Risk Vs. Risky - Stock Trading

I have been trading in stock market for some time now and have gained some valuable lessons over last 3 and a half years. I had my share of success (and losses :( as well) and I believe I have done well. I may not have made lot of money, but I have learnt a lot. And I know, through this learning, in next 5 years I will be a billionaire. It's written.

It may be worth it to share some of my learning which may help you understand trading a little better. I am not advocating trading here or suggesting that everyone should start trading. My objective is only sharing and in this process, you may get some help.

‘Risk’ Vs. ‘Risky’: There is ‘Risk’ in trading but Trading is not ‘Risky’. You only need to identify and manage ‘Risk’. For example, there is a ‘Risk’ in driving, but we do not consider driving ‘Risky’ as we know driving and traffic rules well. However, even if we know traffic rules well and are an expert driver, but drive rash or don’t follow traffic rules, it becomes ‘Risky’. Similarly, there is ‘Risk’ in taking a flight but flying is not ‘Risky’. I have made an attempt to differentiate between ‘Risk’ and ‘Risky’ and I leave it to you to decide how successful I have been in this.

Some rules to trade safely:
- Put aside an amount of capital for trading. Never use it for any purpose unless it is “extremely important/emergency”. Repaying a loan, payment of a bill or taking a vacation is not an emergency.
- Do NOT use borrowed money for trading.
- Your trading capital should not be more than 10%-20% of your net worth. This ensures that you do not go bankrupt/broke even if you loose all your capital. It will not happen if you follow ALL the rules :)
- You should not risk more than 10% of your trading capital on one trade/share. For example, if you have net worth of Rs. 5 lakhs, keep aside only Rs. 50,000 for trading, maximum risk you can take is Rs. 5,000 on each trade. If the gap between your Entry price and Stop Loss price is Rs. 5 per share, DO NOT buy/take more than 1,000 shares (in this example). THIS RULE IS VERY IMPORTANT.
- ALWAYS FOLLOW YOUR STOP LOSSES.
- ALWAYS HAVE A PRE-DETERMINED EXIT POINT. It could be price (i.e. STOP LOSS or with a profit) or it could be amount of Profit, say 5k, 10k, 20k etc. Do not forget to consider the brokerage you pay for trading. Also, keep in mind the next rule when determining the profit amount.
- Your Reward to Risk ratio shall be at least 2:1. In above example, if you are risking Rs. 5,000 on a trade, your potential profit (i.e. difference between sell and buy price multiplied by number of shares) shall be at least Rs. 10,000. When I send you any trade picks, I take care of this aspect most of the time.
- Do NOT expect each trade to be profitable. Odds are that 5 out of 10 trades may not be profitable and end up in a loss, but you will still make money. The losing trades may be the first 5 or last 5. You never know. My experience is that 6 out of 10 trades that I pick, are profitable. And 2 out of 4 are neutral (no profit, no loss) provided you followed the STOP LOSS strategy.
- Continuing with the above example, if you lost first 5 trades straight (which may not happen), you will lose Rs. 25,000 but will cover the loss in next 2/3 trades PROVIDED that you follow the Reward to Risk ratio ‘religiously’.
- Think of trading as Roller-coaster ride. We all know that riding a Roller-coaster is Not ‘Risky’ as all the safety measures are in place. You feel excitement, anxiety, fear, it goes up and down, sometimes faster and sometimes slow. Compare with Stock Market. Now, just imagine, you did not fasten the seat belt, or the strap or didn’t lock the front bar/rod/door :) STOP LOSS/% ge of capital to risk/Reward to Risk ratio etc. are the safety measures of this Roller coaster ride.
- Once you have a profitable trade, start trade count from 1 for determining odds in your favor.
- Small profits, if preserved, will make you Rich. Consider this, if you make 10% every month on the capital available, and never took out a single rupee out of it, in 5 years, the amount will be 81 times of capital invested, after paying tax @ 34% on your profits every quarter. Guess what would happen if you make 15% every month, it will be 794 TIMES! And it is possible as well as Practical.

write to me at sumit@sumprati.com