Trader's Corner

Humans are an optimistic bunch. They love sunshine, smiling faces, happy endings and soaring markets. Perhaps it is this natural trait that draws the investors to stock markets in the final stages of a bull market when things are extremely rosy with scarcely a cloud in sight.

It is again this tendency that accounts for the trader’s disillusionment since they invariably plough in all their capital near the market peaks only to see their accounts wiped out in a few sessions. Most of the pain can be avoided if traders stick to a trading plan.

Trading plans would have an entry point, the profit objective and a protective stop. Needless to say that enough deliberation should be done before deciding on the stock to trade on. If the trade goes against you and the stop is hit, it would mean that the entry signal was wrong and it would be time to move on to the next trade.

It never pays to keep reviewing a trade that has been stopped out. It will only cause unnecessary anguish as the stock would definitely have moved in the direction of your call after hitting the stop. Similarly, do not wage a battle with a stock that has made you book a loss. Many of us get in to this trap and keep visiting the stock every day to try and initiate a fresh trade in the stock that would wipe out the former loss. Apart from satisfying the ego, such an exercise is entirely meaningless.

The level at which stop losses ought to be placed and the amount of drawdown has been discussed in previous columns of the Trader’s Corner. It would however do to pay attention to the ratio between the stop loss and the profit target. For example, the profit target ought to be two to three times the amount risked in stop loss. If the stop loss is placed 1 per cent below the market price, the profit target ought to be at least 2 to 3 per cent above the price. This would ensure that the trading is rewarding in the long run.