Things to know in times of volatility

I've been receiving numerous calls on direct equity investments from existing clients and also many first timers. The frenzy is to cash in on the raging markets after an almost fatal fall in March. The fall itself was a result of mass hysteria on the possible destruction of the world economy by the emerging pandemic and the loss due to the subsequent lockdowns. But as the economies started to open up gradually, those fears turned out to be unfounded and with proactive policies (fiscal & monetary) by the federal governments and bankers have resulted in enormous amounts of liquidity into the system which eventually flowed into the riskier assets.

I'm delighted to hear buoyant stories of many of my known clients and acquaintances making gains in this market and are happy. My only concern is the confidence that they're gaining on the ability to tame the markets for their advantage. Not contesting any of their efforts, I would hope to see a method to their success, and they incorporate a strategy to continue to achieve this. Though, there's no single way of achieving stock market success, I would like to draw some boundaries, which could form a ballpark guidelines, only be appreciated in times of volatility.

Liquidity: Possibly the single most important factor in stock trading. It's needed on both sides of the trade. The trader should remain solvent irrespective of the market happenings and so if anyone is solely depending upon making their living off the equity market then they should've sufficient reserves at their end.

For instance, a stock trading at Rs5 attracts more attention as it's seen as affordable. Even a rise to Rs6 would give a 20 per cent return, but many of such stocks are illiquid meaning not easy to trade particularly in a falling market.

Risk tolerance: This is something most comprehend only after a disastrous result. Taking the very example of the above stock price, what if the stock price falls to Rs4 and wasn't able to divest at the right time due to illiquidity. One ends up sticking that stock in their kitty beyond its utility and the purchaser's comfort zone. While taking a position, almost everyone is aware of a possible loss, but to what extent is not defined and it's critical to define the level in advance. The expectation and bias of our investment doing well could fog the rationality and should be avoided.

Stop-Loss: This becomes the crux of an investment strategy. It defines the limit of risk one is willing to take beyond which the loss becomes intolerable. It thus forms the insurance, that small premium (loss willing to let go) for a reward (a higher loss if held beyond that point).

Return acceptance: I'm coining this word to highlight the significance of expectation that one needs while trading. As and when the price hits the target, the stock has to be re-evaluated for next target and consequently, action has to be taken. Divest, profit-book and/or add further could be looked upon reaching each target.

Portfolio: Enough literature is available to substantiate the need for a portfolio creation. This also helps one look how much one has to allocate into a particular stock at any given point of time so that the risk is not skewed against the trader's philosophy.

Reallocation: It's difficult to say enough when the potential to earn is high and the approach of reallocation. While every position is taken to make most out of it, not all positions in a portfolio do similar at all times and when one stock catapults within the portfolio, the risk needs to be mitigated by reallocating so that risk is not tilted.

Humility: It's one characteristic that takes people long way in life not just in stock trading. Not all sales are distress and the reason for selling could be that their target price is achieved or portfolios rebalance, etc.

Also, read lot about the industry, economy and companies for research, above all be open-minded to accommodate the changes happening in the markets.

(The author is a co-founder of "Wealocity", a wealth management firm and could be reached at knk@wealocity.com)