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Sunday, December 2, 2012

Top 5 Online Trading Mistakes - Part II

We covered Top 2 Online Trading Mistakes in Part I of this article series here. Let’s look at the Next 3 Online Trading Mistakes in this closing part of the series. 

Online Mistake #3 - The Lure of Penny Stocks 

Retail investors like to invest in Penny stocks or stocks that trade below Rs 10 per share, based on someone’s recommendation or after receiving hot tips from subscription websites. Most of these Penny stocks remain illiquid round the year, and come into heavy trading volume action only after a synchronous effort on part of cartel of promoters and manipulators to suck in retail investors.

To clarify this further, a Penny stock is often trading below Rs 10 because all institutional investors and large investors have shunned the stock and are not interested in investing in this firm. Most probably, even the promoter has withdrawn all his assets and the stock is just running as a cover for a ghost company with miniscule assets and negligible operations. Because of lack of investor interest, most of these stocks are illiquid round the year. 

To sell this worthless stock to retail investors, cartel of promoters and manipulators create a synchronous operation hands-in-gloves with Tips providing websites. This cartel aggressively markets the stock to retail investors. Because of low trading price of this stock and accompanying good news, lots of retail investors get attracted to the stock in hope of making a quick profit. The cartel starts buying their own shares and this stock starts topping the daily gainers list, along with carefully planted rumors of company starting an overseas operation, or a large deal won by the company or any such rumors. 

After lot of retail investors have participated in this operation, cartel does a pump-and-dump to quickly sell the stock they have accumulated over the past few weeks. Stock now falls on a daily basis with lower circuit on a daily basis with heavy sell volumes providing no outlet to retail investors to exit. Thus, lot of retail investors remain stuck with worthless stocks in their portfolio, whereas large institutions have no participation and promoter and manipulator cartel having made their money by dumping the illiquid stock to common public. Stock remains illiquid after this operation for a period of 9-12 month before another pump-and-dump cycle comes into operation. 

Online Investing #4 – Trading the Morning Frenzy 

Most retail investors place their order first thing in the morning, before leaving for their office or jobs. Hence, it is a well known fact on the Dalal Street that stock price reflecting in the morning often belongs to the amateur traders. 

Another point to ponder is that early morning is the most volatile part of the trading day. Lot of over-night pending orders flood the exchange in the morning, all urgent exit trades flood the screens, lot of fresh news items are blasting through the news channels and lot of amateur in a hurry to reach their office, place a market order for Buy/Sell at the same time among all this volatility. 

Compare this to last hour of the day, where all the news coming through the day has been analyzed and large players are trading large volumes in a clinical fashion. Last hour of the trading day belongs to the Large and Professional traders and volumes are highest at this point. The closing price of stock is the most important price point of the day, used for all calculations and records, whereas Open price is most often not used for any analytical calculation. 

So, retail investors should not place their orders at the market open hour because their orders get affected by the price volatility and often get the worse price point of the day. Placing limit orders and trading towards last part of the day is the best strategy to get the right price point for your buy and sell orders. 

Online Investing #5 –Unaware of the Bid-Ask Spread 

There are about 5000 listed stocks on BSE and about 2000 listed stocks on NSE. However, due to the institutional focus only on top 200 stocks and ongoing news coverage on only the large handful of companies, liquidity is very poor in most of small-cap and micro-cap stocks. Some of these companies might be fundamentally good companies and can be the next Infosys or Reliance, and retail investors might want to participate in their growth journey and rightfully so. 

Only caution one should take is to be aware of the bid-ask spread you are paying for trading or investing in these illiquid stock. Just to take an example, several stocks on bourses, are having severe spread or gap between the buy and sell price available at any instance. Have a look at the below graphic: 


In the above live example, best Bid price for the stock is at Rs 5.62 per stock, i.e. if you want to sell your stock you stand to receive only Rs 5.62 per stock. However, the best Ask price is far away at Rs 5.8 per stock. Meaning if you need to buy at the same time, you need to pay Rs 5.8 per stock. Hence if you buy one share and sell it immediately at the same time, you stand to lose Rs 0.18 per stock. This gap is known as bid-ask spread, and will affect your profitability significantly. In this case, seemingly small amount of Rs 0.18 is a whopping 3.1% points of loss for a retail investor. This is in addition to the brokerage, taxes etc that you pay for your transactions. Over a lifetime of investing and trading, this 3.1% spread will multiply and cause a large loss for a investor unaware of the bid-ask spread he is paying. 

Thus the best strategy is to avoid illiquid stocks or only trade at time when the bid-ask spread narrows down and you get the best price for your investments. Remember, a penny saved is penny earned.

5 comments:

  1. Excellent, appreciate your work. Keep it up.

    ReplyDelete
  2. Thanks Naren for your informative posts.

    My question :What approach do you take while selling stocks ?

    A lot of times we find buying easy but selling difficult , we always think that price could go a notch higher and end up keeping that stock for a much longer period or seeing it through its peak as well as through its bottom on the chart and sell it somewhere in between due to frustration of waiting for the right moment.

    Many a times post selling the stock it rallies to a new level. Which results in anger or frustration of having missed 3-4% profit in haste.

    I have seen many people keep investing in long term stocks and never sell those for almost 10-15 years. But in those 10-15 years we might see market crashing down many times & then people panic and very often than less sell those stocks at half their previously attained peak value.

    How do you take call on selling stocks ? for short term and long term ? especially long-term stocks when you feel like holding those stocks forever.

    How should one be confirmed of the peak value & be satisfied with the profit gained and not feel sorry for having missed the next rally ?

    Thanks.

    ReplyDelete
  3. Dear Rambo,

    Very nice question!

    A simple approach I can suggest is to divide the total shareholding for a given stock in three parcels - Sell first parcel e.g. 33% holding, when you reach your first target. Sell second e.g. 33% again, when you reach your second target and keep the third parcel, which is remaining 33% of share, with you.

    Now obvious question: How to determine the first and second target. It depends on what you need from market and your timeframe.

    e.g. For smaller timeframes (1-3 months), you can keep first target as 25% gain and second as a multiplier of this.

    For longer timeframes, e.g. 1 year or more, you can hope to get a 2X gain as first target and 3X as second target and let the third parcel grow.

    This is just one simple technique. Selling stocks is much difficult than buying them. Hope this helps for you to develop your own technique.

    ReplyDelete
  4. Answer too, nice.

    ReplyDelete
  5. Hi Naren ,

    Thanks for such a quick reply , the approach you have suggested is very nice & indeed applicable.

    Many a times my un-recognised profit of one stock oscillates between 20% to 100% in a year and i still continue to hold it with a vision of 150%..

    Your idea of dividing into equal parcels and booking profit at certain levels will help me get more cash and enable me to reinvest with an increased qty at lower levels...

    Am currently facing the problem in PVR ..was unable to develop a sell mindset... my holding is at 160Rs the CMP is 300rs , will try out parcel approach in this counter ..

    thanks for helping out on this one. yes selling stocks is really difficult thing !!

    ReplyDelete

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