Indian stock market has been making new highs in August after a brief lull of consolidation in the first half of calendar year 2018. Over the years, equities have outperformed various other asset classes such as gold, fixed deposits, bonds, PPF, post office schemes, etc.
Post demonetisation, many retail investors have parked their money in mutual funds or portfolio management schemes (PMS) to reap benefits of a rising stock market. Some investors prefer to invest directly into stocks by using the information available in public domain such as newspapers, TV channels or internet. However, one look at your portfolio and you will realise that your portfolio isn’t reflecting any of the optimism that’s taking the market to all-time high levels.
Anita, a homemaker, has been investing in stock market for the past many years. She wanted to know how to deal with losing stocks in her portfolio. We asked her what she’ll do if her stock pick went wrong and its plummeted over 25 per cent from her buying price. Her response was that she’d wait till the stock comes back to her buy price and get her capital back. We then asked her what her investment rationale was when she bought the stock. She said she’d bought it to make quick gains of 10-15 per cent in the short term. But now, since the stock has fallen sharply, she is forced to become a long-term investor until she gets her investment amount back.
Fear of booking losses
This is one of the most common mistakes that investors make. Once their investment or trading call goes wrong, they rule out the option of selling the stock in loss. Studies have shown that the pain of losing money is far more intense than the joy of making gains. Investors also try to convince themselves by saying that that this is just a paper loss as they have not booked it yet.
Another mistake made by investors is that they hold on to losing stocks thinking it can’t fall any more as it’s already fallen, say 25 per cent. You will be surprised and shocked to see that a stock can fall even 90 per cent from its peak price. PC Jewellers, Manpasand and Vakrangee are some of the recent examples where the share prices have more than halved in a short span of time.
Another rookie mistake investors make is trying to book early profits from winning stocks to compensate for the losses they are making in losing stocks. If there are 10 stocks in your portfolio, of which seven are falling, while three are gaining, the common approach is to book gains in the three winning stocks and holding on to seven losing stocks.
Review your portfolio
One should keep reviewing her/his portfolio periodically, at least once in three months. When you review your portfolio, your focus should be more on the company’s business performance than its stock price performance. If the company’s business is doing well, then a fall in its stock price can be used to average the buying price instead of cutting losses. However, you must keep an eye out for red flags in a company’s business performance, such as if the company is making huge losses due to competitive pressure (for example, the recent telecom war between three telecom giants); fall in the selling price of the company’s products (sugar prices dropped from Rs 45 per kg to less than Rs 28 per kg, creating huge losses for sugar companies), auditor’s resignation from company ahead of quarterly results announcement, etc. Once you spot such red flags in your portfolio’s stocks, it is best to book losses than get emotionally attached to the stock, hoping to recover invested amount in future.
Similarly, if the business performance of winning stocks is much better and future prospects are good, compared to losing stocks, it makes sense to book losses in losing stocks and add more to winning stocks.
The chances of making more money in winning stocks is higher than recovering capital in losing stocks. Also, try and limit exposure to a particular stock or sector to not more than 10-15 per cent of your overall portfolio. This will ensure that you don’t end up making huge losses, in case the investment bet goes wrong in one particular stock or sector.