" To make money in the stock market"
Well, that is a legitimate goal. But it is not always true. Me being in the stock market for the last few years, I have came across many professional traders. Most of them (with high probability point), follows two rules
- Rule no 1 : Never lose money in the stock market
- Rule no 2 : Do not forget Rule no 1
Normally, investors follows two kinds of methodology when putting their money into the market.
- Bought no of shares ending with zeros at the end (bought 200 HCC)
- Invested rupees ending with BIG zeros (Invested 1 lakh rupees in HCC stock)
Well, this may be related to our thinking. Have you heard anyone schedule a meeting at 11:12 am or 1:17 pm? It would be either 11 am or 1:3o pm.
Art of "Position Sizing" helps to rewire our thinking. Here is my approach to position sizing.
- Allocate not more than 10% of my net worth in the investment or trading account. If your networth is 10 lakh rupees, I would set aside 1 lakh for my stock account
- Do not hold more than 5 stocks at a time.
- Limit your losses to 2% of your trading account per stock. With 1 lakh is your trading capitol, this should be around Rs 2000 per position.
You found RPL (Reliance Petroleum) is trading around Rs 220 and heard the news that they are in the process expanding their global presence. You came to the conclusion that RPL would go up in values in future and decided to buy the stock.
Let me add a pinch of technical analysis. Let us assume that you are a long term investor. You found that price of the stock is above 200 day moving average (i.e mvg) and 200 day mvg is around Rs 140 (you can get this values from any financial website like moneycontrol.com, rediff finance etc).
Now you decided to hold this stock till it price drop below 140. That is Rs 80 per share (Rs 220-Rs 140). Maximum allowed money to loose per position is Rs 2000. Now get the number of shares of RPL to purchase. It is simple. It is 2000/80 = 25 shares.
This is something different from buying 100 shares of RPL or investing Rs 1 lakh on RPL.
Good trader or investor always decide about how much money they planned to loose. Amateurs go with how much money they can make. Who wins at the end? You know the answer.
What do you think?
Mahadevan.L
6 comments:
Very Informative post. It changes one's perception on investing. Appreciate if you can also post the calculation in a spreadsheet like format so that it helps an ordinary user.
Yes. I was thinking about this. May be with my stock pick, I will start posting more on this.
Mahadevan.L
A couple of comments
1. The price of Reliance will include the prospect of the project. If you know about the project before you find the price, the market knows it too. They would have bid up the price by the time you come to know about it. If the news breaks soon after you find out the price, the price will jump immediately to include the project's prospects. At that rate 220 for RPL will not be possible.
2. Is this for a short term investor?
Kamesh,
Very good qns. As a trader, you will not buy at market price. Best way to buy this as limit price. i.e you buy RPL at Rs 220 as limit price. If this does not get filled up, you walk away and hunt for another one.
To ans. next qns, I am planning to work on a new post this week. Keep checking it.
Mahadevan.L
Limiting losses is fine. However, I want to profit from stocks that are falling, i.e. Momentum is downward...what is your strategy for such plays?
MTB,
If you are bearish on the stock, you can apply any one of the following technique.
1) Shorting the stock. Sell now and Buy later strategy.
2) Buying put option
3) Selling call against the stock to collect premium.
Mahadevan.L
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