Six Tips for Successful Share Market Investing

Remember Euclid who told Ptolemy famously, “Your excellency, there is no royal route to geometry”. What Euclid said about geometry is equally true of stock market investments. There is no real royal route to profits or investment success. However, a set of common sense rules can go a long way in help you through stock market investments. Now, remember, these are not some stock market investment tips, but it is more like a share market investment plan. It is a set of rules and wisdom points to help you become a better investor.

If you are a beginner in the stock markers, you are going to have a tough time navigating the maze of information, analyses, research reports, expert advice, share market investment tips and rumours. There is no shortage of information and analysis to assist you, but that is positive and a negative for you. You need to find good stocks to invest in India but for that you need a rule book and you need discipline. However, with this deluge of information and analysis, how to separate the wheat from the chaff. Quite often, the stock analysis and the sales pitch look so similar. Thanks to modern trading, you have intelligent apps that help you trade with information and screeners at your fingertips. So the first thing you do is to get hold of one of the best stock market apps on your mobile.

Since you may have neither the time nor the expertise to navigate the maze of information and stock market jargons that is dished out, we have distilled 6 important points that can make you a much better investor. Here is where we take off.

a. Don’t invest without target return and risk tolerance set

That looks quite complex but is actually quite elementary. For instance, when you buy a stock, the upside is your return and the downward movement in price is your risk. You obviously want to maximize your return and minimize you risk. That is possible if you put limits of acceptable returns and acceptable risk. That is what return targets and risk tolerance is all about. If you bought a stock and the stock is down by 15% what should you do? it is tricky when you are in a soup so the best answer is to have discipline of stop loss. 

Similarly, on the upside, profit is what you book and you know pretty well that booked profits are better than book profits. So, get into the habit of taking profits at regular intervals. For that you need to set profit targets. It can happen that your stock may trigger a stop loss and bounce back. It is also possible that you book profits and the stock goes up further. You can never catch the bottom or the top, so just set your target returns and risk and stick to it. That works best in the long run.

b.Returns must be proportionate to the risk taken

This is a golden rule and it is actually simple. You don’t mind jumping from 2 feet but not from 200 feet, because the returns are not proportionate to the risk. This may appear esoteric topic but is actually quite simple. If you buy a stock and have 20% profit target, then what should be the stop loss?  The thumb rule is you trade or invest in markets with a positive risk-reward ratio. Let us understand this better.

Just to take a benchmark, your profit target must be around 3 to 4 times your downside risk. Otherwise, the returns will never compensate you for the risk. Does that also apply to investors? Of course, investors can set longer stop losses and longer profit targets. However, in the case of an investor, you can also use trailing stop losses to maximize your profits for the amount of risk taken.

c. Like it or not, there is no alternative to diversifying risk

Warren Buffett has often said that he always focussed on a few stocks. However, even Warren Buffett used to diversify his portfolio. It is OK to talk about concentrating your risk because you are confident, but that only works on paper. The best of traders and investors diversify and spread their risk. After all, you can bet on luck factor only up to a certain point.

In reality, you need to diversify across assets and themes. For instance, you must look to spread your portfolio across stocks, across themes and across asset classes; like having bonds, equities, gold, liquid assets etc. Ideally, diversification works best when it is across assets that are not highly corelated because that is when diversification really works wonders for you. But yes, there is no alternative to diversifying your risk.

d. Behind every stock there is a company; understand what it does

This is something Peter Lynch used to often tell investors. There is no point in blindly adding stocks to your portfolio. One common complaint is that new investors cannot have expertise on sectors and business models. The answer is simple, start off with your comfort zone. For instance, if you are working for a cement company or if you are into the cement business, then start building an equity portfolio of such stocks. You have a much better understanding of the dynamics of the industry, so other things automatically fall in place. You will find grasping the business of cement companies much easier.

The problem is that when you are unfamiliar with the nuances of the stock you are buying, it is easy to get carried away by advice, tips and rumours. It is best to always resist that temptation. When you buy a stock you are either buying the business, or you are buying a trend. It is OK either ways as long you are aware of what you are buying and why you are buying or what you are selling and why you are selling!

e. Know when to stay away from the market…

Staying away from the market and not trading or investing is also a strategy. That is something most investors miss out. Many star investors have admitted that they most of their money by doing nothing, not by forcing themselves to take action even when the market momentum was not favourable. Buffett was a man who gave the technology stocks a miss in late 1990s. He did end up underperforming his peers in the industry. However, when the technology bubble crashed, Buffett was laughing all the way to the bank.

There is merit in staying out if you are not convinced by the story or if markets are too volatile or valuations are out of sync. It is ironic but true that when you look back; you will have made most of your money because you opted to stay out of a market that you did not understand. There is no harm in giving markets a miss.

f. You cannot ignore your capital position

This is a rule that you must never lose sight off. Whether you book trading losses or investment losses, it erodes your base capital. Define your capital risk tolerance and stay within that limit. Set limits for daily losses, monthly losses and overall portfolio losses. At that point, just get back to the drawing board. If that is taken care of, it will be a lot easier.