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BW Businessworld

Stock Market Trading : Three Things To Know

Trading or long term investing - what would you recommend to a retail investor? Is it true that retail investors tend to lose money when they trade aggressively?

Photo Credit : Reuters


Trading or long term investing - what would you recommend to a retail investor? Is it true that retail investors tend to lose money when they trade aggressively?
For a retail investor the most important aspect to be a success in stock markets is to set expectations right. More often than not people enter stocks as investors and end up trading too frequently or vice versa. Investing and trading are two different approaches to the same market. Choice between investing and trading should depend not on what one would like to do but on what kind of skill set and temperament one has. Trading requires an understanding of how stocks and indices move, which means, a trader may buy or sell a particular stock based on parameters that are unlikely to affect the company's performance over the long term. Investing, on the other hand, requires identification of companies which can do well over a long period of time. Investing requires patience, conviction and a passive yet a review based approach towards markets. Unlike a trader, an investor would want to benefit from long term trends and the power of compounding. Hence, retail investors who lose money in markets may not be limited to aggressive trades. In fact, excessive risk taking, poor price risk management and lack of objective trading/investment plan may lead any category of participants to losses.

How important are stop losses when it comes to trading in equities?
If one were to have a key to making money in stock markets, probably the first rule that successful traders would point out to is "stop loss". It is not very difficult to buy or sell a stock which is trending higher or lower. Most people enter stocks with strong trends and make paper profits. Either greed for more profits or fear of losses stops novice traders from adopting a logical exit strategy. That's why it is said that as a short term trader you should live to trade another day. What this means is appropriate risk management tools are most important for survival of a trader. These include stop losses, appropriate position sizing and hedging strategies using derivative instruments.

What is a 'trading plan' and how can one formulate a successful trading plan?

A trading plan defines what is supposed to be done, why, when, and how. It covers the trader personality, personal expectations, risk management rules, and trading system. An effective trading plan details the steps that a trader must follow when entering and exiting trades. Without a trading plan in place, traders are more susceptible to trading mistakes, overtrading and making impulsive decisions in volatile markets, particularly when trading online. A successful trading plan should detail the following:
1. Asset classes to be traded
2. Universe of securities to be traded
3. Initial capital and acceptable risk
4. Appropriate exposure limits on each trade
5. Entry, exit and stop loss rules
6. Regular review of the portfolio

Tags assigned to this article:
personal finance stock market trading private equity