Fact point checks while averaging stock price

FACT Point check before averaging:

(Gitanjali Gems & Jewellery, is used purely as an example)

1> Check if prices of all stocks in Gems & Jewellery industry is sliding or just stock of Gitanjali Gems.

2> Check if the down ward slide is due to an issue with company’s management (most often evident with quarterly result) or due to price operated by natural market forces of buyers & sellers.

3> Glance through Candle stock charts, to understand the psychology of the stock – draw support & resistance zones, using daily moving averages helps. Check what is the percentage deviation of the stock from the daily moving average levels. ex: 20 DMA, 50 DMA, 200 DMA.

4> If it were to be an issue with the industry i.e Jewellery industry in our example, will that lead to credit contraction across all companies in the sector? Credit contraction most often has a bloating effect across industry even when just one company gets into bad books. Remember getting timely credit facility determines the success of any industry.

5> Check what is your risk reward in other industry stocks, if you were to sell Gitanjali Gems & you decided to move to stocks in other industry. (example – Vedanta – Metal industry). This decision needs to be made with total certainty at a very early stage of investment, as it helps from sulking into a quick sand with no help.

6> Stop Loss – Having stop loss to exit trades rather than averaging is extremely important. But understand that they are two types of stop loss – technical stop loss & money stop loss.

a> Technical Stop Loss: You should let the chart decide where the trade would stop being right. It is that very point where price will deny your original thesis of entering the trade based on the chart structure. For example, if you are taking a long trade with 1000 shares of Rs 100 each. And the nearest support is at Rs 90. So SL will be put there because that is the point which, if broken, will break the thesis of going long in the first place.

b> Money Stop Loss: This is simply deciding how much you wish to lose in the worst case scenario. For example, if you are taking a long trade with 1000 shares of Rs 100 each and you don’t want to lose more than Rs 2000. So, you will place a SL at Rs 98 irrespective of what chart says.

Well, the rationale for choosing which kind of stop loss suits you entire depends on your capital, your emotional intelligence & your risk appetite. Ideally potential stop loss should not be more than 2% of your trading capital for day traders, while for long term investors i.e. holding time above 1 year, i would suggest max 15% & definitely not beyond 20% of your capital. Re-shuffling your portfolio & moving on to stocks in industries with better risk reward helps.