Why risk management in the stock market is your lifeline?
- raytraceventures
- Mar 16
- 5 min read
This seems like an appropriate time to have this conversation regarding the risk management in the stock market. See this meme first!
Since Sep 2024, NIFTY500 has gone down by 20% and majority of the stocks have fallen by more than 40%, specially stocks in midcap and small cap space. Indian stock market was showing the signs of weakness in Aug 2024 and in Sep 2024 it created the top. I informed my community members on 03 Oct. 2024 that it is time to be cautious with your investment (Ref: Fig-1). In the month of Feb, I also saw the weakness in the US stock market and the same was conveyed to the community members on 25 Feb.
Below is the screenshot of the messages shared with the members. This community consists of serious learners who trade and invest in the stock markets. In case, you want to become the part of it, you can join it here: https://t.me/raytraceventures
Now comes the most important point if someone does not follow the risk management, and did not book profit at the right time or don't have experience in value investing then how are they going to buy the dip? Because they were fully invested, believing in vague, incomplete concept of "loooooooooong-term investing". I have been in 100% cash since October because I don't know how to sit in a big drawdown on the capital and hope for the stocks to turn around. If you study the stocks, they were either squatting or started going in a downtrend, breakouts were fading, volume on the buying side was drying up, buying swings had weak candlesticks formation. All these were the signs of vanishing buying force from the market. Now let us understand how much gain is required to recover from a loss in a portfolio. Let's us assume in this correction if a stock in your portfolio went down by 30% then it has to gain 42.9% to recover from the loss or come to the breakeven point (Ref: Fig-2). If someone managed the risk well and on portfolio level they went down by 5% then their portfolio needs to gain by 5.3% to recover from the loss. It is that simple!
Below are some of the examples from 2017-2018 bear market where we can see how many years the stock price has taken to recover. ITDC was trading between ₹500-650 between Apr 2017 to Jan 2018 from that level it corrected by ~86%, created the bottom and to again achieve the price level of 500-650 it had to run 513% which took it 6 years. Finally in Jan 2024 price hit that level. Imagine the ordeal of a long-term investor who bought it between Apr 2017 to Jan 2018.
HPL Electric & Power was trading between the price range of ₹125-165 from Sep 2017 to Mar 2018 from there it corrected by ~89%. It took 6 years and 751% gain in the stock price to again come to that level which it achieved in Jul 2023.
Steel Authority of India in Jan 2010 was trading between ₹205-255 from there it went into correction and corrected by 92%. From there it had to gain 1200% to come to that price level which it was in Jan 2010. By the way it's been 15 years and it has not touched that level yet.
Castrol from Dec 2014 to Sep 2016 was trading between ₹255-210. From there it corrected by 64% and it took it 8 years and 10 months to come to that level with 184% gain.
Now the question is, what should you do? If any of your investment went down this much and you get stuck because nobody knows how long this bear market will be and when the new bull run will start. Well, it is time to have hard conversation with yourself about the risk management. All successful traders and investors manage their risk. We'll talk about different ways of risk management for traders and investors. For now, that discussion is out of the scope of this blog post.
Before we move ahead, a quick example I would like to share with you. Warren Buffett's Berkshire Hathaway invested ₹2,179 Cr in Paytm(One97 Communications) in Aug 2018, acquiring 3.1% stake at a valuation of ₹83,000 Cr. They had to sell the stake in Nov 2023 for ₹1,370 Cr due to company's weak financial performance, incurring a loss of ₹809 Cr (Correction: Fig-7 mentions the loss of ₹507 Cr, it is a typo). The key take away from this example is: Mistakes happen even from the best investors, they reassess the situation, cut their losses and manage the risk.
Bear market's discrimination among stocks NIFTY500 has been corrected by more than 19% since Sep 2024 but many individual stocks have fallen by more than 40%. In previous examples, we have seen stocks which have fallen by 60, 70 or 80% they have taken 5-6 years to cross the highs. Here you can see three stocks, all from the same industry- shipbuilding, how the stock price has behaved. Cochin Shipyard and Garden Reach Shipbuilders have fallen by ~60%, the correction has been steep on the other hand Mazagon Dock Shipbuilders has fallen only 34% and presently trading within ~20% of its all time high and seems to be recovering faster than the former two stocks. Mazagon Dock Shipbuilders should be your top choice for trading or investing when the next leg of bull run will start. Hence, we can conclude that in bear market some stocks fall less than the others showing relative strength, faster recovery to the highs. Such stocks should be in your watchlist as a trader or investor. As an exercise, you can pick stocks from the same sector or industry and start comparing the price and volume activity side-by-side from Oct 2024 to Feb 2025 with NIFTY500 and their sectoral index.
This brings us to the closure of this blog. I hope you enjoyed reading it as much as I enjoyed writing it. If you liked what I wrote and are serious about creating wealth from the stock market you can become the part of Eight Figr League, a credible platform for market participants through which you can know the pulse of Indian, US, China and European stock markets, connect with other great traders or investors, get daily updates, learn fundamental and technical analysis, connect with me over video call.
You can also connect with me over LinkedIn and X(Twitter) or watch me speaking on YouTube about trading, investing and mindset. I'm a student for life, so don't hesitate to send over your views or sources to help me enlighten myself. If you are a beginner and want to learn how I do what I do. The below series of blogs will help, to be read in chronological order:
Thank you for your time. Have a great week ahead in creating sustainable wealth!
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