Narach Investment

INVESTMENT MANAGEMENT AND THE FIRST POSITION


A position in a stock or financial instrument is built over a period of time, while purchasing the same stock over various price levels. However, to begin with we would initiate a position only when we have a confirmation of oversold levels and that there is a reasonable margin of safety available to us.

We expect that, you have understood the various aspects of the first trade. However, before we proceed to the rules of trading, it would be appropriate to have an understanding of how to build a position in a particular stock or financial instrument.

Let's say we have ₹3,00,000/= in our equity trading account. Given our initial requirement to diversify our risk exposure over more than one stock, we would apportion this initial capital into 10 equal risk segments. Each of these risk segments would be a position in a stock. Thus, we have allocated ₹30,000/= per position.

Please note, that we may change this allocation to a larger amount depending on market action and news flow with regard to that particular stock. However, we must realize that we do this at the expense of increased risk exposure; as the stock (or stocks) may not perform as expected.

Let us explain this with an example. We have observed a stock (XYZ Ltd.) with good fundamentals and reasonable growth projections. It has a reasonable EPS and P/E. However, due to adverse market action, this stock has given an oversold price level confirmation. Further, it's price is quoting near its 52 week low. When we check current news flow with regard to this stock, there is nothing alarming. In fact, they are taking action to expand capacity to meet future export demand for their products.

Let's say that XYZ Ltd. has given an oversold signal at ₹100/=. So, we mark this with the purchase of 50 equity shares of this stock. By this action we have initiated our position in XYZ Ltd.

Depending on the volatility of the stock and its Beta, the price down move from here would be 6% to 9%, and in some cases may expand to 12%. As it would be difficult to purchase the stock at rock bottom prices, we can reasonably invest our remainder of ₹25,000/= in the next 6% down move. Over the next few days we find the stock quoting at a price of ₹97/=. Here we would purchase 100 equity shares of this company. So, now we have invested ₹9,700/= and have added another 100 equity shares to our position in XYZ Ltd. Over, the next few weeks the stock price meanders down to ₹93/=. At this point we would invest the remainder with the purchase of 150 equity shares. Here we have invested ₹13,950/=. At this point we have invested a total of ₹28,650/=, and are holding a position of 300 equity shares at an average purchase price of ₹95.50.

Now, as our over all purchase price is ₹4.50 below the initial oversold price level; we have built a certain margin of safety in this position under normal market conditions (or moves). Further, we have pyramided correctly. Still, to provide for a further adverse market action usually caused by an unobserved larger trend that maybe against our expectations we would apply a stop loss at 8% below our purchase price at ₹87.85. It would be relevant to observe that this stop loss is a good 12.15% below the initial oversold price of ₹100/=.

Thus, a fall below this price would mean that we have built a position that has a longer down move to cover, and it would be reasonable to sell this position at this price. Of course, we could invest again in this stock at a lower price at a later date; and by then there would be more clarity with relevant news flow in this regard. For instance, there maybe certain government regulatory changes which effect the profitability of all companies in this industry or sector or certain clarifications maybe need with regard to certain policy decisions.

However, under normal market conditions; the stock price would make one bottom and then retest it after a few days or weeks. Better still it may make a head and shoulder bottom formation. These are all signals for an impending up move in the price of the stock. So, it would be advisable to hold on to the position while it starts its upward journey. We must await the confirmation of an overbought price level confirmation, before initiating the sale of our position in XYZ Ltd.

We have made it sound so simple, and it is. However, we must at all times endeavor to keep emotions away from our transactions in the financial markets. Further, we must respect the equity and other allied markets; and know that we are finite individuals, while the markets are in comparison relatively infinite comprise of millions of participants. Moreover, the markets would exist even after we are gone.