Survival Kit For Newbie Investors - Mind Game

Last post was dedicated to Laws of Nature (http://archana-archdeb.blogspot.com/2009/09/starter-kit-for-newbie-investor-greed.html). Last in this series we will now analyse Mind Game. You may think I am kidding, but stock investing is basically a mind game. It tests your character and strength of your mental fabric. If you have any doubt then as you read on you will realize the veracity of my statement. For the time being, simply promise yourself to follow the rules which govern your thinking while investing.

• Rule # 1. Do not change your mind after placing the stop loss order. Many traders who had wisely put a stop loss order, cancelled the same once they saw that the market is going against them. Some shift the stop loss level to try and give time for market to move in the desired direction. This is a seriously flawed behaviour and may result in great losses. It is seen that 90% of the time a trader will be a winner if he maintains the original stop loss level and refrains from cancelling it. When you cancel a stop loss order you are merely hoping against hopes that market will reverse its direction and move in the direction of your trade. This can have a disastrous outcome.
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• Rule # 2. Be firm in your mind while initiating a trade. You must decide to enter a trade after having given due thought to it. It must be done after you are fully satisfied, having done adequate research/consultation. How can you buy stocks when you don't buy vegetables without making elaborate enquiries about the right price!! But once you have arrived at an informed decision then be firm in your thinking and do not change your mind or cancel the trade without adequate reasons.
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• Rule # 3. Should the market reverse direction never let a profit run into a loss of capital. This can be done by raising the stop loss level progressively. This system of progressively increasing the stop loss level will ensure that you roll your profits and cut losses. But the basic mistake that traders have been doing since time immemorial is that they cut their profits short out of fear, and roll their losses on the hope that the market will move in the desired direction. This is a serious mistake and should be avoided at all cost. Be resolute in your mind and use your stop loss orders effectively, and progressively increase them to stay with the trend, till the stop loss order is triggered.

Survival Kit For Newbie Investor - Stop Loss Order

In the last post we had realised that making few right decisions can completely protect our Capital and thus allow us to be triumphant in stock market ever after (http://archana-archdeb.blogspot.com/2009/09/starter-kit-for-newbie-investor-capital.html). Even Warren Buffet maintains that to be successful "you only have to do a very few things right in life so long as you don't do too many things wrong". But there is a catch here. You are bound to take many wrong decisions in stock market over the long haul. Warren Buffet was well equipped to avoid too many wrong decisions, besides being properly groomed in trading right from early childhood. A little known fact is that Warren Buffet's father was a stock-broker and a parent's influence at an early age in such matters can have tremendous advantage. But most of us are not so very well placed and hence will be prone to making many mistakes while taking trading decisions.

If that be so then what is the solution? The solution lies in limiting your losses from wrong decisions by way of Stop Loss Order. We shall now postulate some golden rules in the words of a legendary trader W D Gann:-

• Rule #1. Remember when you make a trade, you can be wrong, therefore place a stop loss order for your protection.


• Rule #2. When in doubt, get out of the market.


• Rule #3. When you have nothing but hope to hold on to, get out of the market.

With due deference to W D Gann's rules, I would like to hazard a couple of exceptions to the general rule of applying Stop Loss Order in all trades. If you are an investor never put a stop loss order when the stock is trading 80% below its all time high. If you feel that you are entering into a good trade at that level, just go right ahead and buy without stop loss order. You will get a chance to exit honourably even if your trade goes wrong. Simply hold the scrip with patience.

Secondly, if you have confirmation that you are buying in the 2nd phase of a bull run then you may dispense off with stop loss order because the stock price is bound to move above the previous high. If you are not placing stop loss order, then you need to have a firm mind and not panic under any circumstances. In next post we shall dwell upon certain issues relating to investor psychology.