Adopt These Techniques to Avoid Losses in the Stock Market
Of the many stock market crashes, the most famous ones have caused a collective loss in Sensex of nearly 13% points in the past in a single day as a result of Covid. Individual stocks have also faced some major losses in the past like the infamous drop of popular unicorns like Zomato, PayPal, and Nykaa as they touched record lows earlier this year.
Although people enter stock markets to make good returns, many may burn holes in their pockets.
In such a situation, quitting the stock market altogether may seem like a reasonable option while some others prefer to hold on to their investments apprehensively. To start investing after a loss requires discipline and a strong mindset.
The gain needed to restore a loss can be calculated by the formula:
[1 / (1 – % Loss)] – 1.
So if you made a loss of 20%, you need to recover [1/(1-0.20)]-1 = 0.25 = 25%.
Therefore, you need to make a profit of 25% now to recover your losses.
Stocks often stablise after a dip. Sensex fell around 3,000 points owing to the global panic around the pandemic only to rise by 1,300 points the very next day, marking the highest single day recover. Therefore, making a recovery in the stock market is always a possibility.
Tips and Techniques to Recover Your Loss
Are you afraid of losses? Here are some techniques and stock market tips to adopt beforehand to reduce the impact of a potential loss.
- Adopt a stop-loss technique
The stop-loss strategy is the most critical trading strategy that all investors and traders should follow to reduce the risk of losses.
Stop-loss is a standing instruction to sell stocks when it drops to a certain price. With this strategy, you determine the lowest stock price you are willing to go with. It helps minimise the risk of further loss.
With a stop-loss in place, you don’t have to keep monitoring the movement of the stock. If the stop-loss is triggered, the shares will automatically get sold. However, sometimes the markets bounce back after a big loss. Since your stock is sold after a stop-loss is triggered, it eliminates the chances to recover the loss from potential profits.
- Adopt a repair strategy
The repair strategy is another option for investors to reduce their losses without adding risk. With this, you can purchase one ATM call option and sell two OTM call options for every 100 shares of the stock that are currently giving you losses. The premium from selling two OTM call options will cover the cost of purchasing one ATM call option. This way, if the stock price falls lower than the call option you purchased, you will get to keep the premium on the two calls sold. If it rises just above the purchased call option, you will limit your losses and keep the premium. If the two calls sold get exercised, you could make a profit from the one purchased call option and buy more shares if you think the stock will further increase.
You purchased 10,000 shares of ABC Ltd in June Rs. 100, which has now fallen to Rs. 90.
Your loss: Rs. 10,0000 (10,000*(100-90))
To put the repair strategy in motion, you purchase 1 ATM call option at Rs. 90 strike price by paying a premium of Rs. 5 and sell two OTM call options with a strike price of Rs. 100 at a premium of Rs. 2 each. Therefore, you pay Rs. 5 but get Rs. 4 in return, essentially only spending Re. 1 per share i.e. Rs. 10,000 (10,000 shares * Re.1).
If ABC Ltd options expire below Rs. 90, both call will expire worthless resulting in a loss of Rs. 10,000. This is a better position than doubling your position at Rs. 90 level and incurring a loss of Rs. 1,00,000 (10,000*(90-80)).
If the option expires above Rs. 100 then you will sell all your stocks. You will earn Rs. 4 from the premium of the OTM options sold and Rs. 10 profit against the premium paid of Rs. 5 from the ATM option purchased. Therefore, net profit will be Rs. 90,000 (10,000 shares *Rs. 9).
If the option expires at Rs. 95, the OTM call options will expire worthless and you breakeven with the ATM call options. Your net profit will be the premium you earned from selling the OTM options which is Rs. 40,000 (10,000 shares * Rs. 4).
If you incur heavy losses, don’t lose hope. The scope of bouncing back is always there. Start small and reanalyse your strategy. You need to check your goals and think long-term.Start your trading journey with Astha Trade, backed by 20 years of experience. Open your free Demat Account today!