New to stock market investment? If your answer is ‘yes’ then read on. If your answer is ‘no’ then also read on, because to survive in stock market on long term we need to constantly remind ourselves of the simple age old and proven golden rules of investment in stock market.

At this point I am taking the liberty to seek a promise from newbie investors and that is a promise to not make the mistakes most seasoned investors have made sometime or the other in their lives. The harsh reality is that the market does not pardon mistakes and some mistakes can be almost fatal. You can avoid all these pitfalls by simply adhering to certain golden rules which I am terming somewhat flamboyantly as ‘Survival Kit for Newbie Investors’.

To further drive home the point let me present to you an unspoken secret of investors in stock market.It is on record that in Wall Street the seasoned traders/investors always talk of their profits and not the losses sustained by them. This gives newcomers the feeling that there is only money to be made in this market and hardly any chance of losses. But the damning truth is that if you do not enter the arena having donned adequate protective gear then the chances of losses are far too many. And your protective gear comprises of the golden rules contained in this ‘Survival Kit for Newbie Investors’.

In case you manage to survive without the protective gears then you should consider yourself extremely lucky. If that is the case then you would be better advised to try your hand at a casino, since your Lady Luck is benevolent towards you. For most of the investors though, that is not the case and hence my over-emphasis on adhering to golden rules of investment. To stretch the point further I would strongly maintain that even with protective gear, you need to be always on your guard. Keep your guard up anytime and every time because a champion boxer knows that the moment he lets his guard down in complacency, he can be knocked out by a freak blow. In recent memory in India one is reminded of Satyam scam as an example of such freak blow.

The bottom line is, if you want to be a consistent champion investor you need to abide by some golden rules. If you have to err, then please err on the positive side. Make no such move that can erode your capital. So what if you have missed an opportunity, at least that mistake has taken nothing from your pocket which is a huge positive in a stock market. This brings us to an important issue of Capital Management which we shall discuss in the succeeding paragraphs.

Capital Management

Money invested in the stock market is your hard earned money. Preserve it with all your power of will and wit, because believe you me, its a jungle out there where might is right. If that is fully understood then lets go right ahead and enunciate few golden rules of Capital Management in stock market.

Rule #1. The capital that you employ in stock market should be from your disposable income. Under no circumstance should you violate this rule. This means that you should not ever take loan to finance your trade. To drive home the point let me remind you that Indian investors had taken huge loans from financial institutions ably aided by broking houses for the much hyped and overly priced IPO (Initial Public Offer) of Reliance Power. And they got bust!

Rule #2In any single trade never commit more than 10% of your capital. In case it fails then you will not have to spend sleepless nights over it. And you will be in a fighting fit condition to recoup that loss in other trades. But just imagine if you were to commit 80- 100% of your capital in a single trade and it fails. You will be wiped out of the market for good.

Rule #3Initially make it a habit to take out the profit you earn from stock market and keep it in separate bank account not linked to your trading account. You should keep on siphoning this profit till it equals the amount of your initial capital employed in stock market. For example you have done an initial investment of INR 1 million. You should take your profit out of your trading platform till your profit equals INR 1 million. Then you are mentally free to trade the market since you have fully secured your initial capital in this manner.

Rules enunciated above are to be adhered to in letter and spirit. You may crib about these rules since they may curb your style, but they are a must for your long term survival and success. Let me assure you that if you take few right decisions , it won’t take you more than a couple of years to accrue profit equal to your initial capital employed. And imagine a scenario only couple of years down the line when you are trading in the market with your initial capital fully protected by following Rule #3 above. You will have the psychological advantage to go aggressive in trade and make killings after killings. Of course those killing trades will have to be entered into with proper protection of stop loss order. Always remember to put on your protective gear, since its a war – a jungle war! Next we shall evaluate the efficacy of this protective gear called Stop Loss Order.

Stop Loss Order

Warren Buffet maintains that to be successful “you only have to do a very few things right in life so long as you don’t do too many things wrong”. But there is a catch here. You are bound to take many wrong decisions in stock market over the long haul. Warren Buffet was well equipped to avoid too many wrong decisions, besides being properly groomed in trading right from early childhood. A little known fact is that Warren Buffet’s father was a stock-broker and a parent’s influence at an early age in such matters can have tremendous advantage. But most of us are not so very well placed and hence will be prone to making many mistakes while taking trading decisions.If that be so then what is the solution? The solution lies in limiting your losses from wrong decisions by way of Stop Loss Order. We shall now postulate some golden rules in the words of a legendary trader W D Gann:-

Rule #1. Remember when you make a trade, you can be wrong, therefore place a stop loss order for your protection.

Rule #2. When in doubt, get out of the market.

Rule #3. When you have nothing but hope to hold on to, get out of the market.

With due deference to W D Gann’s rules, I would like to hazard a couple of exceptions to the general rule of applying Stop Loss Order in all trades. If you are an investor never put a stop loss order when the stock is trading 80% below its all time high. If you feel that you are entering into a good trade at that level, just go right ahead and buy without stop loss order. You will get a chance to exit honourably even if your trade goes wrong. Simply hold the scrip with patience.

Secondly, if you have confirmation that you are buying in the 2nd phase of a bull run then you may dispense off with stop loss order because the stock price is bound to move above the previous high. If you are not placing stop loss order, then you need to have a firm mind and not panic under any circumstances. Next we shall dwell upon certain issues relating to investor psychology.

Greed And Fear

As a new investor you have to first clear your mind of greed and fear. It is easier said than done. Yet you need to constantly remind yourself not to be caught in this trap of greed and fear. I say it is difficult because of the fact that greed and fear are part of basic human nature. You have to toil hard to go against the grain of basic human nature, and that is why I am harping so much on this point. But once you can achieve this frame of mind then you will be able to avoid the catastrophic events of stock market. Hear out what William Gross has to say – “Markets invariably move to undervalued and overvalued extremes because human nature falls victim to greed and/or fear”. By staying clear of greed and fear you will avoid the pain of regret as well as save yourself the pain of burning a hole in your pocket. Some of the golden rules are:-

Rule # 1When faced with sure gains do not be risk-averse, while faced with sure loss do not become risk-taker.

Rule # 2.Beware of situations when high percentage of participants become overly optimistic or pessimistic of the future, it is a signal for the opposite scenario to occur.

Rule # 3. Never aim to enter or exit trade at exact market bottom or top. If you succeed to catch the exact market top/ bottom then you are lucky amongst millions, which most of us are actually not.

Rule # 4. Avoid entering trade in bubble situations and speculative runs. Sit on the sidelines till dust settles down.

There is a human tendency to give too much weight to recent experiences and extrapolate recent trends that are at divergence to statistical odds and rationale. That is how investors become more optimistic and aggressive in their trade when market goes up and more pessimistic than necessary when market goes down. Let greed and fear not grip you in such situations. Simply remember that what goes up has to come down, and vice versa. Laws of nature will ultimately govern everything in our lives and stock market is no exception. The legendary W D Gann gave utmost importance to the laws of nature and astrology while devising his super successful trading strategies in different markets. In the following paragraphs we shall  learn to pay our obeisance to the laws of nature.

Laws of Nature

We need to acknowledge the fact that Laws of Nature govern most of the events on this planet. It is ridiculous to try and defy the supreme powers of nature. If that is accepted then there will be no difficulty in following certain universal laws of nature that work even in stock markets. To be successful in stock market on the long run you will have to observe these laws with fanatical respect. Read on to familiarize yourself with some of these laws and make a strong mental note to follow them at all cost:-

Law # 1. Markets like everything else in life moves around in sinusoidal cycles. The cyclical nature means that you have to take the ups with the downs. Human emotions of euphoria and inflationary speculation ride the crest of the cycle, where as on the other extreme the emotions of despair and panic straddle on the trough of the cycle. Have the strength, courage and conviction of avoiding such extreme herd mentality while investing in stock market.

Law # 2.Marketmanipulations are possible only in the short term, thereafter laws of nature take over in the long run. Primary trend cannot be manipulated . No single individual or group of individuals can exert influence on the major trend of the market.

Law # 3.Good days cannot continue in perpetuity.There will be good days with the bad. This means that even the best of companies will have to encounter some bad days along its journey. Which brings us to the point that if you believe you are secure from losses by investing in a good company, it is untenable. So do not be emotionally attached to any company. If the situation so demands then do sell X company and enter into a more promising Y company. At the end of it you are in stock market to make money, not to buy ownership of companies. Keep an open mind and do not be dogmatic about which company you buy. As far as you are concerned all businesses are good so long as your buy trade gives you return of your choice.

Law # 4. Persistence on luck leads to bankruptcy. This behaviour of over-dependence on luck is manifested in stock market in the form of over-trading. One of the biggest blunders of traders is the desire to get rich in a jiffy and hence they over-trade. This calls for heavy dependence on luck. There are numerous examples of big and seasoned traders getting jettisoned out of stock market forever, only due to over-trading. You should guard against this evil with all your might, by strictly following the rules of capital management and stop losses.

Mind Game

You may think I am kidding, but stock investing is basically a mind game. It tests your character and strength of your mental fabric. If you have any doubt then as you read on you will realize the veracity of my statement. For the time being, simply promise yourself to follow these rules which govern your thinking while investing.

Rule # 1. Do not change your mind after placing the stop loss order. Many traders who had wisely put a stop loss order, cancelled the same once they saw that the market is going against them. Some shift the stop loss level to try and give time for market to move in the desired direction. This is a seriously flawed behaviour and may result in great losses. It is seen that 90% of the time a trader will be a winner if he maintains the original stop loss level and refrains from cancelling it. When you cancel a stop loss order you are merely hoping against hopes that market will reverse its direction and move in the direction of your trade. This can have a disastrous outcome.

Rule # 2. Be firm in your mind while initiating a trade. You must decide to enter a trade after having given due thought to it. It must be done after you are fully satisfied, having done adequate research/consultation. How can you buy stocks when you don’t buy vegetables without making elaborate enquiries about the right price!! But once you have arrived at an informed decision then be firm in your thinking and do not change your mind or cancel the trade without adequate reasons.

Rule # 3. Should the market reverse direction never let a profit run into a loss of capital. This can be done by raising the stop loss level progressively. This system of progressively increasing the stop loss level will ensure that you roll your profits and cut losses. But the basic mistake that traders have been doing since time immemorial is that they cut their profits short out of fear, and roll their losses on the hope that the market will move in the desired direction. This is a serious mistake and should be avoided at all cost. Be resolute in your mind and use your stop loss orders effectively, and progressively increase them to stay with the trend, till the stop loss order is triggered.