Retail investors are back in the market. The huge inflow of new depositary accounts opened between March and April 2020 reflects the activity. As per records, Central Depository Services Ltd (CDSL) has opened 1.2 million new Depository Participant (DP) accounts during this period as against 4.2 million DP accounts between April 2019 and Feb 2020.
The new breed of Robin Hood investors are moving rapidly on the back of online trading activity but proper risk management and asset allocation is yet to be understood.
Some key problems and challenges include lack of knowledge, reading, networking and process. Almost 90 per cent of the retail investors and traders don’t know what the company manufactures, what are its revenue and profits, dividends paid, management quality, which is like driving a car without brakes.
Compromising on asset allocation and position sizing is the second big problem where one sector or stock comprises 80 per cent of the entire portfolio. This leads to severe imbalance in the risks associated and massive losses when things go wrong.
Position sizing is often completely ignored, which leads to retaining losers and selling the winners. For an ideal asset allocation it is better to have a combination of debt and equity. Position sizing could be maintained by having a small portfolio of 5 to 10 stocks. Many face information overload and noise in the markets by seemingly complex and contradictory advice on business channels and advisory websites.
New investors may find it easy to use books to get started and stay connected.
One of the biggest challenges that new investors and traders face is having limited capital, which prompts them to buy poor quality stocks.
They need to focus only on quality blue chips or invest through mutual funds - a safe way to generate better returns over the long term. Most retail investors and traders lack the emotional mindset whether to speculate, trade or invest.
A wrong speculative trade often becomes a long-term investment for a retail trader. Thus having clarity on the emotional mindset can have a huge impact on the profit and loss account.
It is better to stick to either trading or investment and not mix both as this can lead to huge losses in volatile markets.
Penny stock is another common problem with most retail traders and investors who feel they are buying at low cost.
This is the reason retail shareholding in penny stocks like JP Assoc, JP Power, Manpasand, Idea have increased significantly.
Investors must avoid penny stocks completely and focus on quality businesses, which are wealth compounders over the long term.
The author is Director Research at ProfitMart Securities