Trading Rule – “Begin with defining your time frame”…

Long term and short term can be too generic and misleading at times. Irrespective of whether you are a trader or an investor, you need to define your time frame. Remember, time has an opportunity cost and capital does not come for free. When you enter into a position as a trader or as an investor try to mentally define your time frame. After all, the most important goal for you is to make the best of your capital…

SETTING YOUR TIME FRAME IN CASE OF TRADING POSITIONS…

Actually, setting a time frame becomes all the more critical when you are a short to medium term trader. The onus of churning your capital and maximising your ROI on the capital becomes a lot more important in case of traders. Traders normally have a very short time perspective. That is where you have to eschew the temptation to wait a little longer. You have entered a position with a 1-week perspective. If your trade did not work in that time frame, then it is your job to just move on. Similarly, when markets are getting volatile and predictable, it is important to proportionately shorten your time frame so that you can reduce the overall risk of your portfolio.

SETTING YOUR TIME FRAME IN CASE OF INVESTMENT CALLS…

Unlike a trading position, an investment call is taken for the long term. Here your focus should be to hold on to winners long enough. But again there are exceptions here too. As an investor, you do not just set a time frame of 2-3 years but you break up the target time frame into granular portions. So you will have a view that the stock will move up by 70% in 3 years subject to certain key developments in terms of profitability, growth and order book over the next couple of quarters. What if these developments do not materialize? That is when you need to take a call on revisiting your original thesis. Whether you are a trader or an investor, there is a time value to money and hence you need to treat time frames cautiously. When the stock has disappointed in its initial milestones, as well exit the stock and look to come back to the stock later. Long term shifts in the market also call for resetting your time frame. If you are long on a stock and the market P/E ratio is at 29, then it is time to revisit your time frame, as this is against historical patterns.

“At Berkshire Hathaway our investment time frame is forever” –Warren Buffet

6 TRIGGERS TO RESET YOUR TIME FRAME…

  1. Let us look at the trader’s perspective. It is possible that you may have initiated a long or short trade in a stock and there may be some macro developments that may have changed your original game plan. Let us say, you are short on Bank Nifty futures and the RBI is likely to announce a rate cut in its forthcoming credit policy. Even while you are not sure of the actual RBI intent, as a trader your first instinct should be to reduce the time frame of your holding and protect your capital.
  1. The second trigger to shorten your time frame in a trading position is when the volatility is likely to shift. If you are long or short on the futures and you expect the volatility to go up either due to global risk or due to F&O expiry, then it will have two implications. On the positive side, it could enhance your profits but on the negative side it could deepen your losses. As a smart trader your primary focus should be to manage the risk in your trade and not worry about the returns that you could earn. The rise in volatility is a clear sign of higher risk in your trade and that could impair your capital in the first place. It is necessary for you to first focus on reducing the time frame of your position.
  1. There is also a situation when you can enhance your time frame of the trading position. For example, if you entered a long position with a 15 days perspective and the stock went up by 15% on the third day, what should do? Prudence may dictate you to book profits and exit the position. But since you have a buffer, you can take the risk of enhancing your holding period so that you can eventually get the full benefit of the price movement on the stock.
  1. Let us now turn to the investment time frame! The first case is of an underlying shift in the industry dynamics. There are lot of examples. Telecom being disrupted by Jio, mobile phone manufacturers being disrupted by Chinese producers, hotels being disrupted by aggregators like OYO are all examples when you need to shorten the time frame of your investment position.
  1. When it comes to your investment position, the valuations matter a lot. The euphoria in the market may have taken the market to 35 times earnings and your particular stock to 50 times earnings. Even though your company is still showing impressive growth and good margins, it is a basket case for you to shorten your time frame. You may not exit, but use shorter time frames to assess the profitability of your position.
  1. Finally, you also need to assess your time frame for investments based on the yields on alternate investments channels. For example, when the yield on debt is just 7%, then you can afford to wait longer on equities. But if debt is offering you 12% then the entire opportunity cost of holding on to your long equity position changes. That is because you are losing 1% each month you persist holding on to your equity positions.

FLEXIBILITY IS THE KEY TO MANAGING YOUR TIME FRAME…

The crux of the story is that, irrespective of whether you are a trader or an investor, it is all about managing your time frame. This is, perhaps, the more undervalued decision and yet one of the most important decision traders and investors need to take. Remember, most investors lose out in the markets not because they get their view in the market wrong. They actually lose out because they are not able to adjust their time frame with the changing conditions. That is exactly where your focus in the markets should be!

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