Pt 4

Newbie's Guide to the Stock Market Pt. 4

Part Four: Capital Management, Cut Loss and Taking Profit

Capital Management

For the fourth, and final part of our stock market discussion, we are going to examine the psychological aspects of trading or investing in stocks. Again, I do not want you to take this part very lightly, as the condition of your mindset is of utmost importance during when you place your trades.

Always remember, and take a mental note of your initial capital. This should serve as a reference point for future actions.

It is important to note that you cannot always win in every trade you make. Thus, it is important to make sure that the money you lay out to invest in a certain company must be prepared to be lost. However, one need not have the mindset that "I'm prepared to lose it all".

The best way to manage how much of your capital to "invest" is to set your own rules and it should be determined with the amount of capital you plan to invest with. 

Say you plan to start off with RM50,000, perhaps it is wise to first consider risking only 10% of your capital. If you start with smaller amounts say RM10,000, then splitting it into parts of 3 perhaps is a better idea. The rational behind keeping some cash, and risking the rest is this:

Let's say things to come your way, and you would have lost RM5,000 from your initial investment of RM50,000. You would be left with RM45,000. You wouldn't need to sweat it out to make extraordinary gains with your money left. In fact, you need to gain a mere 10-12% for you to gain back to your initial investment. It isn't difficult and usually you could target oversold, fundamentally strong companies. A quick bounce back could net you a 10% gain easily. 

However, if you would have lost RM25,000 on your initial RM50,000, you will have to sweat it out. Infact, you have to gain double (or gain 100%) on your capital that's left to breakeven. That means that your stock price must double. Since that's quite rare in the Malaysian stock market, you might have to play it out with a few big trades. That increases your risks and prolongs your timeline to be be breakeven, or even break a small profit. 

Cutting Loss and Taking Profit

One should instead, set a limit or a price in which he/she might want to sell the stock when it has fallen below the purchase price [cutting loss], or when it has gained against the initial purchase price [profit taking].

There is no one "Method" to determine when to cut loss or when to take profit. The best indicator I would recommend is by referring to the charts, and candle sticks. In this discussion I would discuss a little further the application of technical analysis using candlestick charting.

A chart detailed with Technicals that you could draw-up for yourself: click to Enlarge

Things to look for:

1. Uptrend or Downtrend candlesticks, as shown by light blue indicators in the exhibit above.

2. Drawing resistance and support lines. The more frequent the candlesticks touch your line, the better. It shows consistency. I.e. Line 2 has quite consistently supported the candlesticks. 

After determining your resistance and support lines, as well as potential uptrend or downtrend candlesticks, you can then determine your strategy. As you can see from the exhibit above, if you were trading somewhere between January 2013 and February 2013, you would have noticed (as indicated by green indicators), that the candlesticks have broken through Line 2. Upon realizing that, you could have sold your stock and avoided big losses. 

As of now, if you have owned the shares in the company listed in the exhibit above, you would be looking closely for a breakthrough of Line 2, which might mean a possible uptrend tendency.

If however, you would have bought the stock when it hit Line 1, you would be looking to take profit when it hit Line 2, and failed to breakthrough it. Instead it retreated. The information is however, incomplete and it is up to you to pull the trigger. 

Be reminded that nothing can predict prices accurately a 100%. Please note that indicators are only partly accurate, and should not be the sole basis you use to predict the share price movements. Be ready to accept the fact that you cannot always sell at the highest price, but such analysis does give you the maximum possible return on your investment. However, no one ever knows how high or how low it will go, correct?