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Tuesday, June 17, 2008

How to lose more money and become a better investor

You may be among the unfortunate many who got caught up in the buzz of the Sensex hitting 20000, and jumped in to the market in January 2008. That means you are sitting on substantial losses. Even if you had entered in January 2007, you are probably making losses.

This is just the time for you to turn your ‘paper’ losses into ‘cash’ losses. Which means actually selling the shares in which you are losing money instead of holding on to them. Why would you do such a 'foolish' thing?

Because you never know how low the market can go, and when it will rise again. (The previous bear market from 2000 top to 2003 low lasted three years. This one has only completed 5 months.)

If you bought a share at Rs 100, and it falls to Rs 50, you lose 50%. But if you hold on expecting to sell when the stock reaches 100 again, you are expecting a 100% rise in the stock price. Not impossible but highly unlikely.

If the stock falls further to Rs 33, your loss is 67% but to get back your original Rs 100, the stock has to rise 200%! (Do not use this 'opportunity' to buy more. Your average price may go down, but your losses will keep increasing.)

A better investor will quickly learn the concept of a 'stop loss' - a price below which (s)he will 'book' losses and get out. Setting a stop loss is an art, and will depend on your risk taking ability and your conviction in the quality of the stock.

For example, if you have bought Tata Steel at Rs 900, you can set the stop loss at 30% and not sell unless it falls below Rs 630. But if you have invested in Ugar Sugar, then the stop loss should not be more than 10%.

So you decide to take my advice and 'book' your losses. Now what to do with the money? Do NOT, repeat DO NOT, put it back in the market right away. Put it in a short term fixed deposit or a Liquid Mutual Fund, and watch how low the Sensex goes.

Chances are it will test its previous low around 14700 and go even further down to 12000 levels - if oil prices and inflation continue to remain unfavourable.

In the meantime, do not sit idle. Buy some books and start doing your homework. The next post will discuss a few books that I have found helpful.

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