Imagine you are new to the stock market. The markets are making new highs, with a bit of correction here and there. You assume that anything you buy would rise in value and you'll make bumper returns within a few days, right? Wrong!
The stock market isn't your ‘21 din me paisa double’ scheme where whatever you touch turns to gold. Investing in the stock market requires you to curb any greed or fear you may have to make informed investment decisions. Whether you’re new to the market or have been investing and trading for a while now, you can ensure more discipline in your decisions by following a few golden rules, listed below.
- Don’t put all your eggs in one basket
Putting all of your money into a single stock denies you any scope of hedging your investment. If the stock goes up - great! However, there will be instances when the stock corrects. In case of a heavy drawdown, you can be at the risk of losing your entire capital if you put all your money in a single place.
- Decide your time horizon
As you already know by now, the market isn't a place where you will double your money in a few days. Of course, you may get lucky if you get an allotment in a jackpot IPO like IRCTC or Avenue Supermarts, but those instances are few and far in between.
It is important to be very clear of your investment timeframe. Some people consider two weeks to be short-term while others may think two years is a short-term investment duration. So, you need to define short, medium and long-term horizons for yourself. Ideally, a longer time frame is the best method for decent capital appreciation. Even if you buy a ‘good’ company for Rs. 100 and expect it to become Rs 500 in a month, you could be the one at a loss.
- Time the market
Experts say it is very difficult to time the market - Agreed! There is no way to easily determine where the market is headed. Consider the rally that the Indian equity market has seen from March 2020 (Link to the factors influencing the market article). Now, who would have guessed that? It is important for you to know at what time you wish to enter the market.
The old adage goes "buy the dip, sell the rally." That is possibly the most ideal way to remain invested in the market. When you are assured of the quality of your investment, a 10% correction would not force you to press the panic button. In fact, you may even buy more. Similarly, if you think a stock has given you enough returns from the time of your investment, there would be no harm in booking your profits. For example, if a stock has given you 4x returns over the last decade, you may choose to book your profits and invest those funds elsewhere. Even if the stock goes up further post your exit, it should not bother you as you were determined to exit at that price.
- Don't understand? Don't invest!
This is a thumb rule! If you don't understand how a particular aspect of the market works, it is better to maintain your distance from it. Let’s take the Futures & Options market for example, which can be an extremely complex space to understand, particularly Options. Unless you understand its complexities, you would prefer other simpler ways of remaining invested in the market.
- Avoid the herd mentality
Herd immunity is what we are currently hoping for, but one thing you should never hope for is to have a herd mentality and blindly follow what others do. "An ace investor buys xx% stake in ABC company." The news flashes on your screen. You may think "Wow! He's bought a stake; I should do too." But, do you know the company? Its business? The risks associated with it? While you may think that an ace investor cannot go wrong, you also need to remember that this ace investor may have the risk appetite to wait for the price to rebound if it drops 10% the next day and another 10% the day after. The ace investor may even buy more on such a correction. However you need to consider if you can afford a 20% drop on your investment in just two days, with your limited capital reserves.
- Ignore ‘Tips’
Somebody sends you a WhatsApp forward asking you to buy 10,000 shares of xx company at Rs. 2 for targets of Rs. 20 in the next three months. You've never heard of the company's name and don't even know if it even exists in the first place. Yet, you chose to put in your money, anticipating quick returns.
That Rs. 2 becomes Rs 0.50 over the next three months and your investment turns to nought. Such stocks are usually operator-driven and illiquid, which means that you may enter the stock easily, but find it equally difficult to exit, especially after prices have crashed. So, you would rather tip your food delivery valet or your restaurant attendant instead of paying attention to such ‘tips’.
- Use proper judgment over emotions
Fear and Greed are two contrasting emotions, both of which can be detrimental to your stock market stint. In a bullish market, you may expect everything you buy to go up rapidly, but that may not be the case. For example, IRCTC is up over 10x from its IPO in 2018. You enter the stock at elevated levels but will you get similar returns over a similar timeframe? Maybe not. Moreover, a person who has entered at Rs 300 won't mind even if the stock corrects from Rs 4,000 to Rs 3,000. He is still sitting on gains. However you, having entered the stock at Rs 4,000, would mind a lot if the stock corrects to Rs 3,000.
Similarly, in a bearish market, panic selling may cause you to exit your investments, even in quality companies. At a time when you should be buying more, you choose to exit and the stock rebounds swiftly from lower levels. As a result, you are left lamenting and regretting that instead of buying more - you chose to exit without proper judgment. Choose evaluation over emotion, especially in the stock market.
- Diversify Your Portfolio
It is not a compulsion that 100% of your portfolio needs to be equity-focussed. You may choose to park some of your investments in Mutual Funds, opt for SIPs, and invest in ETFs, as there is a broad gamut of investment options that you can choose from. How does this help? Well, firstly it offers a hedge in case one asset class depreciates, as you can still rely on the other to outperform. Investing in bonds, gold, and real estate are some other options through which you can diversify your portfolio.
- No Leverage
This is one of the most important rules for investing in the market. If you plan to invest in a volatile market, you need to ensure that you invest only surplus funds that you can afford to lose, in case there's a correction. Leveraged investments are not only risky but can spell trouble in case they go wrong. Hence, debt free = tension free.
- Monitor your portfolio
Consistent monitoring of your holdings is necessary to ensure that you can diversify or even exit a particular investment when the time is right. If you cannot do so, seek help from a certified financial planner who can take care of your investments.