Every trade is an interesting game where each player has his own rules and still everyone plays together. But every player before entering the trade has to decide his strategy and game plan for that trade.
Before going for a trade, ask this very basic question: What type of trade is this? At most we classify trades as: Long term, Positional and Intra-day.
Long term trades:
These trades are called investments. The primary goal of an investment is to preserve capital. The investment should be made purely based on the fundamental factors of the sector and the company’s business and a premature exit should be made only if there is a change in the fundamental factors before the price target is achieved.
Fundamental investment calls should not be associated with stop loss levels. The daily price fluctuations should not raise ones blood pressure as you should accept volatility as a part of the game. An investor should get realistic expectations of returns from the investments and hope to get the best, but should be prepared for the worst.
If your trade horizon is one week to a fortnight then you can make use of the science of technical analysis where by the trading ideas are identified based on the technical factors. These are known as positional calls and are basically based on price and volume actions and other trade statistics.
As positional calls may not be in sync with fundamental factors, while taking a position based on technical you should always make use of stop loss levels. Positional calls should not be converted into long term investment just because a stop loss has been hit. At most, these ideas are given in multiple ways like Market Diary, Awacs or Derivative Products.
Intra day trades:
Trades undertaken to be squared off at the end of the day are intra-day trades. All intra day trades will always have stop loss levels and the same have to be followed strictly. These may not be in sync with fundamental calls and there can be fundamental buy and intra day sell or vice versa. The scrips on which we give intraday calls there may or may not be any fundamental view.
Globally, it has been observed that trading based on the best of the technical tools will have a success ratio of not more than 60-70%. You should look for a favorable reward-risk ratio which is normally 2:1 for an expected profit of Rs 2 you are accepting a risk of losing Re 1.
So even a 50% success ratio may generate handsome returns. Always remember that trading without stop loss is like driving without brakes.
So, even a 40% success ratio can yield good profits if stop losses are clearly kept and targets properly defined. Intra-days calls are given through Market Diary, Awacs or Derivative Products.
Many investors take position in equities without deciding the type of trade it is and thereby do not have clear exit rules. Hence, they sometimes sell their profit making stocks with very small movements in price just because of anxiety even when there have been no negative developments in the underlying fundamentals.
Sometimes they don’t sell even when the fundamentals have changed drastically. Both the situations can lead to missed profit opportunities and losses. Judicious classification and planning of every trade can greatly enhance your investment experience by eliminating emotions and reducing risk.
After deciding the type of trade, the trader commits another cardinal sin: changing the type of trade. If a stop loss is hit he concepts a day trade to positional and positional to investments. Many investors still hold Reliance Natural Resources Ltd (RNRL) and Reliance Petroleum Ltd (RPL) as they converted their positions trade taken for a few days to investments.
To put it simply, a long term investment is like a marriage (one that needs not to be sold on divorce). Medium term investing is like an affair and intra-day trading is like that very risky venture: one night stand.