Tuesday, 18 October 2011

My Rules for Investing

I have been investing for a long time now. After reading a lot on the subject of investing, speculating and trying my hand at all forms like day-trading, swing trading, technical analysis, derivative trading and investing for the long term, I have come to realize that the last one suits my temperament the most and one in which I have actually made good returns.

I have also come to realize that investment discipline is critical for success. And for discipline, a strict set of rules to be followed is critical. These rules should help in deciding when and what to put your money in.  The rules would continue to evolve along with my personal and vicarious experience in the markets.

Here are my set of rules:

Rule 1: Focus your investments. Do not diversify unnecessarily.

Do not invest in more than 15 stocks in your portfolio. It is difficult to follow and track more than 15-20 stocks at a time. It is important to keep yourself focussed on your best investments.  To add a new stock to the portfolio, judge the relative ranking of current holdings and remove one. There may be slight temporary anomalies to this rule to protect paying taxes while selling. So, if a stock is to be held on for a few months more to save on capital gains tax, then the total stocks can go up for that period.

Rule 2: Be sure of the story and check back frequently to see if it is intact.

Be very clear as to why you are buying a stock. You should be able to explain your investment thesis to your mother/wife (I mean someone who is not very clued into stocks) in simple language. The more you understand the story, the greater your conviction.

Rule 3: Plan your sale.

Sell when the story is over, or
Sell when you reach your target price ahead of plan, or
Sell when the fundamentals deteriorate, or
Overall market prices are very high

Rule 4: Never buy or sell in one go.

It is important to stagger you buy and sell to average out price spikes. Also, rarely will you have the money to buy your required quantity in one go. Also, staggering while helps in most cases to get a better overall price. Similarly, while selling, specially, when your target price is reached, it is better to sell in stages.

Rule 5: Plan beforehand what you would do if the price goes down by 10-20% after you buy.

There are two options. 1) Buy more and 2) Stop loss. Make up your mind at the time of your initial investment what you want to do if the price goes down. If your conviction is high, buy more. If this was a dip-stick buy, then maybe cover your losses.

2 comments:

  1. Good tips, abhi!
    A very dumb question on your point 2: Be sure why you are buying a stock!

    NN- I (and almost everyone in the world) buy a stock to make money! Of course I check the following before I buy it-
    has the company been doing well in the past?
    Is it's future earnings/profitability intact? (QoQ/YoY profits are going to be good).
    Are the global markets conditions going to hit the stock bad? etc etc.

    So, What do you mean by investment thesis? And what exactly do you mean- "why you are buying a stock"?

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  2. Good question. Let me try to explain what I mean. Most people buy stocks by hearing or reading about it in the financial media (CNBC, Economic Times etc). Very few people look up a little on the financials. Looks like you do. Good for you. You are probably doing better than 80% of small investors.

    Interestingly, looking up the the financials is not enough. It is just the first step. You need to understand the risks. What can go wrong in the future. Where the future revenues are going to come from. How the overall sector is likely to do. What is the competition like.

    Keep asking yourself why repeatedly. Why do you think something is likely to happen. Why do you think the company is likely to do better. Why will it make more money tomorrow than today.

    And finally, most importantly, you need to have a clear idea of the price you are paying. That is part of your stock story. Are you getting value for money at the price at which you are buying?

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