Stock investing is not just an art, it is a science and those that understand the science of the stock market are prone to succeed. Stock trading activities should not be engaged in haphazardly rather it should follow a process.
To be successful, stock market trading should encompass three major processes; price forecasting, timing and money management.
- Price forecasting is a process by which the investor finds out or gets an indication of which way the market is expected to trend. This is a critical first step in trading because it helps the trader or investor decide on when to enter the market and when to exit.
- Timing, on the other hand, helps the investor to determine specific entry and exit points. It is possible to forecast the direction or trend of the market correctly but if your timing is incorrect, you still can end up losing money in a trade. So, to be successful in stock market investing, you should not only know or predict the direction of the market correctly, you should be able to jump in or out at the right time.
- Money management as it relates to stock investing deals with such things as deciding on the allocation of funds, portfolio makeup, how much money to invest or risk in one listed company stock, the type of stops and whether to trade conservatively or aggressively.
Basically, the three ingredients of successful stock market investing noted above are so intertwined that price forecasting tell the trader what to do in terms of buy or sell, while timing helps him or her decide on when to do it with money management capping it up with how much to commit to the trade. With those processes, you know the what, the when and the how.
Sweet and methodical as the process sounds, this blog article will dwell on money management guidelines:
- Don’t invest more than 50% of your funds in the stock market. Just like asset allocation plays a vital role in portfolio performance, fund allocation plays similar vital role in helping you manage the money you are staking in the market. The other 50% should be placed in Treasury Bills to act as a reserve should the market turn against you in the future. So, if you plan to invest N100, 000 into the Nigerian stock market, use only N50,000 for stock trading and leave the other N50,000 in CBN Treasury Bills.
- You should not commit more than 15% of your funds to one trade. It is a well-known fact that diversification is very virtuous in stock investing, so by committing not more than 15% of your capital into one trade or position, you are ensuring that you will only lose about 15% of your investment should anything bad happen to that one position. Risk management can’t get better.
- Do not risk more than 5% of your total equity in any trade. By committing to not loosing more than 5% of the unrealized gain you have already accumulated on a particular position, you will be guided as to the appropriate time to exit a position or how and when to place a stop loss order, if you have to.
- Do not buy on margin and if you have to, limit it to 20% of your committed funds. Currently, the Nigerian market does not allow margin trading, but this may be permitted in the future. For those trading in market that allow margin trading, the purpose of this guideline is to protect against getting too heavily involved in debt which may be catastrophic should the market turn the other way and the margin calls come calling.
- Make use of protective stops to guide against loses. While protective stops help protect profits and limit loses, such order should be placed in line with the market volatility. The more volatile the market is, the looser the stop should be.
With better money management, investors will be in a position shield themselves from calamities of market melt downs and financial crisis.