How to be a trader, as well as investor – Part 3

Please read the first part and second part before you go further.

Q: What about the other way around when you are making money, we often hear that people bought at Rs 100 and sold at Rs 110 and the stock moved from Rs 100 to Rs 200, they made small chunks of it but could not hold for the entire rise or doubling of the stock. Is it also to have that maturity to say that I am not playing for small gains and maybe something good is happening out here and I will play for a bigger game?

A: Yes exactly, they need to define, at the end of the day you have to define yourself, you have to define your system. Just as when people trade for Rs 10 and are able to take Rs 50 hit on the downside, similarly it should not be the other way round that I am ready to stand for Rs 50 on the upside, but my stop losses are very thin, so immediately the stop losses get triggered or there about. You really have to have great perspective in terms of time, in terms of entry, exit, stop losses and there’s always this ratio. You cannot have a stock that is a sure short and risk-free. Then why are you in the equity market? You should be having money in FD because that’s the only sure short method. So there has to be a balance and there has to be the risk-reward profile and it maybe 2:1 or 3:1 but the ratio always has to be there.

Q: Do you work with preset systems and over a period of time have you become a more disciplined trader?

A: Yes. Our human mind tend to break everything down in systems, have it beautifully structured, because when you have a discipline and a structure, there is a greater chance of success. I use technicals, so its much easier for me because there is nothing relative about it. Price is a reality and some of the great traders have said that have a discipline or have a system that is so simple that you can virtually programme it because when you programme something there is nothing left for intuition or interpretation. So make it so simple that whatever system you follow, technicals/fundamentals or whatever, it is so well defined that there is no chance of your mind playing games.

So it is very important to have discipline because it gives you a system and takes away the influence of emotions and all the external factors at that point in time.

Q: How important is it to know our limits?

A: Management of risk and risk controls are very important. There are some areas where we have to come up to some critical points, critical decisions. One is, what trade size? Trade size is very important. Just as a sort of intuition, we say okay buy 5,000 or 10,000, depending on the person’s capacity. Why do we take these numbers? It is just intuitive, it is just by habit. You feel too bullish, you say okay buy 20,000 and if you are little unsure then you buy 5,000. Very often we do not know what the stock price is? What is the volatility?

So it is very important that one decides when one enters a trade where is one’s stop loss. How much hit can I take? So based on what my stop loss is, assuming that I get it, I should then take a trade size equivalent to that. The recommended thing is that I should not trade more than 5% of my capital risk on a single trade. That means if an idea goes sour, my stop loss gets risky, my portfolio or my capital should not come down by more than 5%.

So if we look at it in the inverse manner, when you first calculate risk and stop loss and then decide your trade size, this is how your whole size of trade will remain under control. So this would be a very important clue. Look at it the other way round, first look at how much loss I can take and then decide how much I should buy.

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