Investment in Equity (Part 4)
Sunil M S
Before we go into anything else, let us repeat the theory, so that we may not forget it: Buy when price starts rising, and sell when price starts falling. In the preceding chapters, we had also decided that we will buy when the price rises 5% from its recent bottom, and that we will sell when the price falls 5% from its recent top. This is the theory, in a nutshell, that I propose. I had also suggested that the 5% trigger is only illustrative. You can choose a trigger with which you feel most comfortable. If you feel more comfortable with a 10% trigger, fine, go ahead and choose it. If you are comfortable with 6, 7, 8 or 9%, that too, is fine.
In this regard, there are only two things to be borne in mind. One, the trigger should not be shorter than 5% and longer than 10%. Triggers shorter than 5% may lead to a larger number of deals which, in turn, may lead to net losses. Triggers longer than 10% may not be as profitable as triggers between 5% and 10%. Two, once you choose a trigger, you should stick to it. You shouldn’t switch triggers or waver between them. Because, every time you switch from one trigger to another, the price movement can make you repent the switch.
For the purpose of this write up, we shall choose 5% as the trigger. By trigger we mean the price movement which will trigger you into action. Your actions can only be two: buying or selling. When the price rises 5% from its recent low, buy, and when the price falls 5% from its recent high, sell.
The greatest advantages of following such a definite policy or system are:
(1) When the price of a scrip climbs 100% or 200% or even more (remember, Reliance Capital climbed more than 2000% in four years!), you will find that you had already bought the scrip when the price had climbed just 5%, and you will still be holding it if no correction in the price has set in so far. You will always be a part of every such powerful rally. You will never be in a situation wherein the price has been steadily climbing but, you were not holding the scrip. The system will make sure that you do not sell a scrip while it is rising.
(2) When the price of a scrip crashes 50%, 60% or even more, you will find that you had sold the scrip away during the initial stages of the crash itself; you will have sold it away when the price had fallen 5%. In yet other words, you will never find yourself continuing to hold a scrip when its price has crashed 50%, 60% or even more. The system will also make sure that you do not buy a scrip while it is crashing.
The above mentioned two greatest advantages also represent, conversely, the two greatest fears of every investor, and take good care of them both:
Not being long when the price of a scrip is shooting up. When a scrip is rallying, you will be able to gain the benefits of the rally, only if you are holding that scrip. When a scrip is shooting up, you will not derive any benefits from its rally if you are not holding the scrip. In other words, if you are not long in the scrip which is rallying, you will be missing the bus. The system I have suggested will ensure that you remain invested in the scrip whenever it is rallying.
Being left holding the scrip though its price has been crashing down, down and down. Every crash will eat away a chunk of your net worth if you are still holding on to the scrip while it is crashing. This is, no doubt, the greatest worry of every investor: depreciation in the worth of the investment. This is the greatest risk every investor bears. Perhaps, this is the bane or curse of investment in stock market. There can be umpteen reasons for stock market crashes. No one can predict it with precision. The theory or the system I have proposed will give you 90% protection from this fear or risk. Once you are adequately protected from this greatest risk, you will find stock market a better place to live in.
Well, the benefits do not end there.
Let me give an example. Let us imagine that we are holding a scrip which is priced, at present, at Rs. 200. It crashes 50% to just Rs. 100. You will have sold it away when the price had fallen 5%, i.e., to Rs. 190. After continuing its fall, and touching Rs. 100, it rises 5% to Rs. 105, and you will be buying the scrip at this level. You had sold the scrip at Rs. 190 and you are now buying it back at Rs. 105. Suppose you had been holding 100 shares of the scrip, and when you sold them away, you received Rs. 18905 after a 0.50% brokerage (the actual brokerage can be lesser). This amount, less another 0.50% brokerage, will be available for buying the scrip back at Rs. 105. Since the price is as low as Rs. 105, the funds you have will be sufficient to buy 179 shares at that rate, and you will buy the whole of 179 without fail.
The advantage is obvious: In the above given illustration, when the scrip crashed 50% and then started rising, you were able to buy 79% more shares of the scrip. Thus, with every crash, your holdings will go on increasing. And, with every subsequent rally, the worth of your holdings will also rise in tandem with the rise in price. After every rally, when the price falls, you will sell the scrip at higher rates, earning profit depending upon the extent of rise in price. If the price rises more, you will earn higher profit, and if it rises less, you will earn lesser profit.
A natural derivative of the above suggested theory is that the whole sale proceeds (less the two way brokerage) of a scrip should be fully and solely used for buying the scrip back. If the scrip crashes and starts rising, you will be able to acquire it in greater quantities as illustrated in the above given example. Rallies and crashes in stock market are a matter of routine. Both are parts of the same cycle. They will lead to frequent buyings and sellings, and with every buying or selling, either your cash balance will go up or your holdings will go up. Either way, your net worth will go on increasing more often than not. These prospects of growth will make the whole system, suggested above, worth not only practising, but practising religiously too.
Scrip selection, risks involved, buying and selling through stoploss orders, speculation, etc. are some of the topics which will be dealt with in the future parts of this series of write up.