Stock markets have always caught the fancy of investors looking at inflation-beating returns and wealth generation. However, making money in equities is not that straightforward. It requires patience, an inherent understanding of the way the market functions, and in-depth research and analysis, among other things. If we take a quick look at the way the markets have responded to the pandemic in the last few months, it has been a roller-coaster ride. With high market volatility and an uncertain outlook, most investors found themselves grasping at straws to make the right investment decision.
Such events highlight the volatility of stock markets and the risks associated with stock investments. However, to be in better control of your investments and ensure that your financial goals are met, you need to approach stock investing in a planned and strategic manner.
Besides this, there are many groups on social media including WhatsApp, Facebook, Twitter, and other chat apps where stock advice is freely available. On top of all these, there are business news channels where stock experts give non-stop stock advice. All this creates a dangerous trap for innocent investors, who often mistake this non-stop flow of stock advice as genuine and invest based on it without understanding the reality.
Not all stock advice that you receive is genuine or backed by detailed research and analysis. In fact, many people give stock advice with vested interests under which operators use the pump and dump method to cheat innocent investors.
As the saying goes “look before you leap”, it is always to prudent to conduct thorough research before arriving at any decision. When talking about financial investments, it is advised to perform comprehensive research, and more so in the case of picking a stock.
Investing in a stock is a complicated process where decisions require intensive research and cannot be taken in haste. Typically, stock markets are considered to be volatile and subject to national and global influence. Research is an essential aspect of creating a portfolio.
In March, when the stock markets crashed due to the lockdown and pandemic, many investors panicked and sold their stocks to minimize their losses. While this seemed like the best thing to do, it was not an informed decision but an emotional reaction to a stressful situation.
Within a couple of months, the markets have started recovering and on course to bounce back. While some companies suffered due to the economy coming to a standstill, stocks of fundamentally strong companies survived the crisis and began their path to recovery. If investors wouldn’t have panicked and analysed the stocks that they need to sell and the ones that they should hold on to, their losses could have been curbed.
Stock markets are volatile by nature. Hence, if you keep making investment decisions based on market volatility, you will always be exposed to the risk of buying/selling at the wrong time. So, a more prudent approach is to create an investment plan and stick to it while making minor changes based on data-driven analysis. Emotion-based decisions are usually counterproductive.
Performing research before investing is a must. It is only after thorough research that you can make some assumptions into the value and future performance of an investment. Even if you are following stock trading tips, it ideal to do some research, just to ensure that you are making an investment that’s expected to get you maximum returns.
When you invest in equity, you purchase some portions of a business expecting to make money upon an increase in the value of the business. Before buying anything, be it a car or phone, you do some degree of research about its performance and quality. Investment is no different. It is your hard-earned money that you are about to invest, so you must have a fair knowledge of what you are investing in.
Minimize Losses
For making wealth in stock markets, knowing when to sell stocks is equally important as knowing when to buy stocks. The investor should not end up selling those stocks early, which go on to make millions for their shareholders. At the same time, the investor should not keep on holding a stock even when it shows the signs of a deteriorating business situation. Therefore, deciding when to sell stocks becomes a trickier decision than buying them.
“Cut your losses short and let your winners run” – This sage advice has been doing the rounds in the stock market since years. The general practice among investors is selling stocks after a small gain only to watch them head higher or holding a stock with small losses only to see them worsen. However, unless investors and traders take a certain amount of calculated risks, making money in the share market would be difficult. Hence, avoiding losses should not be the aim but it should be minimizing them.
And the first thing that comes to one’s mind to minimize losses is to place a stop-loss. Stoploss is the only way to minimize losses but actually, it is the most common element in multiple small losses because more often it gets hit and then the price moves in the originally anticipated direction. Generally, stops are triggered and then the prices move, thus traders lick their losses every time although they are small in number but become huge over time. But that doesn’t mean that stop loss should not be kept instead they should be far and scientific. The correct way to reduce losses is to manage risks effectively.
Many financial advisors recommend implementing a rule to cut all losses on an individual stock at a maximum of 7% or 8% of the initial purchase price to manage risk. No one is right every time they buy a stock. This is your insurance policy to prevent severe losses that will be difficult to come back from. In many cases, you may be able to get out of a poorly performing stock even before it reaches this threshold. If the stock rebounds and breaks out again, you can always buy it back.
It’s important to remember that this rule pertains to your initial purchase price. Once you are upon a stock, you can give it more room for normal fluctuations. The difference is if you are down on your initial purchase, you’re probably starting off wrong. The stock is not acting the way it should after a breakout. If you are already up on a stock, the stock has acted correctly and you have a profit, so you can afford to give the stock some room and not get shaken out by a normal correction.
Timing your buys correctly is an important part of this concept. If you buy fundamentally strong stocks emerging from sound bases in up trending markets, they won’t often correct more than 8% of your initial purchase price. But if you make a mistake, this rule is there to protect you from severe losses.
The best time to sell a stock is when it’s on the way up, while it’s still advancing and looking strong to everyone else. If you wait for a stock’s exact top, you’ll likely be late. You can very easily be caught in the 20% to 40% market corrections that can hit market leaders.
If you are holding a stock beyond its initial 20% to 25% move because you believe it has the potential to be a big winner, you will need to stay conscious of a few other sell signals. The overarching concept to remember is that while you should buy stocks based on a combination of fundamentals and technicals, you should sell based solely on technicals. By technicals, we refer to price and volume movements in a stock best tracked with stock charts.
When stocks top, the fundamentals will often still look great. If you wait for the bad news to come out, you will be too late. Institutional investors spend their massive resources and industry contacts looking for any signs that a company’s earnings growth is slowing. Therefore, as an individual investor, you would likely be among the last to hear about a fundamental change. The big advantage you possess, however, is size. An individual investor can usually exit a position rather quickly and not affect the stock’s price. On the other hand, large institutional investors, with the huge number of shares they hold, cannot begin exiting a position without leaving tracks and the process can take weeks to unfold. If you learn to interpret sell signals correctly, you can recognize when demand for a stock’s shares wanes.
There may be times when you think you have spotted a stock with strong fundamental and technical characteristics, but the stock doesn’t act right after its breakout, and so you are forced to sell. Don’t completely forget about that stock. There’s a chance you were just early in your timing or the general market conditions weren’t right. Keep the stock on your radar. If the stock breaks out again from a proper base, don’t be afraid to buy it back.
Many investors will refuse to sell a stock that is down because that would mean “admitting” they were wrong in the first place. If you’re down on a stock, you already have a loss. Holding on doesn’t change anything. Financial planners recommend cutting losses at 7% to 8% below your purchase price. In many cases, your capital will serve you better allocated to another stock with a stronger likelihood to advance.
Selling right is as important as buying right. It’s easy to get attached to a stock that has advanced a lot from your purchase price. You might really like the company story and the fundamentals may still look fabulous. If you ignore signs that a stock is topping, however, you may watch your hard-earned gains evaporate. Remove emotion from the equation. Employ a rule-based system to help spot when a stock is topping.
The Bottom Line
The ultimate goal of every investor is to make a profit, however, not every investor or analyst is good at it. Never blindly accept what stock analysts have to say and always do your own research. Not everybody can be an investing expert, but you can always improve your analytical skills when it comes to stocks.
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