Stock market investing is synonymous with attractive and quick gains and capital appreciation. However, the returns offered by the stock market come with risks attached. You cannot get good returns without undertaking the volatility risks associated with stock price movements.
Stock prices are subject to fluctuations, and these are a part and parcel of the stock market. While the price might increase attractively in a bullish market, the same may plummet the next day. So, while you are earning returns one moment, you might incur losses in the next moment as the value of your stockholding falls. So, what should you do? Should you not invest in the stock market altogether?
Though the stock market is a risky avenue, there are ways in which you can avoid losses. You don’t have to abstain from stock trading or stock investing. You just need to be a little wise when it comes to investing in the stock market. Here are some tips which, when followed, would allow you to avoid making considerable losses in the stock market.
Tips to avoid losses in the stock market
Learn about the market – Knowledge is power
One of the many reasons why many investors suffer losses in the stock market is because they start their investments with limited or no knowledge. The stock market is a trading marketplace, and unless you know the ins and outs of the domain, you will incur losses. A little knowledge is a dangerous thing, isn’t it?
Equip yourself with the knowledge of how the market works. Learn the pricing techniques of stocks so that you can anticipate which stock would make a profit and which might suffer a loss. Also, the stock market and the economy of the country are interlinked. If one moves up, the other will follow. Even if the stock market falls, if the economy is strong, the market would rise so that you can remain invested.
When you approach stock investing with complete knowledge, you can avoid making rookie mistakes that incur losses. Learn about the stock market and then jump on the investor bandwagon.
Research the stock you pick
Do you follow the herd mentality when investing? If you do, it’s time you give up the habit. Don’t pick stocks only because they are popular with other investors. Research the stock before investing in it. Find out the company’s financial position, fundamentals, projected cash flows, market capitalisation, market sentiments around the stock, and prospects.
If the company is poised to grow and has strong fundamentals, its stock would not give you losses.
When investing, either pick already established companies to avoid a possible downturn or those you have researched into. You can take the help of your broker to do your research but always make an informed choice.
Have a long term perspective
While it is true that stock investing has the potential of quick returns, you should invest with a long-term perspective. There is no quick-fix formula for returns in stock investing. You can ride on the market wave and make quick bucks when the market is rising but always think long-term for stable returns. Long-term investing reduces the risk associated with stock trading.
Moreover, even after a crash, the stock market always rebounds and gives positive growth. You just need to give it time. For example, the S & P BSE Sensex opened at 15,534.67 in 2012, and in 2021, the market opened at 47,785.28. A growth of more than 300% within nine years only.
This is why long term investment is the keyword to avoid losses in stock investing. Even if your stock’s value falls, you can remain invested and wait for the value to bounce back and grow so that you can earn positive returns. If you have a myopic vision, losses would be impossible to avoid.
Past performance does not guarantee future profits
Another common mistake that many investors make is to rely on stocks’ past performance when selecting them for investment. Past performances can never give you the projected future return.
For example, the stock of Jet Airways or Videocon had a good track record for many years before the company went bankrupt. Had you invested in these stocks based on their performance, your investments would have been useless after these companies faced bankruptcy. Historical performance does not guarantee future profits. You should assess the financial fundamentals and have a good understanding of the market the company operates in before investing in it.
Study the company’s price-earnings ratio, which would help you understand whether the stock is undervalued or overvalued. Investing in undervalued stocks would yield profits while overvalued ones may not have great potential for profits. Moreover, a company with a strong history of profitability would be financially healthy compared to companies that have not yet generated revenues. So, stock assessment on financial aspects is essential.
This assessment would help you understand whether the company is under stress or not, and then you can make the right choice of investment.
Stop-loss can work wonders
When it comes to profits from stock investing, the sky’s the limit. On the other hand, the losses can run into the ground. One way to minimise your losses is to use the stop-loss tactic. Under this tactic, you instruct the broker to sell the stock when it reaches a particular price level, called the stop-loss level. This is significant when the stock prices are falling. By selling off at the stop-loss point, you can prevent further degradation of returns if the prices fall further.
For example, say the stock price is at Rs.1500, and then it starts falling. You expect a further fall in the stock price, and you put a stop-loss order at Rs.1350. Now, if the stock price reaches Rs.1350, the broker would sell off the stock so that you can avoid losses in case of further devaluation. On the contrary, if the stock price starts rising, you don’t have to worry because stop-loss doesn’t limit your profits, only your losses.
Use the stop-loss strategy when prices are falling. Estimate the minimum price at which you can sell the stock and still make a profit. Set this price as the stop-loss price so that you can avoid losses when the price falls further.
Leave your emotions at home when you set out to trade in stocks
How many times have you let your emotions dominate your investing strategy?
When it comes to stock investing, practicality matters, not emotions. If you let your emotions dictate your trading activities, you would eventually face a loss. So, when you are buying and selling stock, be practical and keep a cool head.
Remember, upturns and downturns don’t last lifelong. If the market is bullish, it will enter the bear phase after some time, and if the market is bearish, it would rise and become bullish. The stock market is a roller-coaster ride, with both profits and losses. To avoid losses, you need to be clear-headed about your investments. If the market is rallying, rein in your emotions of investing all your wealth. Go slow.
Similarly, when the market falls or enters a downward phase, don’t get emotional and sell off your stock immediately. Be calm and take your time. When the market is rising, invest slowly and carefully. Similarly, when the market is falling, don’t liquidate your investments. Hold on to them as the market would recover.
Emotions might let you make the wrong decisions about buying and selling stock. But when you are practical, you can carefully weigh the pros and cons of the market dynamics and then invest with caution.
Diversification is the name of the game
Have you ever heard the saying – ‘Don’t put all your eggs in one basket’? If you have, do you understand its meaning? When you put your eggs in different baskets, if one basket gets damaged or if one egg is bad, you still have other baskets to fall back on. The same holds for stock investing. Diversification should be the mantra for successful investing. Choosing a variety of stocks is vital in preventing losses. If one stock suffers a loss, the other might not thereby decrease the risk of losses.
For example, say you buy two stocks A and B worth Rs.100 each. Now, if the price of A moves down to Rs.95 and the price of B rises to Rs.105, your losses are nil. Even though you have invested in stock A, the profit from stock B has nullified your loss.
Though stock trading is not as simple, diversification plays the same role. You should pick stocks of companies belonging to different sectors. This way, if one industry underperforms, your losses would be minimised due to the growth in other sectors.
The latest example of diversification one can see in the COVID pandemic. When the pandemic struck, the stock market started sliding due to lockdowns and uncertainty that affected the industry. Stocks of manufacturing companies started falling, but stocks of FMCGs and pharmaceuticals were on the rise. So, investors with investments in different sectors managed to earn profits despite the falling markets because they had exposure in the pharma and FMCG sectors, giving them the best effect of diversification.
So, aim for a diversified portfolio of stocks. Invest in different sectors for maximising profits and minimising losses.
Also, don’t overdo diversification. Excess of everything is terrible, and the same is true for diversification. A highly diluted portfolio would fail to give you significant returns from a performing sector. There might even be higher chances of loss. So, diversify, but with reason.
Hedge against losses
Hedging is also a useful tool that can help you prevent losses from stock investing. Hedging means cutting down losses from one investment by investing in another. Hedging in the stock market can be done through futures and options contracts or call or put actions. Similarly, when the market is falling, you can hedge your investments by investing in alternative avenues, like gold. Gold tends to rise when the markets are unstable. This was observed both at the time of demonetisation and the COVID pandemic when the markets were in turmoil, but gold prices rose. So, you can use gold or other investment avenues or trade in futures and options to hedge against equity investments.
Learning is a never-ending process, and when it comes to the stock market, new rules and regulations are always being updated. Therefore, you should update yourself with the latest changes in the market and the companies comprising the market. Also, master the art of stock investing for an in-depth understanding of the market and how it works. Take online courses, read books on stock trading, understand the strategies of successful investors and expand your knowledge base. Also, keep track of current affairs that can help you understand which company is poised to grow to invest in it and grow your investments.
Track your investments regularly
Neglect is another reason why investors suffer losses. Stock trading is a dynamic activity. It is not a fixed deposit scheme where you invest and forget. To gain maximum returns, you need to be proactive with your investments. Be updated with market movements and rebalance with changing market sentiments. Invest when the prices are low and sell when prices rise to make maximum profits.
Check which stocks are giving you good returns and which can be sold off to cut your losses. Track your investments regularly so that they are relevant to the changing dynamics of the market.
Profit and loss go hand-in-hand with stock market investments. You can use the tips mentioned above and minimise your losses, but there is no guarantee of avoiding them altogether. Given the volatility of the market, losses are inevitable. Still, if you are careful with your investments, you can steer clear of them or suffer minor losses that do not deteriorate your portfolio. A wise investor is a profitable investor. Be both!