Investors must pivot portfolios towards top-quality stocks

At these elevated market levels, traders must use stop-losses

The Sensex is up 131.5 per cent from its March 23, 2020, lows. The mid- and small-cap indices have registered even higher gains of 167.5 per cent and 232.5 per cent, respectively, over the same period. Meanwhile, new investors have entered equity markets in droves, as is apparent from the sharp rise in demat accounts (up around 23.7 million till the year ended September 30, 2021).

“During the pandemic, many new retail investors, mostly millennials, jumped into stock markets as traders and investors in search of a new income stream,” says Vivek Bajaj, cofounder, Stockedge and Elearnmarkets.

But equity investing can be fraught with risks, especially after markets have seen massive run-up.

“Volatility is inevitable. Traders, especially novices, need to be careful at the current levels,” says Chandan Taparia, vice-president, equity derivatives and technical, broking and distribution, Motilal Oswal Financial Services.

Avoid poor-quality stocks

In a bull market, many bad companies with dubious promoters and poor corporate governance standards also rally. Many investors who are new to fundamentals-based investing get lured into investing in them in the hope of making quick gains.

“Retail investors often ignore the financials of companies during bull runs. A key rule of investing in a bull market is a gradual shift towards quality stocks,” says Bajaj.

When the inevitable market correction comes, these stocks will be hit less. And they also tend to recover faster when markets revive. Poor-quality stocks tend to fall more and sometimes never achieve their previous highs again.

Investors should also avoid investing in penny stocks, based on tips.

“Some penny stocks are recommended because they have a low price-to-earnings (P/E) ratio. This can be deceptive. A low P/E usually indicates lack of confidence in the stock. Avoid the low P/E trap,” says Bajaj.

Go for sector rotation

Consider sector rotation.

“When a stock begins to lose momentum or gets stuck in a higher range, shift to another sector. The best way to maximise your portfolio gain and ride a bull market is to book profits and do sector rotation,” says Taparia.

Investors should also book profits periodically since the stock markets are never a one-way street and corrections do occur periodically.

“Go for profit booking once your price target is met. The timing of entry and exit matters a lot. Tata Steel, for instance, was a compelling buy at ~300 in March 2020. Today, it looks fairly valued at around ~1,300. If someone buys this stock today, his risk would be higher,” says Amit Jain, chief strategist, global asset class and cofounder, Ashika Wealth.

Place stop- losses

Seasoned traders always put rule-based stop-losses in place. If stocks decline rapidly, inexperienced traders will be unable to react. A stop-loss can save them from large losses.

Letting your emotions take over when you are losing money on a trade and overriding a stop-loss can compound your troubles.

“Trading with strict stop-losses becomes important when markets are

at lifetime highs. If momentum reverses and stocks fall steeply, your portfolio could be impacted severely if there are no stop-loss triggers,” says Jain.

Avoid overtrading and leveraging

Those who don’t have a defined trading system are at risk of overtrading. Traders should only engage in the number of trades they can handle properly. Overtrading also raises transaction costs.

Avoid trading with borrowed money. Not only can it magnify losses, it can also leave the trader indebted.

“Unwind leveraged positions at these levels and instead increase allocation to gold to hedge against the possibility of higher volatility,” says Jain.