Sideways till the edge of sanity!!

1. We are seeing the Indian markets trade sideways for almost two weeks now. Some say its the lull before the storm while others say its forming a strong base before the next upmove. You may be in either camp, but i would want to be very careful, be it storm or base formation!! Either of the parties could be right, the storm could take us higher or pull us down, the base formation could be the bottom or a plateau being formed and we could fall off the cliff edge!!
   The bottomline remains that we are here to make money in the equity markets. The risk reward ratio should be favourable else it makes no sense guessing the direction of market movement and getting caught on the wrong foot and losing money in the process. This has been the case with many people over the past few months. When they thought, we were set to see a correction and went short on the markets, they burned their fingers. Similarly when an upmove was imminent, they lost money in options as markets traded flat and option premiums eroded due to time value. So what should one do in order to maintain one’s sanity in these markets. Here are a few things which could help the investor class preserve its sanity in these volatile and uncertain markets:
   Understand your risk appetite - Its cliche but should be remembered, higher return expectation would always be accompanied by higher risk. One would say its difficult to gauge one’s risk appetite. I would say ask a few simple questions and the answers would tell you if you are risk averse or high risk taker. Would you prefer getting assured return of 8% per annum with capital protection or a chance to make 25% profit or a loss of 25% (capital erosion of 25%)? If you choose 1st option, you are no doubt risk averse and it is advisable to stay away from equities at these volatile times. If you feel you have the capacity to withstand a 25% capital erosion in the short time, then jump into the equity markets and make a killing but be ready to get rude shocks now and then.
   Play Derivatives safely – Derivatives are like financial time bombs, ready to explode. Don’t buy derivatives with the same mindset as if you are buying a stock. First of all derivatives expose you to leverage and secondly derivatives should be better used for hedging rather than taking naked positions. Options is all the more dangerous as we are seeing in current markets. Option premium erodes drastically with time and with the month end expiry coming close, it would tend to become zero! One safe way to play F&O is, do options for the 1st two weeks of a month and in the 3rd and 4th week play only in futures. This would save you from the pain of losing all the option premium incase your call on markets went wrong.
   Invest for long term – Make two separate portfolios. One for the long term wherein you would keep building the nest for the golden years. The other portfolio could be the short term trading portfolio which would satiate the trading nerve in you. Never mix the two. Quite often what is seen is that you buy something for trading and when it goes into loss you say to yourself “this is a long term investment”. Clearly avoid doing such mistakes. By doing so you are making a long term portfolio of junk (heard on the street type of) stocks. Build quality portfolio for long term and trade on news and rumours for the short term.
   Build cash reserve before trading in equities – Always invest that much money into equities which you would not want to touch in the short term. Remember equities could give you a rude shock in the short term and your hard earned money could remain blocked when you need it in the near term. For short term money, its idle to park it into debt instruments.
   Each investors case varies from the other and it is imperative that one does a thorough self analysis before entering the markets. One simple thumb rule is that play with that much money in F&O which you are willing to lose without getting sleepless nights.