all size of creatures – Fish, Sharks & Whales – even the broader capital markets should have a mix of traders, investors & punters. And that, each of them play a crucial role in providing liquidity to the equity markets.

      The trading community plays a crucial role in providing the necessary liquidity and fluctuations to the market.

      By giving trading Do’s and Don’ts, I dont mean to discourage the investment activity in stock markets. In fact, if a person is really interested in ‘wealth creation’, long-term investment is the only way out.

      Moreover, trading has it’s own set of rules and disciplinary ways of operation; it is a calculated ‘gamble’. Many types of short-term analysis can go into systematic trading.

      Mine was just an attempt to highlight the vagaries of short-term trading and busting commong myths.

      Thanks for you valuable thoughts :)

      1. Madhav Shivpuri says

        Right. Traders and speculators – may they prosper!

  3. Divyesh Shah says

    Dear Sir,
    It was really worth reading your post and being a novice it is really billion dollar tips for me.
    I would like to know from you that how could I start trading i.e What should I do in the beginning and which will be the right time to put-in?

    Thank you.

    1. Viral says

      Divyesh,

      Nice to know that the article was useful to you.

      As regarding starting the trade, let me tell you that first differentiate between ‘Trading’ and ‘Investment’ – What you want to do? Have a clear perspective in your mind. Investments are for long-term and trading is done with short-term perspective.

      If you want to fall into trading, always do it with Stop Loss; and ensure that you never marry the stocks that you hold. In investments, you have to watch a plenty of aspects as your gaol is to stick with your investment until your target is achieved over a period of time. so, you have to ensure that you get into only good fundamental stocks.

      Also, remember stock markets is all abotu controlling your ‘Fear’ and ‘Greed’. If you’ve done that you’re game for this calculated version of gambling.

  4. Altaf Rahman says

    Hello Viral,

    Nice post, but only regarding day trading or short term investment. What about Long term / Medium term. As you are an expert on stock markets, readers of Trak will benifit if you can post regular articles on stock investments.

    You can give a monthly Long term tip regarding some blue chip company where people can hold for a year or more. Similarly you can give medium term tip once a week. This way people can build a portfolio professionally. I know you rode the recession successfully with great discipline.

    At the moment some of the Indian blue chip stocks are languishing at one year lows. Gaints like NTPC, BHEL, Rel. Communication, Rel. Infra, Rel. Capital, Sesa Goa, Financial technologies, and mini blue chips like Suzlon, Punj Lloyd, IVRCL Infra, GMR Infra, India Cements, Guj. NRE Coke, Great Offshore, Tech Mahindra are few of them.

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