How to become a Good Stock Trader !

As explained in my previous post that as a trader one should have a checklist or at least some bit of setup to trade else he is not doing serious business but just taking a chance.

 

This might be one of the most boring posts as it has no trade recommendations 🙂 So read ahead at your own risk 🙂

 

A basic 7 step checklist for a trader. This is just a quick one i have made though my process has now totally become intuitive and keeps changing but this could be a good guideline for traders to evolve their own system.

 

1) Reason to Trade

2) Conviction/Probability of success as per system.

3) The Opportunity

4) Risks Involved

5) Sizing up the Position

6) Time

7) Relative Opportunities and Review

 

So now let us try to get a little detailed in each of the steps

1) Reason to Trade.

 

This is the foremost important thing. The basic rule about trading is - Its not necessary to trade everyday.

Reason to trade is based on what sort of analysis takes place to justify a possible direction in the stock or index. Some of the common reasons - Technical Analysis, Announcements, Special Situations, Insider News, Gut Feel/Screen Reading.

Although sticking to Technical Analysis would give the best results. Out here the most important thing to note is if the reason ceases to exist one should exit. Like say i would be betting on Reliance to come out with bumper results but the results come out to be way below expectation. In this case the reason is no more there so one should exit no matter where the price is.

Similarly in Technical Analysis if i am trading a pattern/signal/Indicators or any observation. Moment the parameters change i need to exit.

2) Conviction/Probability of Success.

Although conviction in Analysis comes if you are doing it right consistently and through experience of trial and error with a system(Technicals ideally). Its better to get guidance from an experienced teacher who has learned from his mistakes or a tried and tested system then to waste a lot of time doing trial and error !!.

Even if someone is trading on Insider News ( thats also needs analysis ) one needs to give weightage to the source :). One should not be buying just because your milkman or panwala said or there is a crazy sms or just overheard it in the train!

Also after a few trades with a system one realizes which is the best set of parameters. Like News from X men or a buy signal on my technical observations. Accordingly one needs to choose the best probable trade.

 

3) The Opportunity

Now this is the major problem with many of us. Moment we see some interesting stock or a possible trade setup we just go ahead without realizing the opportunity.

The size of the opportunity or the possible upmove is also important. Just for example one of the trades i advised Birla Cotsyn say at 1 rs with a possible upside of 30% but if your brokerage costs end up to 10 % !! Is there an opportunity ?

Many a times there are arbitrage opportunities or at times a pattern suggests a move of 2-5%. But does this size of trade fit into your critieria.

So one needs to first calculate the size of the opportunity before going ahead.

4) Risks Involved

Without Risk there is no Business. But if you dont have a fair idea of the RISKS INVOLVED you may have no BUSINESS!.

The most important part of trading is calculating the risk-reward. Now going with the first 3 steps i have found a Technical Pattern on a Rs 100 stock which suggests a highly probable upmove of 10 rs.

So here i am staring at a gain of 10 Rs possibility on upside but what is the risk i am ready to take !!

Most of the lay investors think the risk is 100 Rs because i m buying a stock worth 100 Rs. Nope as a trader one is only ready to take a minimal risk or loss capapcity which is affordable. Suppose my system suggests a stoploss of 90 Rs.

So in this case risk is 10 rs and reward is 10 Rs this gives a risk-reward of 1:1 which is like flipping a coin ! In that case either the trade picking is wrong or one is playing stupid.

According to me for a short term trader the ideal risk-reward should be higher than 1:2 or rather 1:3. The leverage trades which i give are when i see a 1: 5 !

For example the long call on Sensex at 16000-16400 with a stop of 15900 gave me a risk of 200-400 points but an upside possibility of 1000-2000 points. Unless and until i dont see a similar risk-reward i wont like to bet big !

5) Sizing up the Position.

This step is what changes a good analyst to a good trader!

Putting all eggs in one basket is risky but similar having huge no of baskets is basically useless.

In this case one needs to give a good weightage to the best trade setups. For example say sometime back my favorite stock was HUL but i have only 5% of my portfolio in it and maybe other bet which is purely speculative dabba stock on news which has 20% weightage! Isnt that stupid.

So out here one should have a sizeable position on STOCK/INDEX which gets the best rating in the above 4 steps. - Strong Technical Breakout/High Probability Pattern/Big Opportunity/Exception Risk Reward. So where one gets such a combination that should be a good 15-25% of the entire portfolio.

6) Time

I have hardly noticed a trader keeping a time period to his position apart from a day trader who is forced to square of !

As the price dictates the exit and entry one should also have a time period attached to every short term trade. One cannot hold on to a stock till eternity and miss the relatively better trades. As a trader money should keep working and not sleeping on a dead stock !

So if one takes a view of 1-3 months then it should not stay in the portfolio unless its a winning position :). If a position is moving in the intended direction one can fiddle with the time period but not with a losing position as that deprives your capital of the various opportunities available.

7) Relative Opportunities and Review.

In the end Trading is all about Relative Returns. If a trader was looking out for 10% returns annually then he may have been parking of his money in all other assets apart from equities. Also a trader would always want to get an X return Annually or beat the market return.

So for every trade the same should be the case say for example Nifty is now at 6100 my trade setup tells me not a place to buy and the upsides are limited so might as well sell and use the same capital to look for Stock Specific Longs then try to eat the last bit of the trade.

A trader needs to keep reviewing his position with regards to the opportunities available. Say if the capital is fully deployed and there is a 50% trade opportunity with lowest risk. Out here one needs to exit some other trade which may have lesser opportunity and would be on losing side.

 

Finally all the above is seriously useless as 80% of the traders think only after taking a position !! I have hardly seen any questions on why one should buy or sell a stock.

All the questions are like this

I have  X  stock say NTPC at 210 what should i do?

I am short in Nifty what is the downside target ? ( this question assumes the person you are asking is also bearish )

Can you give me the targets on X stock i have a big buy position?

Majority of the questions are asked after a trade is taken.One thing i have understood with trading is summarized in the lines below.

 

Once you start thinking a lot before a trade and Nothing After a Trade - You are on way to become a Good Trader. !!

 

( The above means if you have a well though trade all your left with is mechanical execution and mental temperament to stick to the process)

 

Cheers,

 

Nooresh