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Thursday, February 3, 2011

10 DOs and DON’Ts for making money in the stock market

Making big money – really big money – that allows you the freedom to do what you want, when you want and wherever you want must be the dream of every human being in the planet (except those who become monks or nuns). Only a few manage to make the dream a reality.

Those who follow the straight and narrow path end up toiling all their lives – slaving at a job, or trying to run a profession or business. Those who prefer a more crooked road usually have a short career and end up as state guests with free room and board – unless they manage to become politicians powerful enough to stay away from the long arm of the law.

Making really big money is not a realistic goal for most law-abiding citizens. But making a lot of money – enough that you can have a comfortable retired life that doesn’t require you to cut corners and lets you enjoy some of the material pleasures that life has on offer – is a more achievable goal. The stock market is a place that can help you to achieve the goal by supplementing your regular earnings.

Here are 10 DOs and DON’Ts for making money in the stock market:

DO…

  1. Make a financial plan. You don’t have to be a CA to do this. All you need is a little common sense and some knowledge of arithmetic. Think of all the major expenditures – children’s education, daughter’s marriage, buying a flat – at different times in the future and assess how much money will be required for each. That will give you an idea of how much you need to save.
  2. Make an Asset Allocation plan. This is the key. You need to know how much of your savings you should invest in risk-free instruments like Post Office MIS or bank fixed deposits, and how much you can afford to invest in riskier instruments like mutual funds and shares. By maintaining a plan, you will know when to buy and when to sell.
  3. Learn about the stock market before entering it. Can you get into an IIT or IIM from the Kindergarten? Can you face the fast bowling of a Brett Lee or a Dale Steyn if all you have played is tennis ball cricket? In the stock market, you will be playing against the likes of Rakesh Jhunjhunwala and Ramesh Damani. If you don’t know what you are doing, they will take all your money. Read books by Gurus like Graham and Lynch.
  4. Learn how to select stocks and build a portfolio. Haphazardly buying and selling stocks (or funds) on some one’s advice or your ‘gut feel’ is a sure way to make losses. Learn the process of selecting stocks for a portfolio, and holding for the long-term. There are several articles on this blog that can get you started.
  5. Learn to be patient and disciplined. The stock market is not a place for showing off how smart or enterprising you are. Those qualities are great for a business venture. In the stock market, you have to be observant and vigilant. Choose the times you want to buy (near bear market bottoms) and the times you want to sell (near bull market tops) carefully. The rest of the time, just wait and watch. Rome wasn’t built in a day. Neither will your wealth.

DON’T…

  1. Think that making money in the stock market is easy. The stock market isn’t a zero-sum game. While there is a buyer for every seller, only a few make money. The majority lose. They are the ones who thought making money was easy.
  2. Feel like a genius if you have made some money. It was most likely a combination of luck and a bull market. Going through bull, bear and sideways markets with your wealth intact requires determination and perseverance. If you are feeling excited and having fun, a loss is just around the corner.
  3. Forget Buffet’s Rule No. 1. Regardless of whether you have a shorter or longer investment time frame, always set stop-losses. That will help you to limit your losses. If a stock is running up fast, set a trailing stop-loss. (If you don’t know anything about stop-losses, you need to read my eBook. It is FREE.)
  4. Be too greedy. Have profit targets for each stock (or fund) in your portfolio. Once the target is hit, sell 50% and hold the rest with a trailing stop-loss. Sell all when the trailing stop-loss gets hit.
  5. Ever trade. According to Peter Lynch, the odds of success are greater at the race track or casino. Most trade to get rich quick. But there are no short-cuts in life. Trading is the best way to get poor quick; or, to become a reluctant long-term investor (when the trade goes completely wrong!).

There are no sure-shots in the stock market. But if you follow this simple set of DOs and DON’Ts, you will make a lot of money. Not tomorrow, or the day after. But after 20 years. Might as well get started now.

4 comments:

K said...

The beating up of indexes in Jan kept SKS Micro to ignore the selling pressure and is holding up off the lows nicely.

Fundamentally, there is a huge cry on ML companies.

Do you see a divergence building here?

Subhankar said...

I don't track the micro-finance companies. There seems to be strong headwinds due to Government efforts at regulation.

Dev said...

The 5th DO is much more important than any thing else. Its sitting on your backs and waiting that pays in the stock markets. The lesser the action at your end, better the returns.

Subhankar said...

They are all important, Dev - the 5th DO will not help if investors don't follow the first 4 DOs.

If some one had bought and held on to a Suzlon or a Punj Lloyd near the bear market bottom in Mar '09, he would not be making any money after two years.