There are various hypothesis around the globe about stock trading losses. This is one of the most debated subject and reasons of investors constantly losing their investment in stock trading. Stock market is really enormous field, but the common people think it as either profit or loss. The core cause of loss making is the investors go with the trend, rather than the principles which govern the stock market.
CASE STUDY (Indian Context)
Mr X invests rupees one lakh in the stock market.
Adhering to the Herd Mentality without knowledge, out of greed and emotion, buys “penny stocks”*.
*(Penny stocks are those stocks traded at a very low price, have very low market capitalisation are mostly illiquid and are usually listed on a smaller exchange).
When the value of stocks is declining, “don’t average the stock”* is being carried out.
*(Averaging down is when an investor reduces the average cost basis of investment in a particular stock by purchasing more shares of the security as the price declines. This will reduce the average cost per share.)
Subsequently one starts applying “stop loss triggering for share”*.
*(It is an order placed with a broker to buy or sell once the stock reaches a specified price. A stop–loss is designed to limit an investor’s loss on a security position. Setting a stop–loss order for 10% below the price at which the stock was bought, will limit loss to 10%).
Further the value of the shares falls to 50% from the original stock price, again money is channelized into buy the stock, on recommendation from unknown person who calls and assures that one can make 200% profit within period of three months. Without analyzing, one buys those stocks for another one lakh rupee on higher value. Those who are acquainted with stock market trend know that they are being conned by paid analyst. Further following dubious stock messages received on mobile, which are operator driven. Subsequently the stock value inclines by 2% for 20 days and the stock value declines on daily basis and closes on “lower circuit”*.
*(When the markets are falling or rising consistently, stocks hitting upper or lower circuit are a common feature. It also means that investors, especially in a falling market, might find themselves unable to exit, at least immediate from a stock that has hit lower circuit)
At this prevailing scenario one makes desperate attempt to sell the stocks, their attempt fails due to shares in lower circuit. After three months (percentage of reduction- i) 20%, ii) 10% and iii) 5%) the value of stocks falls, still one can’t manage to sell the shares. At this point one loses the ability to think rationally due to enormous amount of stress and starts taking advice from friends, near and dear one involved in stock trading. On their suggestion one goes for “intraday trading”* by using “margin option trading”**.
*(Intraday trading means your broker will allow you to take a trading position that is a multiple of your margin money in the trading account. To that extent, it is more risky and requires a different set of skills and mental make-up compared to delivery trading).
**(In options trading, “margin” also refers to the cash or securities required to be deposited by an option writer with his brokerage firm as collateral for the writer’s obligation to sell the option security, or in the case of cash-settled options to pay the cash settlement amount, in the event that the option gets assigned).
The “margin+”*option, if one has stock worth Rs 50,000, the stock broker will give you power to buy five times of stock value i.e. for Rs 2,50,000.
*(Buying on margin is borrowing money from a broker to purchase stock and this loan from your brokerage. Margin trading allows you to buy more stock than you’d be able to normally. To trade on margin, you need a margin account. Regrettably, marginable securities in the account are collateral.)
Subsequently one has to pay Rs 10,000 for seeking guidance from stock market analysts. In the margin+ trading, the stock broker will provide four days to sell the stocks. On completion of fourth day, stock broker will sell the margin holding by squaring. Since Mr X purchased the stocks in higher rate, it is massive trouncing loss.
The ego never agrees the loss and to attain the profit they start doing “Future and Option trading”*. *(Like share trading in the cash segment (buy & sell shares), derivative is another kind of trading instrument. They are special contracts whose value derives from an underlying security. Futures and Options (F&O) are two types of derivatives available for the trading in India stock markets.)
No sooner based on the recommendation, one starts trading in “put option”*.
*(Put options are traded on various underlying assets, including stocks, currencies, commodities, and indexes. The specified price the put option buyer can sell at is called the strike price. A put option becomes more valuable as the price of the underlying stock depreciates relative to the strike price)
Further after opting the “put option”, one don’t want to “put stop loss”* judging that share will make profit near future and not keeping stop loss in open position.
*(A stop–loss order is simply an order that closes out your position at a specific price. It controls your risk by limiting your loss to that price. If you buy a stock at Rs20 and place a stop–loss at Rs19.50, when the price reaches Rs19.50 your stop loss order will execute, preventing further loss).
The stock price continuously increase and on the “expiry date”* the stocks “square off”** automatically.
*(In case of Indian stock exchanges, the expiry date is the last working Thursday of the month, when the contract expires).
**(Squaring off is a trading style used by investors/traders mostly in day trading, in which a trader buys or sells a particular quantity of an asset (mostly stocks) and later in the day reverses the transaction, in the hope of earning a profit (price difference net of broker charges and tax).
Finally after sum total process, one is left out with only Rs 20,000, in the trading account, sarcastically one attributes the loss made to the stock broker and blame the stock broker to the core, shielding individuals lack of wisdom.
To fine tune the loss, one opens another trading account with a new stock broker, with left out Rs 20,000, without analysing the reasons for loss carry on doing aforesaid blunders.
LEARN TO DEAL THE FOLLOWING MENACE TO BE SUCCESSFUL IN STOCK TRADING.
Greediness/Emotional: One should not venture into stock trading out of greed. Buying out of the money options, tend to expire worthless, going for stocks which trade at less than Rs 10 market value thinking it would multiply 100 fold. Never take emotional decision while dealing with stock trading.
Patience: Patience is most important trait to be successful and profitable in long run.
Lack of knowledge about stock market: One must learn all the principles governing stock trading. Investors need to do lot of home work before making investment. Unfortunately lots of investors simply follow analysts or gossips around. When talking about lack of knowledge, it is not referring some high end mathematical models or stock picking strategies.
Presuming stock market is a gambling: People presume stock market is a gambling, so they want to make quick income out of it. Wrong predictions and expectations are common factors of negative influence. Some investors and investment companies cheat traders by artificially inflating prices through corrupt management, with gray business practices. The future and trend of the stock market at all times unpredictable, no one can exactly predict the future for any company, environment change due to macro, internal environment, political and competition.
Conclusion: Finally one should have clear knowledge and adhere the standard exit technique to avoid loss. Various studies on stock market often concluded that, retail/individual investors are the last few people to buy the stock. It is during the peak time, such stocks experience sell off pressure due to profit booking activities by professional investors. The value of the investment now takes a smack and investors cling on their investment in the hope of experiencing the peak again. The common nature of aversion for loss makes them sell their investments at the initial sign of recovery. It is evident that investors incur losses due to lack of discipline and knowledge, while investing in stock market. One can be a successful player if they encompass the aforesaid ingredients.