"Each investor has a different behaviour and risk appetite. Based on their preferences of the trade-off between risk and reward, one of the above Exit Styles can help," says Shubham Agarwal, CEO & Head of Research at Quantsapp Private Limited.
Knowing when to ‘Buy’ a stock may not be as tricky as to know when to ‘Sell’ it. A transaction is not complete unless the second leg goes through i.e. square-off and it is equally important to have an ‘Exit Strategy’.
But, is predicting a top possible? It certainly may not be due to the randomness and noise. An investor may not be able to grab the exact top for an exit but being around that may practically be possible.
Price ultimately reflects the behavior of participants as a whole which has patterns.
Wait a minute, I didn’t mean I can help you predict the top and neither market cares about my studies. We being market participants can at max follow what market prices and its derivatives have to indicate.
Irrational Exuberance does occur and one of these styles should fit most investors to identify a level to exit.
Predictors are investors/traders who want to reverse the trade at the topmost level possible. Most of the market swing tops witnesses a ‘Buying Climax’ followed by a sharp ‘Reverse Force’.
Most of the Candlestick patterns like: Bearish Engulfing, Spinning Top, Hanging Man, Evening Star, etc. are built around this common behavior.
But, here is a second rule of validation that such action should be in a completely isolated area and not within an oscillation.
Riders are a category of investors who follow a ‘Trail and Stop’ methodology. This is a wise method which does not get carried away with short-term pattern failures and is less prone to being stopped out that often.
This style can be best understood with an example: Let’s assume you threw a stone towards the sky. Now, the stone will initially keep moving higher and higher while the velocity will keep decreasing and there will come a point where it will stop moving any further and reverse.
Similarly, The Riders don’t care how high the stone (market) could go and they keep trailing their Stop Loss level higher and higher as the market moves and once come to a point that the market finally moves below that level, stopping out the trailing stop and leading to an exit.
Have you experienced the market moving up again post your stop loss got triggered? Don’t worry it’s a common phenomena and here is the way out.
Style of ‘The Hedgers’ is to not get carried away with temporary levels of the market and keep hedging the downside while locking the profits with a known small loss of premium.
This keeps them in the trade with unlimited upside potential while the downside is protected which can be shifted as the instrument goes higher to lock more and more profits.
Smart investors can also bring their hedging cost down significantly using Option Strategies as long as they are ready to take risk beyond a level. For example: Hedging for 2 percent- 10 percent fall but open below that.
Each investor has a different behaviour and risk appetite. Based on their preferences of the trade-off between risk and reward, one of the above Exit Styles can help.
Disclaimer: The author is CEO & Head of Research at Quantsapp Private Limited. The views and investment tips expressed by investment expert on moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.