Make way for logic

By controlling your emotions, you can actually earn higher returns from the market. We tell you how to do it.

     Print Edition: May, 2010

Who doesn't know the fundamental rules of investing? Unless you are living on an island with no access to information, it isn't news that one must buy low and sell high or that one should stick to the target price. Yet, every time there is more money to be made or lost, the left side of the brain becomes comatose. So if you can control your emotional reactions, the chances of following these rules increase. How can you do this? By creating systems that force logic and discipline at all stages of equity investment. Here's how.

Before entering the market
It is the time when you recall that a gym buddy was gloating about a stock you had never heard of. You research and discover that the stock is priced at Rs 500, cheaper than the blue chip you were mulling over. Convinced by your research and the evidence (the buddy's experience), you buy.

There are a number of flaws in this strategy. Starting with the information source—an unreliable peer—to the assumption that a low-priced stock is the same as a cheap stock. Says Dipen Shah, senior vice-president, private client group, Kotak Securities: "Investors think that a share worth Rs 2 is better than one at Rs 200 though the latter may have higher value. They also choose stocks that are moving up fast, though this could be due to irrelevant reasons like higher operator interest."

If you are dabbling in equities, the lure of anecdotal evidence is a constant threat. However, it is predominant at the stage of choosing stocks. The thought process is, if it was good for my friend, it is good for me, never mind the difference in the stock's buying price. All things considered, the total money outgo outweighs other financial insights. Similarly, as Shah points out, the faster a stock's price runs up, the quicker is the validation of the investor's choice. This short-term gratification is so overwhelming that you forget long-term gains.

Beating such psychological predilections is easy if you do your homework. Make a list of the filters for every stock, which should include the balance sheet strength of the company, the sustainability of its business model, the capability of its management and, finally, the valuation of the stock. You can add to the list depending on your investment acumen. Sometimes it may seem silly to pass a biggie through your scanner, say, a Bharti Airtel. But do not be deterred by the obvious. The more thorough your checks, the lesser are the chances of emotional reactions steering you away from investment logic.

When the markets rise and fall
You can't help being thrilled by an upswing. As your portfolio notches up profits, you become more confident about your stock-picking abilities. So what better time to add more stocks to your kitty than when a bull run validates your investment skill? The problem is that by doing so you end up buying high. Shah points out that due to a steep rise in the markets, some stocks become overvalued. Therefore, chances are that instead of buying more, you should be booking profits on stocks that have zoomed past a credible price range.

Contrarily, a downswing in the market is not the time to panic and beat a hasty retreat as you end up selling low. Instead, you can buy more stocks in your portfolio to average out their cost, provided you are sure about their quality. But is it possible to add more to your kitty even as it turns brighter shades of crimson every day?

It is impractical to suggest that you control emotions as the market swings wildly. So the only way out is to ignore it completely. Says Vikas Sachdeva, country head, business development, Bharti Axa: "A market cycle lasts five years. Irrespective of when you enter the market, if you have a long-term view and are comfortable with your stocks, you will make money." Therefore, review your portfolio regularly, but don't hit the transaction button each time the market moves up and down.

While exiting the market
You diligently set a target price for your stocks, but when the goal is achieved, you are hesitant to cash out. The questions on your mind: did you set your sight too low? Is there more money to be made on the stock? Imposing rules in an uncertain environment is never easy. But this is one phase of equity investment where will power is a must. Says Shah: "All investments must be goal-oriented. Invest with a reasonable target profit, say, 30-35 per cent, and then exit. Of course, there must be a flexibility of 10-20 per cent either way, depending on market movements."

If you can't do it yourself, set automatic triggers with your broker to book profits at a predetermined level. You will soon become a patron of regular profits instead of erratic bouts of profit and losses.

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