This is quite a common problem that most traders and investors have faced. You get into a trading position or into an investment position but that may have gone awfully wrong. That not only results in losses for you but also impairs your confidence in equities. What most people tend to do is to give up on equities altogether. Remember, the biggest risk in equity markets is not taking any risk. By not taking the risk of equities, you are actually compromising on the long term wealth creation potential of your portfolio. The challenge of getting into the markets after making losses calls for both psychological preparation and some astute discipline. Assuming that you have lost a large chunk of your capital, how do you induce yourself to get back into equities? Here are 7 steps that can help you along the way..
Step-1:Keep the stop loss discipline as part of your strategy..
We all know the value of the stop loss but rarely practice it in reality. We end up being so confident about our trades that we ignore the stop loss. Alternatively, we do not see too much value in a stop loss when we propose to hold on to our position for a longer period of time. Probably, we are also under the illusion that we can subsequently look at stopping out our positions when the markets go against us. Each of the above is a dangerous argument. Remember, your losses can multiply and erode your capital with just a couple of days of bad markets. Even during the bull market of 2003-2008, people lost large amounts of money in intermittent corrections as they did not follow the stop loss discipline. Remember, 2 basic rules; if you are a trader do not initiate the trade without defining a stop loss, if you are an investor have a mental estimate where you would like to exit the position.
Step-2: Nobody made money by over-trading..
This is another very important rule. When you make losses, your natural tendency is to recover the losses through overtrading. That will only worsen the situation because you are already taking decisions in a state of panic. First, you must avoid panicking in the markets. If you have lost money do not be in a hurry to recover the money immediately but wait for the market to give you the opportunity. One of the secrets of trading is that you make profits by waiting patiently for your opportunity, not by jumping into every percentage point of volatility that presents itself.
Step-3: Define how much of your capital you are willing to stake..
Every loss that you incur erodes your capital. Not everyone is lucky enough to make profits in their first trade. In case, you have made profits in your initial trades, then try to measure your maximum loss on the basis of how much of the profits you are willing to give away. That gives you a better perspective of risk.
Step-4: Focus on managing risk; returns will take care of themselves..
This is a rule not many traders or even investors tend to appreciate. As a trader your primary focus should be on the risks that you are exposed. This risk may be in the form of maximum loss on a trade or percentage of capital you are willing to risk. This risk may also be in terms of when you should be in the market and when you should be out of the market. The risk can also be in case of what percentage of your equity should be trading capital and how much should be investment capital. When markets are grossly undervalued as in 2009 or 2013, then your focus should be on greater allocation to investment capital. You can make a lot more money with minimal efforts.
Step-5: Focus on the art of selling..
Nobody made a profit in markets by buying. You only make profits by selling. As a trader you should look at booking profits at regular intervals. Averaging is a loser’s game. When you average your position you only add on to your existing mistakes without any concomitant benefit. Identify checkpoints when you need to sell and exit your position. You should sell your trading positions once the profits are better than expected. You must also sell and exit your position when the volatility and uncertainty is too high. Remember, never buy in doubt; always sell in doubt. When it comes to investment focus on the art of rolling stop losses and break-profits to keep your liquidity register ringing.
Step-6: Try to closely analyse where you went wrong..
This is very critical. The best of traders and investors have losing trades and dud investments. The difference is that smart investors and traders introspect and learn from their mistakes. You may have got in too early or too late. Alternatively, you may have not bothered about getting the right price by hurrying through the trade. The key point to remember here is that hope makes for a good breakfast but a bad supper. Just hoping for a better day tomorrow does not help. You need to pinpoint where exactly you went wrong. That is the key!
Step-7: Accept responsibility for your trades..
This may sound simple but it is a lot more complicated than you may care to believe. The normal tendency in most of us is to blame the market or some external factor for the losses. Remember, risk management is in your hands. Therefore it is essential that you take the responsibility for each trade and consciously work out the risk management that is required for the same. That is where it all starts!
Remember, neither trading nor investment is anywhere close to rocket science. It is about getting the basics right. If you find that too complex, then you always have the choice of equity funds. But these steps will make your job much easier.