Role of Market Discipline in Share Market

Discipline in share markets is considered to be a pre-requisite to be successful. The reasons are not far to seek. The stock markets, by default, are fraught with risk and uncertainty. It is hard to predict even with the best of stock selection skills and trading panache. That is why discipline matters. Discipline is an approach to trading and investing. It is all about resting your trading and investment strategy on a set of rules and principles so that you have a rule-based response system to most trading situations. This reduces the element of subjectivity to the extent possible, if not entirely. Good trading rules are important in learning how to buy share.  However, even those who concoct great rules tend not to follow them.  

Most people lack the consistency necessary to stick to those rules even when things are going badly. Discipline, therefore, is not only about setting the rules but also inculcating the mindset to follow these rules diligently.

Market discipline is all about consistency in your response

You cannot react at random. On a day, when a stock corrects by 8%, what should be your response? You need to flexible but then your approach to such a situation should be consistent. You cannot double up on one day, sell on the other and hedge on the third day. That is where discipline comes in handy. Make the decision.  Will you be consistent in following your rules or not?  Most people who invest or trade never make the decision.  It is almost impossible to be a consistent winner in the stock market without the consistent application of good decision rules. You can never have a clear answer to a set of price movements but your response in terms of risk management should be consistent.

A clear policy in your reaction to market events

As a trader, you have a variety of market stimuli. How do you react to the same? It could be any of the data pieces that flow in on a regular basis. It could be an earnings announcement, a new jobs report is released by the government that shows more people are jobless, the inflation may have shot up suddenly, interest rates may be getting hawkish etc. Markets will be markets and so they will respond the way they do. What is more important is how you respond. That can only be standardized with a clear set of rules that forms part of your trading discipline. Discipline is important here because it is not just about setting the rules but also about adhering to them.

You must avoid an emotional response to any situation

One of the basic approaches to the market must be to let your head rule over your heart. In other words, you need to avoid an emotional response to a situation. That is easier said than done. Here are some of the instances when you could tend to take an emotional response to a situation:

·         Your favorite stock is down by 15%. Fundamentals are pointing to a prolonged down cycle in the stock but your heart is asking you to hold on. In such cases, emotions can be quite strong. 

·         You have chosen to keep off small-cap stocks considering the valuation risks involved. However, you notice that others who bought small-cap stocks in the last 3 months have seen stocks appreciate by 30-35%.

·         You lost money twice in the stock in the last 6 months and again the stock is looking to trade at an attractive price point. What exactly should you do? Head tells you to buy the stock but heart cautions you not to.

How you respond to the above situations is a lot about rules and discipline. For example, in each of the above cases, a simple trading rule that is documented should see you through. When you set a discipline, it is about protecting your risk. Subsequently, you may be right or wrong in profitability terms; that is immaterial. What is material is that you at least know your risk in a worst-case scenario. That is why discipline matters a lot.

Trading 101 – Why discipline actually helps you

How does discipline actually help? A consistent discipline-following strategic investor times his purchase so he can buy when the risk of further downside is minimal.  The same discipline helps to ensure that you do not get married to a stock and treat buy and sell decisions as discrete decision points.  Finally, discipline is also about an exit strategy, because unexpected bad things happen and they will continue to happen.  One is more likely to make money on a transaction, and the other is more likely to lose money on the same transaction.  Discipline out here is a combination of structured thinking, sound strategy and rigid implementation. The difference between a mediocre performance in the markets and a superior performance under the same set of conditions is seen so often. More often than not, this difference is nothing but plain discipline.

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