Friends’,
dealing in stock markets is dealing with volatility, uncertainty and
market factors which are beyond one’s control. Many among us, or almost everyone at some point of time must have experienced that “whenever I
buy, the stock is down the very next moment and the stock goes up whenever I
sell”. This happens because we fail to understand the stock market behavior. Many
investors among us are reluctant to book their losses. The problem is we always
want to see our money growing. We never ever think of selling off the stock
once it starts falling, on the contrary we start questioning ourselves "what if
that this counter goes up after I sell it in the losses". This “What if” is a psychological
nature of us which always challenges our emotions and costs dearest to our
wealth. We hold on to that stock hoping it to bounce back and ultimately it
makes you realize that you are too late to sell, making you an compulsory investor.
If you go through my blog posts where I always
quote my views on any particular stock with a stoploss, and always without
fail I mention that I respect the markets and will sell once the stoploss is
triggered. Keeping a strict stoploss will not only protects the capital but it
also allows to invest in any other better option. Suppose, if you buy a stock
at Rs. 100 and it goes down by 10 % your loss is of Rs. 10 – as usual reluctantly people
don’t like to sell at loss, so hoping for the stock to bounce back he will hold
on to it, further the stock tanks another 10 % making losses to go up from 10 %
to 20 %, now you are more reluctant to book losses and now you start saying that
you are a long term investor knowing very well that it will take a very long
time to break even.
Let’s
take a simple mathematics drill which will make you understand the importance
of keeping a stoploss.
Example:
If you buy a stock at Rs. 100 and maintain a strict stoploss of 8 %, suppose if it
falls to Rs. 92 hitting your stoploss and you don’t sell, then the same stock
will need to jump 8.7 % to get back your break even point of Rs. 100. Similarly, in the table given below explains that the Longer you
hold on to your losses, the Harder it is to get back your money.
Percentage Loss
|
Percentage to Break Even
|
|---|---|
8.00 %
|
8.70 %
|
10.00 %
|
11.10 %
|
20.00 %
|
25.00 %
|
40.00 %
|
66.70 %
|
50.00 %
|
100.00 %
|
60.00 %
|
150.00 %
|
80.00 %
|
400.00 %
|
The
table above will indeed help you in making the hard decision in easy way. This stoploss mechanism also pertains to the best fundamental stocks like
Larsen & Tubro – suppose you buy Larsen for the long term say for 6 months
at Rs. 1400 and if it goes down further to Rs. 1288 showing you losses of 8 %, you
sell at Rs. 1288 as your stoploss of 8 % is triggered. Selling at stoploss will
not only protect you with further down side but will also provide you with an
opportunity to enter back in L&T when it tanks further at Rs. 1185. As
L&T commands best fundamentals you decide to jump on to it at Rs. 1185 (off
course this time too with strict stoploss of 8 % or Rs. 1090), it’s of more of
the probability that it will bounce back once the sentiments of the markets
improve hence giving back your money with profit of 18.14 % (buying at Rs. 1185
and selling it at Rs. 1400).
Choosing
the correct stoploss here is a key; if
you are a long term investor with moderate risk taking ability then you should
go for 8 % as your stoploss trigger, but if you are a trader than Trialing Stoploss using Average True
Range or ATR will serve you better. ATR was
developed by J. Welles Wilder is an indicator that measures volatility. This
number does not provide an indication of Price direction but it only provides
an volatility and slightly modifying this number will make this number easy to
understand; this is calculated by subtracting current High & Low of the
stock and then multiplying it by 2, further dividing it by the days close.
Suppose you are trading ACC today you would set your
trialing stop loss as -
2*48.6/1221.35 = 7.95 %
What
are you doing here is you are simply attaching a risk tolerance level i.e. 2
based on the stock’s intraday moves averaged over a period of time. Here
your stoploss for ACC should be 7.95 % from today's close. This is an indicative
levels and just gives an rough idea about the volatility that stock may
face in respect of prices the next trading day. And this should not be taken as
a thumb rule.
Some Key points before executing a trade:
- A stoploss should be considered & decided before a position is entered.
- A stoploss should be placed immediately at the time of entry.
- A stoploss should not allow more than 2 % loss of your account balance.
- Only risk 1 % of your total trading capital on any one trade - when you loose 2 % on that get out of that trade.
- For the day trades a stoploss should not allow more than 1 % loss of your account balance.
