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Why traders should never try to predict stock prices

05 Jan 2023

A trader trades on short term trends and charts. It therefore appears quite paradoxical when we say that traders should not worry about the direction of stock prices. After all is trading not about buying low and selling high? The truth is that predicting stock prices is difficult and more so if you are a trader it really does not add any value. There are ways to predict stock prices, albeit imperfect. But the fact is that a trader need not obsess over getting the direction of the market or of specific stocks precise. For a trader how to play the momentum is more important than how to predict stock price movements. Let us look 5 important reasons why traders should not obsess over trying to predict prices..

It is not practical to catch highs and lows of the market
Buy low and sell high is good on paper. Practically, no one has managed to achieve this consistently. Different stocks react differently to the same set of stimuli at different points of time. Therefore you need to forget about buying low and selling high. Even the best of traders never try to catch the tops and the bottoms of the market. Trading is an internal activity and therefore it must be an internal decision. If your profit target is achieved or if your technical level for buying has been reached, go ahead and execute the trade. If you start second guessing the trigger with fundamentals and technicals, you are only going to miss out on the trading opportunities.

Momentum is more important than direction
What is the difference between momentum and direction? Actually the difference is quite subtle but extremely significant. For example, the overall momentum for the market may be positive. Within the market overall, the momentum may be against the sectors like IT and pharma but the momentum may be in favour of sectors like banks and realty. As a trader, you must limit yourself to getting a broad understanding of the nature and strength of the momentum. If interest rates are headed downwards then you know that the rate sensitive sectors like banks, realty and auto will benefit. That is favourable momentum. Within the sectors there will be specific good stocks and great stocks. As long as you catch the momentum property, you are in business as a trader.

Timing is more important than time in markets
It is common for many traders to get into a trading position and then suddenly start thinking like long term investors. Let us say you bought Reliance at Rs.880 and it has touched your target of Rs.920. You have earned 5% in 15 days and that is a case of lip-smacking returns. Just because a large FII is saying that RIL looks good to touch Rs.1000, don’t change your trading strategy. You have timed the trade perfectly and made your profit. The message for you is to take your profits and walk out. Don’t let afterthoughts convert your trading position into an investment position. That is the first step to giving away your discipline as a trader.

Trading is all about discipline
In fact, trading is about a variety of disciplines packed into a single unit. You need discipline in entering into trade positions like volumes, price volatility, reliability of technical charts etc. You need discipline in setting strict stop losses and adhering to these stop losses. Once your stop loss is hit, your position has to be closed. After that it really does not matter if the price went down further or bounced back. Your discipline is that as far as your trade is concerned, it is closed and over. You also need discipline in terms of profit targets and regular profit booking. After all, profit is what you book! Once your target is reached, don’t get second thoughts. That discipline is very important in trading.

Finally, the primary purpose of trading is capital protection
As a trader your primary job is not to earn a target return or to double you money or even to get all your trades right. Your primary responsibility is to protect your capital. As long as your capital is intact you can survive to fight another day. Set very strict limits for capital loss and portfolio impairment. You can also set limits at a trade- specific and day-specific level.
A very important insight for a trader is that it hardly matters if you get your direction right 50% of the times or 100% of the times. The worth of a trader is typically judged by how he acts when the market turns against him. That is when the true mettle of the trader gets tested. In such times, your knowledge and predictive skills will be of little use. It is trading discipline alone that matters. As a trader focus more on trading discipline than on predicting prices.

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