{"id":371642,"date":"2023-10-11T11:01:12","date_gmt":"2023-10-11T05:31:12","guid":{"rendered":"https:\/\/zerodha.com\/z-connect\/?p=371642"},"modified":"2024-02-18T11:04:55","modified_gmt":"2024-02-18T05:34:55","slug":"hope-is-not-a-strategy","status":"publish","type":"post","link":"https:\/\/zerodha.com\/z-connect\/varsity\/hope-is-not-a-strategy","title":{"rendered":"Hope is not a strategy"},"content":{"rendered":"

A few years ago, I came across a microcap real estate stock. It got ownership of hundreds of acres of land parcels in multiple cities as part of a PSU restructuring. The plan was to develop residential and commercial buildings on these land parcels.<\/p>\n

Given the value of the land it owned, the stock looked very cheap. I was hoping it would be a multi-bagger stock once the buildings came up.<\/p>\n

After several years, it is still a plan. There is no revenue. The stock price has nosedived 40%. And I am still waiting for a turnaround. Now, my strategy has come down to exiting at breakeven.<\/p>\n

But is it really a strategy? The company\u2019s performance, whether good or bad, has no regard for my purchase price. So what I have is hope, and not a strategy, that the stock price will rise.<\/p>\n

My investment is in four digits, so it is not worrisome. Nevertheless, my approach is flawed. And it is also common. I have come across several clients in the past who have held on to large loss-making bets because they did not want to book losses.<\/p>\n

For some, booking a loss is the psychological equivalent of accepting failure. Holding on to a notional loss in the hope of an eventual profit is still okay for them. Let\u2019s run a few numbers and see how this is problematic and what could be a better approach.<\/p>\n

Let\u2019s say you bought a stock at \u20b9100 last year. It is down 50%. So the current price is \u20b950. For it to return to your purchase price, the stock has to rise 100% from the current levels.<\/p>\n

Now, for a bit, forget your purchase price and ignore all the past stock price movements. Check the fundamentals of the company and analyze if there is any reason for its stock price to double from \u20b950 to \u20b9100? Do you expect a profitable quarter after a series of loss-making quarters? Or do you see any major acceleration in revenues or earnings? If your analysis cannot justify a possible price rebound, perhaps you are holding on to hope, not strategy.<\/p>\n

So, what could be your strategy? You could have various strategies. Let me elucidate a few.<\/p>\n

    \n
  1. Buy a replacement<\/b>: You look for some other stock where your analysis suggests a possible rally. See if this stock has the potential to grow faster than the loss-making stock. If yes, book losses and take \u20b950 out. Invest it in this new stock. Your aim is to get back to your initial \u20b9100 capital. It does not necessarily have to be from a stock that lost your initial capital.
    \nOf course, this stock will have to grow more than your capital because the profitable stock would attract capital gains tax.<\/li>\n
  2. Stop-loss targets<\/b>: In any position you enter, you can set a stop-loss trigger. The idea is to make profits but limit losses if the strategy does not play out. Let\u2019s say you bought a stock and set a 20% stop-loss target. If the stock price declines 20%, the system will automatically sell the stock and arrest losses.<\/li>\n<\/ol>\n

    As these illustrations suggest, a strategy has to be more definite. It must be backed by some data and within your risk tolerance level.<\/p>\n

    Why is your personal risk tolerance level important here? Let\u2019s say you are confident of a strategy\u2019s ability to deliver stellar returns. This strategy could take years to materialize. Until that happens, you must have enough capital to keep covering for the losses.<\/p>\n

    Remember Michael Burry of the Big Short fame? His strategy spanned over 4-5 years. Every year, his strategy delivered losses. Eventually, in 2008, he made about 4x gains. Investors with limited capital or low willingness to stomach interim losses aggressively criticized Burry through those years. The profits made up for the agony, but many could not sustain the agony for so long.<\/p>\n

    Therefore, your capital is also instrumental in your investment strategies.<\/p>\n

    There is a fine line between hope and strategy, and both often step into each other\u2019s arena. In the face of losses or market pain, you hope your strategy works. Your strategy needs conviction. Conviction comes from data, logic, and risk management tools.<\/p>\n

    A strategy may or may not work. But do not let hope drive it. If your strategy is not well-constructed, you might be better off investing in mutual funds.<\/p>\n","protected":false},"excerpt":{"rendered":"

    A few years ago, I came across a microcap real estate stock. It got ownership of hundreds of acres of land parcels in multiple cities as part of a PSU restructuring. The plan was to develop residential and commercial buildings on these land parcels. Given the value of the land it owned, the stock looked […]<\/p>\n","protected":false},"author":242541,"featured_media":371643,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_jetpack_newsletter_access":"","_jetpack_dont_email_post_to_subs":false,"_jetpack_newsletter_tier_id":0,"_jetpack_memberships_contains_paywalled_content":false,"_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[477],"tags":[546,573,545],"class_list":["post-371642","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-varsity","tag-equity-investing","tag-futures-and-options","tag-opinion"],"yoast_head":"\nHope is not a strategy – Z-Connect by Zerodha<\/title>\n<meta name=\"description\" content=\"A few years ago, I came across a microcap real estate stock. 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