“First, expect to be wrong in the stock market.”
My friend Ravi had a puzzled look on his face. He asked me, “What are you saying Vishal? One has to always be right to survive in the stock market. And you want me to expect to be wrong?”
Ravi isn’t an exceptional case. I have seen so many other investors amazed when I ask them to expect to be wrong in the stock market.
You see, one of the most important traits of successful investors is that they recognize the frequency with which they can get ‘clean bowled’ – and thus they have a plan in place to deal with such situations.
This is the first lesson most new investors fail to digest, and thus neglect.
I have been a stock market analyst and an investor for the past eight years. And, to say the least, I have been rather frequently – and on occasion, quite spectacularly – wrong. But that is something I always expect to be.
No one really knows what is going to happen in the future. This is especially true when it comes to the stock market. So why pretend otherwise?
When you expect to be wrong, it makes it that much easier to both plan ahead and manage risk.
There’s little ego tied up in a stock to prevent you from dumping it – provided you have planned for the worst.
The chief problem, as I’ve witnessed over the years, lies in the fact that most investors consider them as ‘masters’. They have the tendency to marry their stocks.
They invest a lot of time and energy into researching a stock before buying it. They study the company, its products, competitors, and its management. They do all this research.
And once they make a decision to buy it, they really don’t want to sell it. They don’t want to get rid of it. Even if they realise later that buying the stock was a mistake.
So they end up with a situation where just because they’ve have put a lot of time and energy into the selection of the stock, when the time comes to sell it, they are very much afraid to cut it loose.
A lot of that has to do with ego, the lack of humility.
“Hey if I sell this stock, I am admitting my stock picking was wrong. What will everyone think of me? I will look foolish!” This seems to be the attitude a lot of investors have.
At Safal Niveshak, this is what we are trying to change – the attitude of ego and lack of humility when it comes to investing in the stock market.
As an investor, it’s important for you to develop a healthy respect for being humble with your stock selection.
When you buy a stock, expect to be wrong. Realise that the odds of your stock selection turning out a loser exist.
And once a stock crosses your comfort level (on the downside), be comfortable saying, “Hey, the stock didn’t work out. I will take my loss and move on.”
At Safal Niveshak, our philosophy is that if you start out with a stock and expect to be wrong, it will save you lot of money in the long term.
That will help you make the transition to becoming a successful investor.
I do have some stocks in my folio which i think were bad decision, however i am not sure about ” stock crosses your comfort level (on the downside)” how do one know whats the comfort level either on the high side or on the low side, specifically on the low side, Additionally when we buy a stock with all the research is it wrong to stick to it, Market may punish stocks badly like it did in 2008 but that does not mean that its a bad business.
The think is i am seeking more clarity of these items.
Vishal Khandelwal says
The ‘downside’ here is the ‘downside to business’ that leads to a downfall for the stock. If you realize you made a mistake buying into a stock in the first place (as you realize for some of your stocks), there’s no point holding it at a loss expecting to recover your capital.
If you do that, you’ll be trying to plug holes in a leaking boat. It’s always safer to change the boat.
Of course, if you believe you didn’t make a mistake – either in terms of business or valuations – while buying a stock, it’s good to hold on to your horses.
I hope this clears your doubts.
How to identify the comfort level for downside? Is applying stop loss limits are way to limit the losses to protect ones losses? Had I applied stop losses on each of my purchases, I am quite sure every stock (both good and bad) that I hold in my folio would have been sold of at losses? Agreed that EGO may stop from selling the stock, that we can overcome easily, only when you can get convinced that the selection is wrong (e.g. Construction stocks and Telco like RCOM). By applying a stop loss, decision to exit is more dependent on the market price of the stock and not the intrinsic value of the stock.
Vishal Khandelwal says
Hi Ajay. I believe the comfort level depends on the conviction you have with a particular stock. And that conviction is tested when even what you believe is a good business falls 15-20% or more. I personally don’t believe in automatic stop-losses, except that the stop-loss is something that I use (in a qualitative sense) when I find that I made a mistake in buying the stock, or when the business deteriorates after I’ve bought it. The first rule of investing is “don’t lose money”, and that is what drives me in accepting my mistakes asap.