In the current volatile market scenario, with stocks fluctuating, some of you may get tempted to try your luck with short term strategies, i.e. not buying to hold but for a quick trade. This can be risky and potential short term traders need to be cautious, or they could get burnt. It’s best to know good short-term trading strategies that are usually followed by traders. At the very least, you will proceed with some knowledge about this method.
A study in the US discovered that investors held stock for an average of 187 days, which is about six months, during the period between 1991 and 1996. The medium holding period was a mere 90 days. There is no data available for the Indian market but looking at the volatility of our stock market, the numbers are likely to be similar. This tells us that there are mostly short-term traders in the market. Is there anything inh-erently wrong with short term trading? Absolutely not, but it is best to know the rules. Also, be aware that short-term trading relies mainly on luck and on some careful studying of the situation.
Day-trade in stocks
In this trading style, traders buy and sell the stocks on the same day or in a very short period of time. The traders take the advantage of daily market volatility to profit. They buy when the stock prices go down hoping that prices will appreciate sometime during the day. At the end of the day, they square off their positions, i.e. take their profit or their loss. This is a very popular way to trade.
The popularity stems from the fact that this looks exciting; the risk taker in you may love the thrill of buying and selling with almost immediate results. Even if the trader loses money, the loss doesn’t seem as big as daily variations are not very volatile.
Day-trading, however, is the most popular way to lose money. A majority of day-traders either lose money or if they make a profit, it cannot be more than a long-term investor. Investors look at daily loss and assume that this is not a big loss but if they total the losses for the year they will get quite a different picture.
Take an example: If you have `1 lakh, you will be happy to earn `2,000 on it. At the same time, you may not be too worried if you lose `2,000. This psychology works against traders. The happiness about making a marginal profit is more than the sorrow of suffering a marginal loss.
The best way to get the best of all worlds is to keep aside a bit of your investible funds for short term day trading. Invest most of it for the long-term and trade with the about 10 per cent of the available funds. No point making heavy losses.
Trading on margin
In margin trading, the investor spends some part from his or her pocket and borrows the rest from the broker on interest. In this context, investors have to understand the concept of initial and maintenance margins. Initial margin is the percentage of the total investment that investors have to put. When the prices go down, your contribution in terms of percentage will go down. After it goes below a certain percentage, the broker will ask you to put more money to take it to the initial margin. This “certain percentage” is called the maintenance margin. This is a high risk high return strategy. The advantage is that if the prices go up, you earn all the profit minus the interest you pay to the broker on his contribution. How-ever, the if prices go down, you take the loss as well as pay interest, whi-ch is a double whammy.
The only risk mitigation strategy is that the investors should never put more money when margin call is given by the broker. The investor, instead, should ask the broker to square off the position with whatever loss has happened. Avoid the temptation to put more money after the margin call.
Selling short
In this short-term strategy, investors borrow and sell the shares and later they have to buy this from open market and give it back to the lender. The idea is to benefit from decreasing prices. Investors short-sell stocks because they assume that prices will go down and when it goes down they buy it cheaper and give it back. The difference is the profit to investors.
Take an example: an investor expects the price of Airtel (`400 a share) to go down. Since he has no shares of his own, he borrows 100 Airtel shares from the market and sells them immediately earning `40,000. After sometime, as he expected, the Airtel price goes down to `350. He buys 100 shares back at `35,000 and gives it back. He earns `5000 from this transaction. We are ignoring transaction costs and other charges for the sake of simplicity.
Short-selling is speculative in nature and investors may lose if the prices go up. There is no guarantee that stocks will go down as expected. There are other ways to mitigate the risk by using derivatives but those are out of scope of this article.
Final word
Short-term trading can be very tempting. It offers excitement, action, and instant gratification.
Compared to this, long term investments can be boring, tedious, and requires extreme patience. However, there is no other way to build wealth but by using long-term strategies. This is true for most of the investors.
There are short term investors who have done tremendously well but they are few and far between. Hence whether the markets are stable or highly volatile, as they are now, investors should put their major resources into long-term investments to build assets and wealth.
(The writer is the CEO of bankbazaar.com)