I have written about educated speculation in the stock markets (here) and about how to create an ideal streamlined portfolio of stocks for the long term (here). A topic I have never touched is short term trading in stocks. The irony is that this is what keeps me busy on a regular basis. If you follow the markets as much as I do, it is hard to resist buying and selling in the short term.

My 7 Rules of Discipline for Short Term Trading

Notice the word that I use is ‘trading’ and not ‘investing’. Also keep in mind that none of what I write below should be treated as a way to trade in derivatives (i.e. futures and option lots). This applies only to cash market delivery trades. Naturally you will do far better with these rules in an environment where markets are either range bound (i.e. volatile) or are rallying. Preferably range bound.

Trading by nature requires far more discipline than any investing operation. Follow the rules below and read them every once in a while to make sure that you are not breaching any of them.

  1. Decide a sum: Make a basket of 10% – 20% or any other amount of your wealth. Call this your ‘short term trading basket’. This money you have demarcated for short term trading should be what you do not need for a very long term. It helps to define things too. For me short term is anything from a day to 6 months.
  2. 10% in each stock (most important): Create an excel sheet where you note down the number of stocks you buy in the short term basket. At no point should you own more than 10% in a single stock in this basket. This means that the minimum number of stocks you will have at any point is 10. It is a good idea to rebalance your portfolio from time to time.

Example:

Your basket is worth Rs. 5 lacs. You buy 5 stocks in it each for Rs. 1 lac. A month later you realize that one stock is up 20% while another is down by 10%. It is time to sell the profitable stock and either keep some cash or reinvest more in the stock which is down by 10% make sure that no single stock has more than 20% allocation of your total funds.

  1. Be prepared to book a loss/ Fix your downside risk: If a stock falls 10% or more, be prepared to sell it. I know, this sounds stupid. “The fall may be due to a short term news item, and in the long term this stock could rally over 50%”. No matter how strongly you believe in this, just sell it. Remember: you are not doing any of this for the long term.
  1. Never (ever) invest on rumors: For me, the excitement or even the entertainment value (if you may) of trading comes from assessing the future, speculating on corporate results and news flow. If I were to leave all this for someone else to do, I’d rather not do any of this. Every day, I get loads of email with hot ideas including from many of you. While I pay close attention to what is being talked about in the news, on blog forums and by market experts, usually it is a reason to be careful. Careful even when I am already sold on an idea. “Question the reason” – is there a reason why someone is positive on something? Did you already believe in his reasoning or are you getting anchored because someone else has a certain view? This is a pretty bold statement to make for someone who is in the business of giving ‘expert advice’. Don’t blindly listen to me. Don’t blindly listen to anyone.
  1. Don’t try to imitate anyone – Know that everyone has their own style. On a lighter note – I once heard a story of someone who created a business where he wanted to book losses. It was tax efficient for him to show losses in that business. The idea was noble and the approach unique. Naturally, asking such a person about the fundamentals of this line of business will get you nowhere. Many diversified businesses in the listed space have verticals which are meant to create losses – businesses meant for surrogate advertising are a perfect example. I doubt if Carlsberg is making any profit by selling club glasses.

Point?

Don’t buy a stock because a mutual fund allocated 0.49% of their fund to it. They may have a very long term view in the business or they may just be speculating far more than you. Individual investors, particularly some of the renowned ones get dime a dozen forms of incentives to take position in a company. In fact, in recent times I haven’t seen any stock doing well after a big investor bought into it. It is usually the unheard of names which go on to create most wealth for shareholders.

  1. You don’t always have to trade: Sometimes it’s better to leave your money in a liquid or arbitrage fund. Take a break! Typically, every 2-3 months.
  1. Don’t be harsh on yourself (or me): The rules above are indicative in nature. They will help you but they are not foolproof. I can guarantee you one thing; you will be a far better short term trader if you can keep this discipline. Following these rules is easy, breaking them is even easier.