Are you a bull or a bear? Why not both?

Most small investors thrive in bull markets. They feel comfortable by buying low and selling high. The adventurous buy high and sell higher. The sophisticated buy more on small corrections to support levels. They make the trend their friend.

All their best laid plans go haywire when bears attack. Panic sets in as portfolio values go crashing. Stock prices fall below 'buy' prices. Some book losses and get out, promising never to come back again.

Others make a bad problem worse. They start 'averaging down' - buying more at lower prices. When the stock shows no sign of recovering, they lose heart and book huge losses.

What happened to making the trend a friend? The analytical side of the brain gets scrambled when money is rapidly going down the drain. The only thought is 'take the money and run'.

The smart ones - they become that way after losing money in bear markets - know that you can be a bull AND a bear depending on the trend. 'Buy the dips' when the trend is up. 'Sell on rise' when the trend is down.

The 'buy the dips' is the easier strategy to follow. No wonder small investors prefer it. You keep buying as a stock's price moves up. No selling is involved - till you decide to book profits when upward target is met.

'Sell on rise' is harder, and requires practice to succeed. For every sell, you need to buy back at a lower price. And then repeat the process - till the correction ends. Deciding when to buy back requires skill.

Studying long-term technical chart patterns to identify support and resistance levels can prove invaluable for identifying entry and exit points. 

Sometimes stocks get into consolidation phases that can last months. What to do then? If the consolidation range is reasonably wide - say, 40-50 points instead of 10-15 points - draw a line through the middle of the range. 'Buy the dips' below the mid-point, 'sell on rise' above the mid-point.

For longer term investors, it is better to be a crocodile or a python (both have a lot of patience) instead of a bull or a bear during consolidation phases. Just wait patiently for a price breakout in either direction.

Should you 'average' down during a correction?

Interactions with small investors over the years throw up the same questions repeatedly. Here is a recent example:

"I bought 100 shares at 60. Bought 100 more at 80. The stock moved up to 100, but I didn't book profit. Now it has breached the stop-loss at 75 and fallen to 65. I am still holding. Can I 'average' now?"

Two mistakes have already been made: (1) not booking partial profits at 100; (2) not selling when the stop-loss was breached. Now the investor wants to 'correct' the two mistakes by committing a third - trying to buy a stock on the way down.

When a stock is correcting from a top, one needs to make an assessment of both the short term and long term trends. If the short term and long term trends are down, there is nothing to be gained and much to lose by 'averaging'.

There are no supports that can hold when bears go on the rampage. Better to take it on the chin and book a loss quickly instead of waiting for the stock to regain your 'buy' price. (Remember that the stock doesn't know or care about your 'buy' price.)

If the short term trend is down but the long term trend is up - in other words, a correction in a long term bull market - then 'averaging' can make some sense. 

However, the smart move will be to wait for the correction to be over and buy when the stock resumes its up move. This is easier said than done.

One has to be very savvy about support and resistance levels to decide when the correction is over and whether the resumption of the up move will be followed by another down leg or not.

That was the long answer to the question.

The short answer is: Never 'average' down. 'Averaging' on the way up is a better strategy.

Is Selling Short riskier than Going Long?

'Selling Short' is a strategy when you are feeling bearish. You expect that the stock market as a whole, or a specific stock you may or may not hold, will be falling lower. So, you decide to sell first - and try to buy later at a lower price.

Shorting usually means selling some thing that you do not already own. You obviously can't own the index. But you can buy/sell an index in the F&O segment or buy/sell an index ETF.

How can you 'short sell' a stock that you don't own? By borrowing the stock - either from a friend, or from your broker. You may need to pay a 'margin' amount for doing this.

'Going long' is the opposite of 'selling short'. You are feeling bullish, and expect the stock market or a specific stock will be rising higher. So, you decide to buy first with the expectation of selling at a higher price in future.

Most small investors take the 'going long' route. It is an easier concept to understand and implement. But it works best when a stock or an index is in a bull market.

A stock or an index doesn't move up in a straight line. There are periods when there is an up move, followed by periods of correction. Such corrections provide opportunities for adding more. The tactic is called 'buying the dip'.

'Selling short' works best when a stock or index is in a bear market. Every fall in a stock or index is followed by periods of correction when there is a price rise. Such corrections provide opportunities for selling more. The tactic is called 'sell on rise'.

Now that you know all about 'selling short' and 'going long', which strategy should you follow? It should depend on the strategy with less risk. So, which is the less riskier strategy? This can be explained with examples.

Let us say you buy a stock at Rs 50. The price rises to Rs 70 and then corrects to Rs 60. You 'buy the dip'. The price rises to Rs 90 and then corrects to Rs 80. You 'buy the dip' again. This time the stock price touches Rs 100 and you decide to book profit.

But making money in the stock market is never that easy. What if the stocks price drops to Rs 40 after you bought it at Rs 50. Will you 'buy the dip' by 'averaging down' or sell the stock at a loss? 

Many small investors lose a lot of money when they 'average down' by buying a stock as it falls. Theoretically, the stock's price can fall to zero, and you can lose your entire investment.

A better strategy when a stock or an index is falling is to 'sell short'. But there is a problem here. What if you ' short sell' the stock at Rs 50, expecting it to go down, but it rises to Rs 60? Your friend or broker - who loaned the stock to you - may want the stock back.

You have two choices. Buy back the stock at Rs 60 and bear the loss of Rs 10 per stock. Or, you can keep your short position 'open' by paying an interest (called 'margin') and hoping that the price will eventually fall.

But the price keeps on rising, till you are forced to buy back at a much higher price and sustain a considerable loss. Theoretically, the stock price can rise to infinity, which means your loss can be infinite.

That may not happen in real life, but it isn't impossible for a Rs 50 stock to rise to Rs 500 (a 'ten bagger'). By 'going long' on a Rs 50 stock, you can lose Rs 50 at most (unless you 'average down' - in which case you can lose a lot more). By 'selling short' a Rs 50 stock, you can lose Rs 450 if the stock rises to Rs 500!

By applying a proper stop-loss to what you buy or sell, you can limit how much you can lose on a particular transaction. However, the fact remains that 'selling short' involves a greater risk than 'going long'.

(In a bear market, a less risky strategy is to 'short' a stock you already own. That means no borrowing and no paying of 'margin' money. Say, you decide to sell Tata Motors at Rs 500 - hoping to buy it back at a lower price. But the price moves up to Rs 550. You don't lose any money because you already owned the stock. But you do lose the opportunity of making an extra Rs 50.)

Read this article in investopedia.com to learn more.

Five Stock Investing Pitfalls To Avoid

Before you start on any project - whether it be building a house, or travelling to New Zealand on vacation - you need to make a plan. And to make a plan, you need to gather information and consult experts (like an architect or a travel agent).

Investing in stocks to build wealth for the long term is also a 'project'. It requires a lot of effort in learning and consulting experts and planning. Otherwise buying and selling stocks become random activities with little chance of building wealth.

Even after you do your homework and have proper financial and asset allocation plans in place, you need to understand and apply fundamental and technical analysis concepts to decide which stocks to buy, which stocks to sell and appropriate times for buying and selling.

Those are the easy steps to learn and implement. Far tougher is to learn how to control your emotions. To remain impassive and do disciplined investing according to your plans when the stock market is rapidly climbing or falling steeply requires years of experience.

Successful wealth building through stock investments involves planning, regular investing, staying patient and avoiding mistakes. Here are five common pitfalls (mentioned in a recent investopedia.com article) that prevent many small investors from becoming successful:

1. 'Cheap' is not necessarily good value for money - Small investors have a tendency to avoid large-cap stocks because they are 'too expensive'. In any case, mid-cap and small-cap stocks give better returns - don't they? A stock is 'cheap' for two reasons - either the company's operating fundamentals are weak or, it has not yet caught the eye of savvy investors. The trick is to be able to distinguish between the two. Even a fundamentally strong company can trade in the stock market at low valuations for a long time. 

2. A high P/E ratio doesn't mean a stock is overvalued - P/E ratio is an important metric that is often misunderstood. A P/E ratio of 12 doesn't make a stock a better buy than one with a P/E ratio of 42. Why? Companies that require frequent capital expenditure often trade at low valuations. If the average P/E for a sector is 10, and a stock from the sector is trading at a P/E of 12 then it is 'expensive'. But if a company is continuously growing and earnings are keeping pace with growth, then a P/E of 42 can give an excellent investment opportunity.

3. Cutting your winners quickly and letting your losers run - Most small investors should do the exact opposite. Booking profits quickly in a winner and keeping a loser for a long time in the hope of getting back the 'buy' price is a ticket to disaster. Learning how to set a 'stop-loss' will prevent a small loss from becoming a big one. A 'trailing stop-loss' allows you to ride the profits in a winning stock.

4. Averaging when a stock's price is falling - Averaging down is one of the biggest pitfalls that can turn a small loss into a huge one. Why? Because theoretically, a stock's price can become zero. You can go on buying as the price falls, but it can fall even more. If you are really convinced about a company, wait for the stock price to stop falling and then average on the way up.

5. Not being aware of the broader market trend - During a bear phase, big money is made by selling first and then buying back at a lower price later. Such a strategy - called 'short selling' - is not recommended for inexperienced investors. Bear phases eventually come to an end. During bull phases, one can buy at a lower price and sell at a higher price for profit. (Many small investors in mutual funds stop their SIPs during bear phases. That is not recommended.)

Read more

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Want long-term happiness over short-term thrills? Buy experiences, not things

Many small investors enter the stock market with the hope of making some quick gains. They may have heard stories from their friends or colleagues about making a killing in a sugar stock that quadrupled in 6 months, and want to jump on the bandwagon.

So they buy another sugar stock and are excited when the stock spurts 15% shortly after they purchase it. They book out with a small profit, and boast about their investing acumen to all and sundry. 

The thrill of the ride gets into their blood, and they want to repeat the experience with another stock. This time, their luck runs out as the stock tanks immediately after they purchase it. They buy some more to 'average down' their cost price - but the stock keeps going further down.

Reluctantly, they turn into 'long- term investors' in the hope that some day they will be able to get back their 'buy price'. That some day may take a very long time to come. Short-term thrill seeking turns into long-term unhappiness.

Sound familiar? As in the stock market, so in life.

We constantly seek instant pleasures - catching Salman Khan's latest film first-day first show, or buying the newest and thinnest laptop or smart phone - not realising that instant pleasures get easily satiated. So you go seeking for the next one.

According to this article in forbes.com, "... people who spent money on experiences rather than material items were happier and felt the money was better spent. The thrill of purchasing things fades quickly but the joys and memories of experiences ... can last a lifetime." 

Spend money for buying experiences. Gift your parents an all expenses paid weekend getaway to Chail or Kalimpong or Kodaikanal instead of buying the latest gadget. Not only will you feel good about it, your parents will share their experiences with you and the rest of your family for many years.

Go out with your friends or family for a concert and dinner. Those "who have more frequent social interactions live longer, healthier lives and experience less stress, depression and feelings of isolation."  

Join a creative writing course, or a foreign language class or an art/music school instead of sleeping late during weekends. Meet new people, learn new things, expand your mental horizons and experiences.

And, for long-term happiness in the stock market learn how to make a financial plan, an asset allocation plan and have the discipline to follow the plans to build wealth over the long-term.

[Want to learn how to pick stocks for the long-term? Subscribe to my Monthly Investment Newsletter today. Paid subscriptions are being offered on a first-come, first-served basis  Subscriptions will remain open till July 21, 2016.] 

8 Common Investing Mistakes and How to Avoid Them

There is an oft-quoted stock market adage: There are two kinds of investors in the market - those who have money and those who have experience. The ones with the experience get the money. The ones with the money get the experience.

The stock market is a place where history keeps repeating itself. In every bull cycle, hordes of new investors enter the market without a clue about how the market works. They make some money in one or two unknown stocks. Profits are booked quickly and immediately redeployed in the next 'sure thing'.

Once the bear cycle starts and stock prices fall, they buy more to reduce their 'average' cost till the stock collapses in a heap. 'Short-term' players become 'long term' investors in the hope of getting back their invested amounts. Eventually, they sell out at a big loss.

When the next bull cycle starts, a new set of investors enter the market and repeat the mistakes of their predecessors. And so it goes on. Is there a way out of this cycle of mistakes and losses?

In an article in investopedia.com, William Artzberger discusses about 8 common investing mistakes:

1. Investing in something you don't understand
2. Falling in love with a company
3. Lack of patience
4. Too much investment turnover
5. Market timing
6. Waiting to get even
7. Failing to diversify
8. Letting your emotions rule the process

Artzberger also discusses how to avoid these mistakes:

1. Develop a plan of action
2. Put your plan on automatic
3. Have some 'fun' money

Read the complete article at this link. 

Want to be a successful long-term investor? Act like a professional golfer

For the uninitiated (and the disinterested), here is a brief outline of the career progression of a typical professional golfer:

• an early interest in the game from a father who plays golf and/or proximity to a public golf course
• interest turns into passion - leading to playing regularly come rain or shine
• lessons from a local golf instructor that fine tunes skills
• appearance in local golf tournaments where skills and potential are recognised by experts
• a golf scholarship from a college/University
• competing in inter-college, regional and national amateur tournaments
• becoming a professional golfer after (or even before) completing a college degree
• honing skills in lower level professional tournaments before qualifying for national/international level tournaments
• maintaining status in national/international level tournaments by winning at least once in two years, or by consistently performing every year to be ranked within the top 100/150
• winning one or more Major tournaments - like the Masters, British Open, US Open, PGA Championship - to earn a place in the Hall of Fame

If you are still with me so far, visualise those bullet points as a large funnel. Thousands of kids around the world show an interest in the game that turns into a passion. As they progress along the skills and experience path, the funnel starts to get narrower and narrower.

Many don't make it to college. Those who do, fail to make a mark in inter-college tournaments. Only a handful perform outstandingly at the amateur level to get a direct entry into a few professional tournaments. The rest grind their way through lower level professional tournaments, and may never get to play in any of the Major tournaments.

So, what does all this have to do with successful long-term investing? I'm coming to that.

Making big money as a professional golfer is extremely difficult, if not impossible. How difficult? Only 5 golfers in the entire history of the game have managed to win all the four Major tournaments in their careers. Many well-known golfers have never won a Major. A few have won one Major tournament only to fade into oblivion after that.

In the recently concluded Masters tournament, last year's winner Jordan Spieth had a 5 shot lead with 9 holes left to play. Everyone expected him to win again. Inexplicably, Jordan dumped two shots into the creek in front of the 12th hole to lose his lead and finished second. 

The game itself requires a lot of skill and dedication. On top of it, one requires an extraordinary amount of patience and equanimity. Unlike in most professional sports, golfers don't make any money just by playing in a tournament. They have to qualify for prize money by being among the top 60 or 70 after the first 2 days of a typical 4 day tournament that has 140+ entrants. Several past winners failed to qualify for the last 2 days of the 2016 Masters.

Tournament organisers rarely help in arranging travel and hotel bookings. So, a golfer has to take care of all logistics and pay upfront from his own pocket for travel and lodging. If he fails to qualify after the first 2 days, he has to pack his bags and go home without earning anything, or head for the next tournament early to put in some practice to iron out mistakes.

Anyone who has been investing in the stock market for any length of time should be able to draw an analogy from the golfer's career funnel. 

Most investors show a lot interest and passion initially. But they become euphoric when a stock's price moves up and get out quickly; or, fail to remain calm under adverse circumstances, averaging as a stock's price continues to move down.

As losses increase, many investors sell and give up. Others soldier on in the hope of recovering their losses, but often fail to do so. Only a very few develop the skills, patience and equanimity to make money consistently and build wealth over the long-term. 

Moral of the story? Learning about fundamental and technical analysis is necessary but not sufficient. Having the correct mental make-up - of being dispassionate at a gain or a loss and taking the appropriate buy/sell decisions - will separate the long-term wealth-builders from the short-term thrill seekers.

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When To Sell Stocks

Anecdotal evidence - from occasionally watching business TV channels – shows that many small investors get attracted to the market when stock prices are rising.

They end up buying stocks at comparatively high prices. When a bear phase starts and stock prices start plummeting, they compound their problems by ‘averaging down’.

When stock prices fall even more, small investors panic and sell at a big loss. The emotional upheaval and loss of self esteem often turn them away from the stock market forever.

The moral of the story? It is important to choose stocks carefully, and buy them at a fair price. It is more important to know when to sell. Your investing success depends on it.

Remember that buying – even at a significant discount to the intrinsic value of a stock – doesn’t make anyone any money. You only make a profit (or loss) when you sell.

The fear of making a loss, and irrational behaviour (viz. thinking that by not selling a falling stock you are not incurring an actual loss) leads to even bigger losses.

In a recent article at investopedia.com, the reasons for selling a stock have been explained. Small investors – even experienced ones – may find the article interesting.

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How to survive and thrive during a bear phase in the stock market

During bull phases, the general direction of the stock market is upwards, but there are frequent corrections and consolidations along the way.

In bear phases, the general direction of the stock market is downwards, but there will be intermittent rallies in between. That is the way a stock market behaves.

Yet, small investors tend to become joyous and euphoric in bull phases – forgetting that a bear phase is around the corner.

They also become despondent and depressed during bear phases – even though duration of a bear phase is often less than that of a bull phase.

The current bear phase is into its 9th month. And, there seems to be no end in sight. BJP’s popularity seems to be waning. Economic growth is sluggish. Corporate earnings are stagnant.

What should small investors do in such a situation?

Stay out of the way of a bear: they are powerful and fearless animals, and will maul you if you try to fight back. The sensible strategy would be to climb a tree to safety. In investment terms, put your money in fixed income instruments or liquid funds, or ‘defensive’ sectors (like FMCG, Pharma) – so that you can earn some returns.

Continue with your fund SIPs: the best way to build wealth from the market is to stay invested for the long term. Bear phases allow you to buy more units of the fund. Allow the fund manager to churn the fund portfolio – it is in his vested interest to do so for best results.

Control your emotions: decision making – specially under uncertain conditions – has to be fact-based and dispassionate. This applies particularly for investments, where your hard-earned money is at stake. If a stock you hold is losing ground fast, don’t try to ‘average down’ because you don’t know how low it can go. Wait for the stock price to turn around. Then ‘average up’.

Follow an asset allocation plan: distribute your investments among equities, debt instruments, gold and cash. The plan will take the guess work out of your investment decisions. Only equities get affected by bear phases. When your equity allocation falls below the threshold you have set in the plan, use the cash to rebalance your assets.

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About asset allocation

5 strategies to follow in a bear market

Most small investors enter the stock market when a bull market is nearing its peak. They don’t have clear goals and strategies, and get caught on the wrong foot by the bear market that inevitably follows. The trauma of losing money in a hurry can be soul-destroying.

Without the necessary skills and experience of surviving in a bear market, investors resort to all kinds of ill-advised strategies in an effort to quickly recover the losses. That only makes a bad situation worse.

The current bear phases in the Sensex and Nifty indices are 14 months old, and so far there has been very little indication of a reversal in the down trends. Experts are saying that the bear phase can last till the first half of Financial Year 2012-13. If they are right, the bear market may sustain till Sep 2012 – another 9 months!

Whether you are one of the unfortunates who are ‘stuck’ at higher levels, or a more seasoned investor who is sitting on cash to deploy at lower levels, here are 5 strategies that you may want to follow in the current bear market:-

1. Remember that bear market rallies are sharp and swift. Don’t jump in by thinking that you will miss a buying opportunity at a low entry price. Such rallies are some times ‘created’ by bears so that they can sell at a higher price.

2. Just because a stock has fallen to a 52 week low doesn’t mean it can’t fall any lower. As long as the trend is down, it can fall lower. If it is worth buying, being patient can help you to enter at a much lower price.

3. A sharp vertical drop in price – often accompanied by strong volumes - usually attracts a lot of buyers who believe that they are being smart by entering at a low price. It is the sign of a ‘panic bottom’, which seldom holds. Prices bounce up on the buying, but then fall lower than the ‘panic bottom’.

4. At the risk of sounding like a broken record (or, a damaged CD) – do not, repeat do not, average down in price. No one knows how much further a stock’s price will fall, or worse still, if it will ever recover (e.g. Cranes Software). It is far better to average up once the price forms a bottom and starts its up move.

5. Major down trends are not reversed in a day or a week. Bottom reversal patterns take a few weeks to a few months to form. Ability to ‘read’ chart patterns can help investors to accumulate a stock while a reversal pattern is ongoing (refer Chapter 7: Reversal Patterns of my free eBook: Technical Analysis – an Introduction).

If you can’t ‘read’ a reversal pattern, don’t worry. Eventually, prices will turn up and a new bull market will begin. You may enter at a higher price, but the chances of a loss can be minimised by using a trailing stop-loss.

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Some strategies about buying stocks

In a post last week, I had discussed strategies for selling stocks. Most small investors know how to buy stocks, but they rarely have proper strategies for selling. So why am I writing about buying strategies?

From the spate of questions I have recently received about when and how much to buy, it seems that discussing some buying strategies may be useful after all. I had mentioned about using the ‘Margin of Safety’ concept and P/E bands to decide entry points in last week’s post.

The importance of those two concepts can’t be over-emphasised. Too many young investors follow the wild west policy of ‘Shoot first, and ask questions later’. Just switch on any business TV channel (just for entertainment) during the day when they take reader queries. 99% of the questions are: ‘I have bought thus and such stock at this price; should I hold or sell.’

It is apparent from the questions that the stock was bought near a top, and the investor is already sitting on a loss. The question – or rather, a plea – is to find out if the TV expert knows some magical formula by which the loss can be quickly turned into a profit, or, at worst, break-even with no loss.

All one has to do before placing a buy order, is to first check whether the current E/P (i.e. inverse of the P/E ratio) is higher than the long-term bank fixed deposit rate, leaving a ‘Margin of Safety’ . Also check that the debt/equity ratio is less than 1, and that the cash flow from operating activities is positive for 4 of the last 5 years.

If E/P is lower than the bank FD rate, then check the P/E band within which the stock normally trades, and buy only if it is available near the middle of the P/E band or lower. These are basic precautions, and will help prevent losses – even if you don’t have the time or inclination to do a detailed fundamental analysis.

If you are like most small investors, the stock price will fall just after you’ve bought it (and, it rises soon after you sell)!! What should you do? Do not, repeat, do not average down. That is the single cause for turning a small loss into a much bigger one. Instead, keep a stop-loss – and sell if the stop-loss is hit on a closing basis (i.e. take intra-day movements out of the equation).

You will make much more money by averaging up. When should you do that? Buy 20-25% of your intended quantity at the beginning. Add more every time the stock dips or corrects on the way up. Follow a ‘pyramid’ strategy – i.e. buy less and less quantity on the dips as a stock keeps moving up in price – till you acquire your intended quantity.

Such a strategy will prevent impulsive buying of 2000 or 5000 shares in one go, in the hope of becoming a Warren Buffett within a month. Talking of Buffett, I love his quote: ‘You can’t make a baby in one month by getting nine women pregnant!’

Wealth-building takes time. If you hone your buying and selling strategies, you have a chance of becoming wealthy in 15-20 years – but not in 15-20 months.