Since of late with Capital markets taking everyone on a roller coaster ride, I am constantly bombarded with requests from friends asking me “what’s the best stock to buy?” , “should I sell this stock at X price?” etc. I very rarely give a direct answer to these questions as it depends on the risk appetite of the person and its always a personal choice.
However, I thought of sharing my rationale on how to win markets and managing expectations based on the same wisdom that was shared with me a couple of years ago. I distinctly remember my introduction to capital markets was around the age of 14 where I was perplexed about a conversation, I overheard on script dividends and share dilution over a family dinner. These conversations and acronyms intrigued me but I soon realized;
- I couldn’t make heads or tails of what was discussed
- My uncles and cousins looked cool and important dropping acronyms which made no sense
- I wasn’t old enough to open a CDS account (Central Depository System)
- I did not have any capital of my own to start investing.
However, seeing how eager I was my father bought me a copy of “100 share trading tips for novices” which was my introduction to capital markets (which I religiously read in three days). I was also introduced to shadow trading or book trading as I did not have any real capital to invest. Today I give the same advice to most of my friends who want to start investing.
What is Shadow trading (Paper trading/Book trading)?
The stock market is always a zero-sum game, meaning your win is someone else’s loss (and vice versa). As such it’s very important not to lose capital when trading. Back in the day (circa 2005) CSE didn’t have a live updated website and only the brokers saw the live screen with updated order baskets. The “Daily News” had a full page of the previous days share trading summary published on a daily basis in the business section which included the highest/lowest trading price and share volume for each company. This was my introduction to zero risk share trading where I used to scrutinize the paper and update my share portfolio. Let me explain how this simple method works;
When you start shadow trading you assume you’re starting off with a hypothetical investment fund (LKR 1 or 10 million for argument sake). Then you allocate this capital in the best possible way you can base on your research. Then on a daily basis, you buy or sell your shares on paper based on the market prices and calculate your net gain/loss. The goal is to grow your portfolio over time and average a return of over 15% (or more if you are lucky). This is called Shadow trading/Book trading/ Paper trading as your trades trail the market and does not account for the actual demand and supply when filling out the orders. However, this gives you an actual sense of the hard work that’s required to get into the groove of trading. Once you manage to grow (or burn) your portfolio over a year; you are much suited to trade with real money as you clearly understand the stakes.
Managing emotion and being disciplined is the name of the game.
A couple of years of trading I was proudly showing off my results (only on paper) to my uncle who pondered for a while and asked me a very intriguing life changing question?
He asked me “Arosha what do you think is the most decisive quality that’s required to succeed in capital markets”?
I took some time and replied naively saying someone who has the ability to scrutinize the financial statements and understand the underlying message in it. Then my uncle went on to give one of the most profound explanations of how capital markets worked (I initially thought it was his way of interpreting it as he was a Psychiatrist. However the more, I thought about it and more experience I obtained I realized how insightful his explanation was).
He said;
“All markets operate on two emotions Greed and Fear. People who master it win the markets”
I mean think about, we hold on to stocks when stock prices increase due to sheer Greed of making more money and hoping to maximize our return. We also hold on to our shares when the share prices tank, due to fear of losing money hoping it will recover to minimize our loss.
The more I think about this, the more I’ve learnt that this principle can be applied to many scenarios in life even outside the capital markets. As such I believe it is best to have a disciplined approach to investing and develop a personal investment criterion. Have a ceiling and floor percentage to the price you purchase and leave your emotions (greed and fear) out of the equation.
Personally, I exit a position if it goes below 15% to 20% (floor) from my buy-in Price and exit at a 10% to 40% gain on shares I’ve purchased (Ceiling). These are all subject to the sectors/ companies I have invested in.
I remember practicing this for the first time a couple of years ago when I had set a benchmark to exit at a 30% gain on CEYLON COLD STORES PLC (CCS.N0000) at LKR 900 per share and managing to buy it again at a 35% discount a few months later. I increased my position substantially with zero investment only due to the fact that I had left my emotions out of the equation.
This approach of pre deciding the exit points and leaving emotions out of the equation has served me well in. Over time you also master not to ponder about the “what if’s” and learn to be content with the gains/losses you make. This is a more much sustainable and realistic approach to investing.
(This is blog post was aimed at those who pick individual stocks opposed to investing with a registered fund management company).
Also read up on “Time is Money” or is it?” to understand how to identify a scalable business.