Just like any journey, when you embark on trading as an investment option, you need to take time to get habituated to your surroundings and to the new context.
You'll need some practice before you're able to navigate with ease. As such, it might not make sense to immediately implement complex strategies used by experienced traders. With that being said, your hard-earned capital is in play and as a result, you must adopt some strategies to help minimize your risk and maximize your reward.
Here are some key strategic moves that you can make. Use a combination of them to get the best results.
Strategy 1 - safeguard against loss while maintaining room for profit
This is achieved by setting a stop loss. A stop loss tells your broker that you want to exit the trade if stock prices plummet to a certain level. For example a trader might purchase shares at Rs 50 and might place a stop loss at Rs 47. Why not Rs 49.5? Because the trader needs to keep sufficient room for the prices to fluctuate. The stock price might drop marginally before it rises. After all, volatility is what gives the stock market its potential to deliver earnings. Stock prices fluctuate throughout the trading day and one never knows which direction they will move in minute to minute. Therefore it is essential for traders to set a stop loss while not being too conservative about where they place it.
Strategy 2 - exit at the right time
Experienced traders often advise amateur traders to avoid letting greed get the better of them when the price of a stock they hold is on the rise. One of the commonest ways to eliminate the emotional trading moves that arise from greed is to set a target price. You know how much you have purchased the stock for. Set a target price and do not stay in the game once you have achieved your target price. The stock price might turn around at any moment.
Strategy 3 - buy undervalued stock or stock selling "at a discount"
In the West, it's all about Black Friday Sales. In India we might put off big ticket purchases (like new televisions) until October-November to avail of discounted rates during Diwali Sales. A favorite of famously successful investor Warren Buffet and his mentor, Benjamin Graham, buying shares "at a discount" is known as value investing. This strategy does require you to wrap your head around concepts like P/E ratio (price to earnings ratio) to decide whether a stock is overvalued or undervalued.
Overvalued stocks are those stocks that have a high price that is not in line with the company's earnings. Some other factor might have driven the price up. However, the price might just fall if the company does not begin to deliver soon. This is known as price rationalization. An upcoming quarterly or annual report might fuel such a rationalization. Certainly you do not want to buy a stock and then watch its price fall.
Undervalued stocks have a price that is lower than what the company's earnings justify. The assumption of value investors is that the price will rationalize upwards, thus delivering earnings to the investor.
Strategy 4 - use BASIC technical tools
As a beginner trader, it would not be fair to expect yourself to automatically and magically begin to use technical indicators like a pro. However, you can use the basics, such as observing the highest price and lowest price of the stock during a given period like say a year to determine whether it makes sense to buy or sell at the ongoing price.
Strategy 5 - avoid herd mentality
When choosing investments, do your own research. Observe the company's balance sheets and evaluate their earnings as well as their potential going ahead - what do their assets and liabilities look like? Keep an eye on news surrounding the company: mergers and acquisitions, new locations are usually good news; a court case is bad news and can affect the stock price negatively. Also keep an eye on the sector: a subsidy is good news; a new tax could be bad news.
However, avoid selling stock because other investors are dumping stock. If a development is likely to be resolved soon, what sense does it make to sell when prices are falling because too many people are selling?
Strategy 6 - play for the long term
As a new trader you probably do not want to play the high risk, high stakes, high pace game that day traders and short term traders play. They're looking to make tiny per-share profits that multiply into large amounts because of the volume that they trade in. These traders pretty much make a career out of trading.
If you're looking at being a passive investor however, it is best to have a long term investment horizon. Prices fluctuate on a daily basis but in the long term, you will usually observe an upward slope in most companies' stock graphs. They look like upward slopes with "teeth" … these "teeth" are short term price fluctuations. In other words, risk plateaus out in the long term.
Keep in mind that this phenomenon is by no means justification for picking stocks haphazardly. You still need to choose carefully, set a stop loss and target price and buy in at the right time - preferably not when the market is at an all-time high.
Strategy 7 - diversify your portfolio
A lot of people - when they travel - divide their forex between various pieces of luggage and their person. The idea is to minimize their loss in case of theft. The same goes for stocks. Well, nobody's stealing them, especially since now they're held in digital form (versus old-school share certificates which could totally be stolen- just like money). However, you invest in a diverse selection of companies across various sectors so that the potential underperformance by one company or one sector is offset by regular or optimal performance in other companies and other sectors.
Well, now that you have these 7 strategies in place, you're going to make guaranteed returns on the stock market right? Wrong! Stock market risk is the only thing anyone can guarantee you on the stock market. Be wary of anyone who tells you otherwise. Always invest only with spare capital that you have put aside after taking care of your daily lifestyle and living expenses. Do your research and yes upgrade your awareness, as you are doing now.
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