Why traders must avoid becoming investors by default - Motilal Oswal
Why traders must avoid becoming investors by default - Motilal Oswal

Why traders must avoid becoming investors by default

When Ramesh Seth bought Reliance for intraday, his idea was to exit the stock when it gave a profit of Rs.5-6. However, during the day his friend called up tell him how Reliance was literally dominating the telecom field and taking away market share from other players in the industry. The result of the conversation was that Ramesh decided to take delivery of the stock since he had funds available with him. Over the next one month, the stock did go up by 10% and Ramesh managed to book profits and come out. At the same time Ashish had bought SBI for intraday and since the stock was falling he decided to cancel his stop loss and take delivery of SBI. Fortunately SBI also bounced in the next one month and Ashish booked profits on his position.

 

In the above instance, both Ramesh and Ashish made money by converting their day trading positions into delivery positions. But there is a basic difference. Ramesh became an investor by design while Ashish became an investor by default. Ideally, day trading positions should not be mixed with delivery positions. The theme is that you can be an investor by design but not by default. Here is why?

 

Distorts the risk-return trade-off

When you are trader you have a different risk-return trade off and when you are investor your trade-off is entirely different. An investor can afford to keep a bigger stop loss and a bigger profit target, something a trader cannot. Also, investment is fund-based whereas trading is more margin-based. If you become an investor by default rather than design; this mismatch in risk-return trade-off will come back to haunt you.

 

Leads to averaging of positions

Let us say, Ashish, in the above instance, already has an exposure to SBI in his investment book. When he decides to convert the trading position in SBI into delivery, he is actually averaging his SBI position. When you buy a stock and the price goes down, it means that your decision was wrong. By averaging your position you are only being wrong twice. Also, you exposure to banking may now be more than what you had bargained for.

 

Increases concentration risk
This is an extension to the previous argument. While the previous point talks about the sector risk, there is also a risk of theme concentration. Your decision to average a particular stock may expose you substantially to themes like consumer theme, services theme, rate sensitive theme etc. Typically, extra exposure to any theme is not what you had bargained for in the first place.
 
Capital may be insufficient

That is a practical problem that most traders could face. When you take an intraday trading position, you allocate capital that is just enough for your margin and your stop losses. You do not bargain for a delivery position which requires higher capital allocation. This may force you to either offload some other position or create liquidity from other sources. In both the cases there is an opportunity cost that you are incurring.

 

Risk appetite may not match the time required

When you take any position in the market, first ensure that it matches your risk appetite and your time horizon. For example, if your appetite for equity investment exposure is 60% of your portfolio and you are already in excess of that, then there is no point it trying to convert your trading positions into delivery positions. You normally get into trading because you want to churn your capital quickly and that is only possible through trading. When  you convert these trading positions into investment positions by default, you are going against your basic risk appetite and your time horizon.

 

Goes against your trading rule book

Last, but not the least, this attempt to convert your trading position into a delivery position goes against your trading rule book. Your trading rule book is the constitution of rules and regulations on which your trading activity is based. One of the basic trading rules that you follow is that an intraday position must be treated as such. Therefore, discipline of stop loss and profit targets is a must. When you convert such intraday position into delivery trades, you are going against your rule book. This is something you should best avoid in the larger interests of your trading performance.

 

There is a popular debate on who makes more money; traders or investors? People also wonder about the benefits of being a stock trader and also try to guess which is better; trading or investing. There are no clear answers. It is more important to maintain discipline in both trading and in investing. As a trader; converting your trading positions into investment positions is something you must essentially avoid!
 

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