The very term golden rule looks quite a bit talismanic. It almost sounds like there is a kind of a talisman that one can offer to make you a successful investor. Believe me, there is no such thing in the basics of share markets.
What you have is a set of wisdom that has culled from the markets from years of trading and investing successfully. Here are some absolutely golden rules on how to invest in the share market
Don’t put all your eggs in one basket
This is an age old wisdom that has come down since generations. Don’t put all your eggs in one basket basically implies to spread and diversify your risks. Smart investing is about how you hedge your risk and the first step is to diversify your portfolio.
Don’t hold stocks of the same type or the same sector or the same theme. The more diversified you are, the less vulnerable you are specific shocks. If you opt for a diversified portfolio selection, you stand a much better chance of being profitable.
If you cannot think for the next 10 years, then just don’t invest
It sounds harsh but it is bang on target. Investing is for the long term or rather the very long term. When you are investing in the stock market, you cannot have a short-term goal or strategy for investment.
People can make huge amounts of money, but they take a risk in the short term. Markets can be notoriously volatile in the short to medium term so unless you can think about the next 10 years don’t even start investing. You only earn profits on a handful of stocks so make the best of it. That is not possible with a very myopic approach.
Yes, you still need to time your entry and exit in the market
You cannot say that since I am a long term investor you need not time the market. Always make the best of aberrations. When you have selected the stocks for investment, you must decide whether it is the right time for investing in that stock.
The best of companies can be absolutely salivating at one price but grossly unattractive at a much higher price. The company still remains the same; it is your perception that differs. It is not just about charts and technicals.
It is also about how best you can use commodity cycles, cyclical upturns and downturns as well as fundamental disruptions to time your investments in the market.
Keep adequate liquidity for entry and for emerging opportunities
Ok, we are defining liquidity out here in two contexts. Firstly, it is about stock liquidity. If you want to own a stock ensure that the stock is actively traded. The liquidity here can be expressed as a percentage of volumes to market cap.
The bottom line is that you must be able to enter and exit the stock without price impact. We are also referring to portfolio liquidity. That means; keep cash handy when opportunities arise in the market at lower levels. At that point don’t get stuck with MTM losses.
When it comes to investing, what you understand is more important
Warren Buffett says that it does not matter if there are 10 things in the market you do not understand. Just focus on the 2 things that you perfectly understand. That is what matters. Buffett himself kept away from technology stocks because he did not understand them.
It is a different matter that today Apple is the largest shareholding of Berkshire Hathaway. But it is OK to miss trends we do not understand. That is the key rule here. Invest in a business you understand. Focus less on the stock and more on the business model and prospects.
Price is what you pay and value is what you get
This is one of the basic tenets of the stock markets. Don’t focus too much on price. Rather focus on whether there is value at that price. A penny stock may appear to be cheap but it may be pointless buying the penny stock if there is no value addition.
Rather buy a stock with a high stock price, if you see value. Normally, value is the leader and price is the follower. If you focus on value then price automatically follows. You can judge value of a stock in terms of growth, risk, and quality. Value is not just about tangibles but also about intangibles.
In the stock markets, always let your head rule your heart
Two of the most common sentiments in the stock market are fear and greed. Sadly, most of us tend to get greedy when we should be fearful and we get fearful when we should be betting greedy. This results in emotions that normally cloud your judgement.
In a bull market, quick wealth is hard to resist. When investors hear stories of fabulous returns made in the stock market in a short period of time, it impels them to take risk without really understanding the trade-off.
That is where you need to let your head rule over your heart. Take decisions based on hard numbers and cold calculations. Finally, when you are in doubt, just go with your gut!
Many of these rules may appear to be right out of some basic common sense lessons that you learnt as a kid. But that is precisely what we all tend to miss out in our investment journey. Carry these golden rules along the way.