Trading in stock markets remains a tough job although it seems quite easy.It requires meticulous planning and thorough technical research before you execute your trading plan.It is imperative to remember that it is not all about placing buy or sell orders.The risk starts the moment your order gets executed and you are in the market.What should be done and at what moment,you shall be aware about this only if you have your trading plan written on a paper with you.
The process of creating a trading plan involves some necessary steps.After going through these steps only,you would be able to minimize the odds stacked against you and maximize your probability of success.Markets always have a 50-50 chance of moving in either direction.Everyday,it is like tossing a coin.It can be head or tails.So,few days of continuous rise or fall is never a signal of sell or buy.After a fall in price of continuous five days,it is not that you should buy it now and it will start rising now and can not fall more.By having a proper trading plan,you can turn this 50-50 ration to 80-20 in your favour for any particular trade.Following are the steps you need to follow before you jump into a trade ;
Define your trading horizon :- First thing,you should have in your mind is the time period you can give to a trade.You can trade Intraday,for few days,weeks or months.Having fixed your time horizon for a trade,it would help you to select the charts accordingly and opting for a suitable trading tool.You can choose to trade via Futures,Options or Cash.If you wish to give few days or weeks but less than a month,it is good to trade via Options.For one to less than three months,you can go with Futures.Futures & Options give you the luxury of cash leverage although the risk is also higher.For a period longer than that,you can opt trading in Cash.
Technical Analysis :- Of course,technical analysis remains the foremost and basic thing to be done before taking any trade,Depending upon your time horizon for trade,go for hourly,daily,weekly technical charts of the stocks you would like to trade in, for technical analysis.Look for any short term chart pattern formation and breakout or breakdown from these formations.Chart pattern breakouts or breakdowns have high probability of hitting their targets and that too in a definite time period.If you don’t find any pattern,look in the charts if there is any breakout above a resistance line or breakdown below a major support line and trade short or long for target of next major support or resistance.You can also use a trend line to initiate a trade.
Calculate Risk to Reward Ratio:- After you found a trade,find its target potential and risk it carries.This is its Risk to Reward Ratio.This ratio determines whether a trade is worth taking or not.Avoid taking trades with risk reward ratio of 1:1 or 1:2.It is always good to have a trade with ratio above 1:3.Lower risk helps holding a stock comfortably in case of adverse movement and the loss is minimized while maximizing the rewards.
Choose a Trading Tool:- Now this is another important part of trade.Which tool should you use?Of course time horizon is important determinant,other factor is user risk appetite.This all depends upon your Risk Profile.Futures & Options (Derivatives) are very high risk trading tools.They give you the leverage in the form of cash where you can get big gains with a small capital with you.But the risks are also equally higher.As the Market Guru Mr. Warren Buffet says –
“Derivatives are the financial weapons of mass destruction”
Unlike Cash Trading,where you can hold your stocks for any period of time,in case of derivatives you have to close your position on or before the expiry of the contract you are trading in irrespective of profit or loss.Although broking or commission charges are far less if you trade in derivatives.
Profit taking or exiting the trade :- In the markets,it is said that it is sufficient if you have made 4-5% returns on your capital in a short span and you should look to close your position or more wisely you can keep a trailing stop loss to protect the gains before any adverse market move washes away all your gains.Secondly,if the stock is not moving reasonably as you were anticipating even after giving sufficient time and you are convinced that it may not move in the desired direction,it would be a good idea to exit that trade.Never be stubborn that you can not go wrong as you have taken the trade after doing all the necessary to do’s.That saves you of time,frustration and any untoward trading loss.So it is always important to apply Exit Strategy appropriately.
Finally,we can also say that you need to properly manage your trade and control your human emotions during the trade.Trading in stock markets is more of an art and requires all the skills besides the research and analysis.Trading remains one the most promising and rewarding business,the need is to take it as a Business like a serious businessman.