Possible ways of losing money in stock markets – 4

Overview:

It has been more than two weeks since my last article. I have been experimenting on some plausible Option Trading Strategies with minimal capital required. So far, it has been a tough journey with no results. May be markets are highly volatile now for a particular strategy to work. Basically, in intraday, most of the moves are traps. Almost 80% of the time, famous candlestick patterns do not seem to work at all. I think such patterns are induced artificially for trapping retail and small traders. After all, we can’t beat the mighty Algo-Trading by hi-tech computers.

Anyway, we shall continue with our series of “Possible ways of losing money in Stock Markets”. I have discussed the first four practices, where new retail investors and traders are trapped, in the previous articles. Let’s move on to the fifth one from the list.

1. Following Fake gurus on social media
2. Trading Penny Stocks
3. Falling prey to Value Traps
4. Purchasing high premium stocks
5. Intraday trading with Margin money
6. Trading Options and Futures without prior knowledge
7. Investing in stocks that you don’t understand
8. Taking short term positions against the market move

Intraday trading with Margin Money:

Margin or Exposure facility is the benefit provided by the brokers for buying or selling of stocks and derivatives. It is extra money (leverage) provided by the registered brokers for buying or selling of stocks, futures, and options. It varies with the different brokers and various orders like MIS, CO, BO, etc. Usually, I only deal with margin benefit while executing Options Strategies like Butterfly or Condors. I never traded stocks on the margin. Here are the links on Margin Trading Facility by two top discount brokers in India, Zerodha and Upstox.

Experienced traders use margin facilities to their perfection. There is a trading technique called Scalping, where traders enter and exit the trade within a very short span, sometimes, in a few minutes or less. In Scalping, the traders target very small moves. But for achieving appreciable capital gains, the volume of the shares or options in the trade has to be enormous. Scalpers make the best use of Margin facility.

Typically, using margin to trade magnifies both profits and losses. I come across many new traders with absolutely no prior experience trading on huge margins like 20X or more. It’s just insane because a slight reverse move in the trade could wipe out the whole portfolio in an instant.

An Example:

Let me clarify with an easy example. Suppose, you want to go long on a company XYZ shares. You have only ₹10,000 in your trading account. Each share of an XYZ company is trading at ₹100. You anticipate that share could go to ₹105 in the intraday. With ₹10,000 in the account, you can only buy 100 shares. At the end of a successful trade, you can make ₹500 (5 x 100). If you are so confident of your analysis, you can use a margin of 10X (ten times). Then, you will be able to buy 1000 shares. For the same trade, you can make ten times more profit.

The reverse is also true. If your analysis fail and the share price drops to ₹95, then the loss would also be ₹5000 since you borrowed 10X (ten times) more margin. In that case, your portfolio will be halved by the end of the trade. If the share price drops to ₹90, the loss will be ₹10000 and the whole portfolio will be vanished. Just imagine, if the share price falls to ₹85, you have an extra debt of ₹5000 along with the already extinguished portfolio.

This is a very simple example to make the concept understandable. In real-life trading, things will be different. You can execute the trade with a stop-loss to reduce the maximal damage. Let’s see how you can do that.

For the same trade, you expect the price to touch ₹105 and have bought the shares for ₹100. You took the 10X margin and bought 1000 shares at ₹100. You can plan to limit the loss to 25% of your portfolio. Then, it’s logical to set a stop-loss at ₹97.5 for the shares. If the share price appreciates as you have anticipated, you can get out with the profits. In case, if the opposite happens and the share price fell suddenly below ₹100 and continued its fall. As you have already set the stop-loss at ₹97.5, you can exit the trade with ₹2500 loss.

But there are situations where stop-loss may not get trigger due to technical errors. If you do not follow the trade manually and stop-loss does not get triggered, the loss would be enormous and unimaginable. It’s prudent to always follow your trade manually until you exit the positions.

Many traders, rather than doing their own analysis, follow the calls from some brokers and websites. I have done a small study on such calls. Usually, every day, some websites provide calls on three stocks, out of which, one goes the right way and the other two calls go wrong or vice-versa. So an innocent trader who follows the calls blindly will only lose the money in the long run. Just think yourselves, if anyone is so confident of a certain movement in stocks, they can get into the trade themselves. There is no reason to share it with others that too for free. To be frank, some companies and brokers advertise the stocks for their own and shady advantage.

My Experience:

I once received a call from one such agent who did not know the basic difference between a trading account and a Demat account. When I asked him a question, he said both are the same. I was upset and had no choice but to disconnect the call.

I am not entirely against margin trading. If you are an experienced trader and know how to use leverage, you can opt for margin benefits. Sometimes, due to technical reasons, the margin in trading accounts would show very high negative numbers. Here’s an article to an unfortunate incident of a youth committing suicide since his account showed $730,000 negative margin trading the options of a share.

I have also witnessed such negative margin amounts around ₹300,000 when I was trading options. Even though I have exited the positions, due to some technical reasons, my account showed a huge negative amount in red. I literally had a mini heart attack since the strategy was only for ₹5000 profit, but it showed ₹300,000 in red. But when I logged out and got in back, the negative margin was gone. Since then, I have stopped trading less liquid stock options. I only trade Nifty index options for now. If you have limited capital, it’s better to trade Nifty or any Index options rather than stocks options, since stocks options move violently and require more capital.

Previous Articles:

1. POSSIBLE WAYS OF LOSING MONEY IN STOCK MARKETS – 1
2. POSSIBLE WAYS OF LOSING MONEY IN STOCK MARKETS – 2
3. POSSIBLE WAYS OF LOSING MONEY IN STOCK MARKETS – 3

Disclaimer:

I provide the information and my views on the website only to educate new investors, stock market enthusiasts, and the common public on equity or stock market investments. Please consult your financial adviser before making any investments in the stock market. In case of any queries, you can contact me via email ID: shivakumar.lachapeta@valueinvesting.online