Always Have Your Plan-B In Place

A successful self trader – Rule # 46

This rule is an extension of the previous discussion on market panics. Any decision must be taken with a plan-b. Remember, plan-B becomes relevant when your decision goes against you. When your decision goes right, your rulebook is good enough. But, do you have plan-b for macro shocks, global uncertainty, monetary tightening, sharp corrections and basket-selling?

Your Must Always Have An Alternative

The Plan-B rule is an extension of the rule on market panic. Plan-B works like a contingency. It is all about the inherent risk of your buying or selling decision going against you. In his landmark book, “Against the Gods”, Peter Bernstein rightly remarks that “Man’s progress in the 20th century is due to his ability to understand, quantify and manage most of the risks”. That is exactly what Plan-B is all about.

The first aspect of Plan-B is what to do when there is an actual loss. Assume that you bought BPCL and the next day price falls due to higher subsidy burden. Let us say you bought SBI and RBI announces stricter provisioning norms. When the price comes down in these circumstances what is your Plan-B; should you just exit, average your position or hedge with options?

The second aspect of a Plan-B arises when there is a notional loss. Let us say you sold a stock and it has shot up further. Should you sell more or just let it go? You are sitting on cash and markets are up. Should you stay put or jump into the bandwagon? Should you participate through equities, futures or through limited risk options? These questions will be answered by Plan-B.

The Three Golden Rules Of Creating Your Plan-B

If It Clashes With Your Rule Book

Just follow the rule book. If your Plan-B suggests that you add more of TCS and your rule-book warns you that you are getting overexposed to the tech sector, just listen to your rule book. In doubt, the rule book should prevail.

Detailing Is The Key To A Plan-B

Try to envisage as many risks to your buy or sell decision as possible. Look at global factors, geopolitics, oil situation, FII investments, local inflation etc. The more detailed your Plan-B, the more effective it is likely to be.

Plan-B Is Relevant For All Asset And Liability Decisions

No, it is not just about equities. If you have bought a debt fund and rates are going down, you need Plan-B. If your home loan has negative equity, you need Plan-B. If you are overexposed to gold, you still need Plan-B.

“To be a winner you must first plan to win, then prepare to win and finally expect to win – Zig Zaglar 

5 Steps To Creating And Working Your Plan B

  1. First evaluate the global risks. Can the strife in the Middle East raise oil prices? Can the problems in Ukraine spill over to the rest of Asia? If the US starts tightening liquidity, will it make more sense to be in bonds or equities? If China slows down, what will be the impact on commodities? And so on…
  1. Secondly, evaluate the India macro risks. Will the RBI cut rates and how will it impact rate sensitive stocks? If rupee is weakening, should you be invested in IT or pharma? If the government is spending heavily on infrastructure, how do I position myself in direct beneficiaries like capital goods manufacturers?
  1. Thirdly have a plan for micro risks. Telecom is losing pricing power, should I hold on to Bharti? The MCX group is in trouble, how should I approach all group stocks? PSU banks could have 10% NPAs, what now? Infosys is losing market share to competition, what next?
  1. What triggers Plan-B is a very critical question. Typically Plan- B is triggered by negative price movements. But it can also be triggered by other pre-emptive factors. Very low delivery volumes, spikes of volatility in prices, heavy short build-up in futures, analyst downgrades and insider selling in a stock can all be reference points to trigger off your Plan-B.
  1. Finally, I come to the principle of relevance. Don’t get into the risk of over-analysis. Applying points 1 to 4 as above is relevant when a particular asset class is more than 20% or a particular stock is more than 10% of your holdings. In most of the other cases, either a focus on global factors or a focus on macro factors or a quick analysis of micro factors alone will be sufficient for you to apply Plan-B. Avoid becoming a sucker for big data.

But Does Plan-B Really Work?

You bet; it sure does. Let me cite 2 examples. When Kingfisher Airlines was flying high in 2007, global airline companies were bleeding, domestic competition was forcing prices down and the group was heavily in debt, which it could never service. A cursory look at any of these factors would have triggered Plan-B and prompted you to exit. Those who triggered Plan-B are surely better off. As for those who held on, they have ended up stacking worthless paper.

Plan-B would have surely helped call the top of gold in 2011. Gold was emerging as an alternative to the US$. From $250/troy ounce in Sept 1999, it had risen to $1900/troy ounce in Sept 2011. In 2010 the Euro crisis had started benefitting the dollar. Liquidity and a US economic revival were creating green shoots in the US. As the dollar started strengthening, the prices of gold peaked out and started weakening. Gold is almost 40% off its peak levels seen in 2011.

Takeaways From The ‘Plan-B’ Debate…

The great Hollywood actor, Will Smith once commented, “There is no reason to have a Plan-B, since it distracts from Plan-A”. Sadly, most of us cannot afford to be so nonchalant when it comes to investments. Today with the explosion of information you have access to most global data points at the click of a button. Expert reviews can help you sharpen and refine your assessment of risks. Of course, when in doubt you can always consult your advisor or your broker. But please don’t jump into any investment decision without a Plan-B firmly in place.

As Pablo Picasso rightly said, “Goals can only be achieved through a detailed plan, in which we must fervently believe and vigorously act. There is no other route to success.” The moral of the story is clear. Start off on your Plan-B right away.

You can ask us your stock related questions with #AskReligareOnMarkets via our Twitter channel @religareonline

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