by Dheer Kothari

Created on: May 24, 2009   Last Updated: June 24, 2010

RISKS OF TRADING ON THE STOCK MARKET

Trading on the stock market is like a double-edged sword. If it works you mint money, if it doesn't you start hemorrhaging! This is particularly so in volatile markets. The opportunity or temptation to make a quick buck is maximum when the markets are volatile. Ideally, traders like to follow trends. To put it simply, you buy into stocks which are in demand on a given day or alternatively you sell stocks which are not in favour.

So, if you are bullish on a stock, you place a buy order at the market rate. Your cost includes the brokerage you pay for the trade. To cut out your potential loss you set a stop loss trade at say 2 per cent below your buy price. In volatile markets, stop losses get triggered in no time. By the time you realise it, your stock hits the stop loss set by you and you end up with a deficit on this trade!

Day trading does not work if you do not have access to real-time quotes or the time to monitor them closely. Most traders book profits too early and hang on to losing positions instead of cutting their losses. To be successful, it is important to retain your liquidity by maintaining a positive cash balance in your trading account. By having a credit balance in your account, you ensure that you can take advantage of major corrections in your identified stocks.

It helps if your positions are within manageable limits. This means limiting your daily exposure  within your comfort zone. It gives you peace of mind and you can do away with panic trades which generally result in losses. However, there are certain risks which need to be taken care of.

An adverse news or development can cause damage to potentially sound stocks. A lost order or a product recall can hit sentiment for a particular stock. If you have buy positions on such stocks it is better to exit even it means selling at a loss.

It is not worth the trouble to buy stocks on analyst tips or broker buy calls. In nine out of ten cases, these are motivated leaks engineered by early birds among buyers waiting to book profits at your expense. 

Sell stocks which are not moving as per your expectations. Even if you know that the stock is worth holding, it may not move on a particular day for a variety of reasons. This could be because there are few takers on a given day. It would make sense to re-enter the stock on a day when its price is rising with volumes. You stand a better chance of making money when the share is in the limelight!

From experience, I have learnt that it makes more sense to own stocks in which you can trade freely without having to worry about losses. Say, you own 10,000 shares of GM.

On a particluar day, you find that the stock has appreciated by 2 per cent without any appreciable increase in volumes. You sell 5000 shares. If the stock falls, you stand to gain by covering at various levels on the downside. If it goes up, you tender the shares for delivery and get the sales value in consideration. The risk of an upside is eliminated altogether. Yes, you miss out on greater capital appreciation if the stock rises say 3 per cent (since you've sold at a 2 per cent gain).

Trading is good provided it is done safely without eroding your capital.

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