| So if you don't get your portfolio in the right stance, where demand is in control, you are less likely to beat the market," writes Thomas J Dorsey. In this 'playbook' he uses soccer as a subtle metaphor to derive valuable insights about the game of investing. |
| Style marks a prolific footballer from the rest. Similarly, in investing you have to find a methodology that you believe in - one that meets your risk characteristics and financial goals - and stick to it. |
| "Don't think there is a better system out there that you need to find out. You need to have conviction in your discipline rather than to run away from it and find another methodology," he says. |
| Underestimating the opponent is the last thing a footballer can afford to do. The market is often more invincible than you think it to be. "Investors haphazardly pick stocks, thinking that the stock market is easy to beat. They fail to realise there is risk, not only returns." |
| Volatility is the price you pay for higher returns. On the plus side, this is why stocks earn more than bonds and cash over long stretches of time. |
| On the negative side, this is why high returns are inseparable from high risk. "Risk-reward analysis helps you identify the potential return in a given stock compared to the risk taken," he counsels. |
| It tells you how many points the stock could rise if the trade works in your favour and how many points it could fall if the trade doesn't. |
| Buying a stock right is like scoring a goal. But for that you need to have a gameplan that helps you decide what to buy and when. It also tells you when to sell or play defence. When you buy a stock that is up on a stem, it increases risk and diminishes potential reward. |
| It is best to buy a stock when it pulls back closer to its support, increasing potential upside reward and diminishing the risk to the stop-loss point. |
| However, buying right is only half the battle won. You have to sell right to win. Periodically reviewing your position - by asking hard questions - is one way to keep guard against wrong sell calls. |
| An account has a limited capital; so ask yourself if your position is the best one to be in. Are you tying up capital that can be put to better use? |
| "Don't hold on to a stock whose technical picture has deteriorated just because you are intoxicated by the reasons for your choice," cautions Dorsey. |
| A strong and balanced portfolio can only be built on a sound investment approach. But the human traits of greed and fear may hinder you from making prudent investment decisions. |
| You may know the right course of action, but emotions at times can act as a drag. To complicate matters, the market is not always fair. Despite proper execution, the outcome may not be as expected. |
| Not every trade is going to work out as planned. You will have times when a stock will go against you for any number of unforeseen reasons. If a trade doesn't work out, it doesn't necessarily mean you made a bad decision. |
| Therefore, it is imperative to educate yourself. "Be sure you understand the gameplan and why you are making certain decisions. If you use your tools correctly, you will be able to accept the outcome, good or bad." |
| Then, stock markets don't always share your notion of what is good or bad. For instance, there are investors who desist from investing during market declines. But you can use declines to try to find stocks that are holding up well. |
| Opportunities arise when the market falls as good stocks often do well during declines. If your stock doesn't surge when the market touches a new high, it signals some impending trouble. But if it is making higher bottoms when the index is making lower lows, it shows strong demand for that stock and you should hold or even add to your positions. |
| Holding on to a position is comparatively easy. The hardest decision is when to sell. "Remember that you won't always get in at the absolute bottom, and you are not likely to always get out at the top," Dorsey warns. |
| When the trade goes in your favour you must have some type of sell discipline, just as you need one if the trade goes against you. One way is: once you are up 30 per cent in a position, you should sell one-third of it to lock in partial profits. |
| This helps you raise cash that can be put to use in another stock, may be one that's just getting going. If the stock continues to rise, you can sell a second third once you are up 50 per cent. Then you could hold that last third until the technical picture gives signs of serious deterioration, such as a trendline violation or relative strength change. |
| When a stock goes against you despite all your research and vigilance, identify your stop-loss point and respect it. Once the stock hits that point, move it to death row. |
| Then it becomes a question of when should the stock get executed. You can wait for a bounce, maybe a couple of days, giving the stock its last smoke. If the stock never bounces during this timeframe, then shoot it! |
| Tom Dorsey's Trading Tips: A Playbook for Stock Market Success Author: Thomas J Dorsey Publisher: Vision Books Edition: 2004, paperback Price: Rs 325 Book courtesy: Crossword |
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