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Investment strategy: Questions to ask before adding stock to your portfolio

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Investing is based on what will happen in the future. The most that people can do is to forecast based on their knowledge and pattern recognition abilities. When you are investing there are so many questions that crop up. Here are responses to some of those.

Investment strategy: Questions to ask before adding stock to your portfolio
"Doubt goes with me everywhere - to the arena, to the practice range, it's there when I awake and when I sleep. Doubt is my enemy because it unnerves me, makes me overthink, but it's also, in some weird way, my friend because it helps me become a sharper shooter." — Abhinav Bindra.
Investing is based on what will happen in the future. The future is inherently uncertain and probabilistic. It can never be known with certainty. The most that people can do is to forecast based on their knowledge and pattern recognition abilities. Their knowledge, in turn, is based on their past experiences. Someone who has lost a lot of money in the stock market in the past is likely to see investing with a very different tinted lens from someone who has amassed a lot of wealth from it.
When you are investing there are so many questions that crop up. Is the market overvalued now? Should I wait for some time before investing? Is this company that I am investing in going to give me good returns? Is the price going to crash after I buy? It is already up so much, should I chase the price? It is down from previous highs, should I buy now? How will the US taper affect the Indian markets? Why are there no brokerage reports on this company? Is it a fraud? Do I know enough about the company? The industry has a major tailwind, so should all the stocks in this sector do well?
The questions go on and on...
And unfortunately, there are no definitive answers.
When I started investing, I used to feel that this doubt that I always have must be because I am not very knowledgeable. The more I know the less doubt I will get. But in reality, it turned out exactly the opposite. The more I learn and practice, the more doubts I get. And the root cause is simple — the future is unknowable.
Doubt is good
All the great investors I have been lucky to interact with are very doubtful about their picks. Rarely have I seen someone to be very sure. Even after holding a stock for many years, there are some niggling doubts that persist. Should I hold on? Should I add to my position? Should I sell and book profits? Should I sell partially?
Doubt comes mainly from three sources — macro concerns, stock specific issues and our own past track record of investments, usually recent ones. And no amount of studying or interacting with management or channel checks can help you in removing your doubt. I have seen so many cases where even the management deludes themselves, perhaps unknowingly, about the future prospects of the business. It just goes to reiterate the basic point that the future is unknowable.
I have seen investor friends sitting on the sidelines with cash since 2017 citing the fact that the markets were overvalued or large macro investors taking large cash calls because a certain index level has been surpassed. Market timing in the face of an uncertain future adds a layer of complexity to the process (and is mostly wrong!!).
Using a Quant mindset to develop an end-to-end process
Then what is the way out? One simple way is to have a well-defined process. I have been a process driven investor for most of the twenty odd years I have been at it. But my process was limited to a checklist, although it was quite extensive. That is what I got from reading a lot from the processes of great value investors. Then I chanced upon quantitative systems and investing. From there I picked up the notion that the process needs to be all-encompassing. It has to start from the universe selection. This simply means which stocks I will research and keep tabs on. Buffett calls it the circle of competence. Quants call it universe selection :-) It is the same thing.
The next is what stock to buy. Ninety-nine percent of the focus of investors are in this. Here you should be clear what time frame you are looking for investing, what is your risk appetite, how much drawdown can you withstand etc. Your fundamental or technical checklist fits in this step.
The next step is the most ignored or least thought through. It is about position management. You need a process for adding more or reducing your positions. This should not be a knee-jerk reaction but a result of a thought-through process.
The next step is the sell decision. Again, having a well-thought through process is very important.
The last step, which is something I have never seen talked about by anyone, is should you retain the stock in your watchlist. There are pros and cons to it and it is also dependent on why you bought and subsequently sold the stock.
Doubt is good. It helps you focus on your process. In investing, you will never get it right all the time. You need to get probability on your side. And that's where having a well-defined process helps.
—Abhishek Basumallick, is the founder Founder of intelsense.in and quantamental.in and moderator of ValuePickr Forum. The views expressed are personal.
Note To Readers

Investing is based on what will happen in the future. The most that people can do is to forecast based on their knowledge and pattern recognition abilities. When you are investing there are so many questions that crop up. Here are responses to some of those.