Prashanth Krish | Portfolio Yoga

Betting on Elections – Gambling or Trading

On Twitter, its amazing to see the number of winners who seem to be right in whatever trade they report (mostly after the move) and in an attempt to get them to commit to something, commented that I was going into the election result day with “Long Nifty” positions.

Good friend, Nitin of Alpha Ideas replied back with a quote by “Paul Tudor Jones” and I quote the same here

“I don’t risk significant amounts of money in front of key reports, since that is gambling, not trading”

Now, unlike the hundreds of quotes available, this is from a guy who is seen as one of the Top Technical Analysts ever (Link) and hence something that cannot be dismissed off hand (as I generally tend to do). This guy has some serious skin in the game (as against the guy who invented that term but seems to spend more time talking than trading – but that is for later:) ).

In many ways, trading is generally seen as Gambling though the gulf between gambling and trading is as wide as the Brahmaputra at its widest point. A gambler is one who takes risk with not much of a risk management and generally in a place where the odds of winning are pretty low.

The big question out here is, If I am positioned for the election result – am I gambling or this is as normal a trade as any other I take? To answer that, let me give you the thought process that made me willing to bet (and I generally bet as much as I can afford – no half measures out here) and why I believe that if one looks at history (and TA is all about the history repeating itself), betting on the long side is the way to go.

I am a believer in positional systematic trading and believe that intra-day trading or discretionary trading (gut based or based on ideas that cannot be historically tested to see its accuracy) is not the way to go. I am also a strong believer in trend following since evidence has shown that all said and done, for some reason that is as yet not explained, trends do persist more often than they are supposed be.

The big profits of a trend follower come from the outlier’s – moves that are 3 / 4 or even 5 standard deviation from the mean and which theoretically should not occur in decades or centuries but which happen more often that not. Its the outlier that ensures the profitability (extra Alpha if I may say) of a trend following system since it generally has more loss making trades than profit making and these one off trades more than compensate for all the losses.

Outliers can occur due to various reasons – Known events and Unknown events. Election results are a known event since regardless of what happens, results will be out by day’s end. On the other hand, a attack on the World Trade Towers in 2001 was an Unknown event since no one knew such a thing could happen.

A couple of years back, I had given a talk on Trend Following and showcased as to how markets seemed to be perfectly aligned with the post event trend even though in case of unknown events, the very event was a surprise. Let me take you through some of the examples I provided in that talk

1. Fall of BJP led NDA Govt in 2004

As can be seen, in the run up to the results, despite the euphoria of “India Shining”, the markets were considerably weak. Markets closed with small gains on result day and tumbled in the next couple of days.

2. UPA wins the election in 2009

Now, this was supposed to be so big a surprise (especially that of Congress along mopping up >200 seats) that Index froze higher. But look at the chart and say that the trend was anything other than bullish

3. Terrorist Attack on World Trade Towers

Now, this was a unknown unknown event of a magnitude not seen in a very long time and yet, Dow was strongly bearish before the event and the only thing that this did was accelerate the fall when markets re-opened.

4. Great Hanshin earthquake, Kobe Earthquake

Japan was rattled by the Kobe earthquake and in a in-direct way was the cause of the fall of Barings Bank (Nick Leeson). One look at the Nikkei chart above, the trend was already present and in fact, it was only 2 days after the earth quake happened that Nikkei started to crack strongly.

5. Russia Bond Default

Russia in 1998 defaulted on its own loan and this in a way shook the world markets then. The default was the key catalyst to the end of one of the biggest hedge funds of that time – Long Term Capital Management. Look at the trend and say that the markets had no clue about it

I believe if one were to dig deep, one can find even more examples of how the markets were most of the time in line with the trend well before the event and the event in itself was not a surprise to anyone other than maybe those in the media.

My own bet on the markets today has been based on a system I trade and has been tested both historically and in real time for quite some time now. Add to it, unlike 2009, this time around, the trends and the results will be during market time and shall not be a surprise at the open.

Its easy to rationalize as to why one should not trade before key events, but as I have shown in the examples above, if you are with the trend, there is little to fear about.

Nifty 7000

If measured in terms of time taken for Nifty to climb the 1000 points from 6000, this has been the 2nd longest since Nifty started in 1996.

The first 100 point move was the start of the massive bull rally we saw in 2003 – 2007. Will this be the starting point of another bull rally? Time shall tell for sure though

What happens the day after a 3% move

What a massive move it was today in the markets with Nifty gaining more than 3%, something that was last seen in September 2013. Since we started trading Nifty futures, this is the 99th occasion wherein Nifty has closed above 3% .

Its interesting to note that of the 98 occasions, the next day has seen momentum continue only on 52 occasions (i.e., 53% of the time) while on 46 occasions, we actually saw the markets reacting.

When it comes to average gains and average losses (using Geomean), the swing turns to the negative side with average loss being to the tune of 1.98% vs average gains of 1.71%.

With statistics being divided more or less equally, I believe that the better way to approach the situation would be to continue to hold on (if one is already long) to their position and exit only on a signal they can trust (or use).

Since we shall see the final phase of elections on Monday and the results will be declared (more or less) on Friday, coming week should continue to remain volatile with both sharp rallies and falls being equally possible.

Buying ill-liquid Stocks

Markets at near all time highs and the euphoria of a further rise in case NDA comes to power (with a massive majority to boot) has meant that retail is starting to enter in a small way. But since most of the big guns have already become too expensive (in terms of price of shares mostly though for many valuations are a stretch at the current juncture), its a season for those stocks which barely saw any trade for hours together to now be the ones much talked about.

Most of these stocks which lay theoretically dead are now roaming around like zombies though from afar, they do seem like normal behavior and hence easy to mistake one for the other.

The problem in most of these stocks is not in getting in as much as getting out. Right now, its time to get out of many such stocks as volumes have suddenly sprung up on the back of pretty good increase in price.

Warren Buffett says and I quote

“Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”

While it makes sense logically, the problem comes in terms of practical suitability of it especially in a market where stocks go out of favor before you know. Add to that, while its true that good stocks are better held for the real long term, our life requirements mean that if for any reason we want to exit a stock, we should be able to do it without having to take massive slippage costs.

Liquidity should be the corner stone of investments in companies where you do not have a meaningful stake and one which you regard as something that could be en-cashed during times of distress. After all, what is the point in having stock worth lakhs if it cannot help you when you need it most.

The thought on the above subject came to me after reading a recommendation by a fellow blogger who has recently recommended a stock that this year alone has gone up by >80%. The problem is not in terms of the rise in itself, as a technical guy, I believe that momentum begets momentum. The concern for me in that stock (other than seeming to be expensive compared to its peers) is that this stock was having a average 10 day trading volume of <3000 for better part of last year (with there being times when it dropped below the 1000 mark as well) and now does a good 25K odd shares.

If and that is a big If, market loses flavor for the stock (in other words, operator having done his deed decides that there is nothing more to squeeze it from), its a matter of time before the stock not only goes back to square one or thereof but also for a investor who has entered the stock at higher levels, getting rid of it becomes even tougher as volumes slip back to the normal levels.

Due to changes in my own belief and trading style, I had disposed off most of my portfolio last year (and despite the massive run markets have seen, my stocks have not participated which has meant that I have been better off without then than with them) but had to hold on to a couple of stocks that were listed on BSE and were in the Periodic Call Auction list. Try as I might, I could not get rid of it ( with avg volume being less than 100 per day on many days).

Recently when I checked out the price, I was astonished to see that not only the price had nearly doubled from where I had first intended to sell but volumes have been much better too. While the strong move did have me thinking of the best possible action, knowing how tough it was to sell the same last year at half the current price, I decided the best way was to exit regardless of whether this will be a case of missed opportunity in case the stock continues to move higher.

The road to hell is paved with good intentions. Just be careful on what road you choose since when it comes to the crunch being on the highway is much preferable to being on a inside road which most of the time ends in a dead end 🙂

Sector Index Performances in India – April 2014

Sector Index Performances in India - April 2014

Hidden Bias in Chart Reading

I am not a great fan of Chart Reading. Its like evaluating a painting, I may like one style and you may like another. Even technicians admit that what they see may not be what the other guy sees and since the probability of being right or wrong is always 50%, its no wonder that some one has to right and that in itself is shown as the reason why chart reading is a great asset to trading.

Biases are unfortunately ever present when it comes to skills where you cannot prove it to be wrong or right. Hence while everyone has to agree that 10 + 10 = 20, a single chart maybe read in any number of ways depending on what the chart reader assumes it to be showing / implicating at that moment of time.

For example, look at this chart picked from here.

The author uses the chart to explain why his bearish bias is correct by showing how the Risk Appetite Index has broken a trend line and indicating a reversal of the current trend. But is that the correct way to read the chart?

The Index has twice dipped strongly. The first time was in June 2012 and the same has been marked. But that was the low for the market (and in hindsight, for the foreseeable future). Second was even more of a deadly drop in March 2013, but Index seemed to care a boot as it accelerated upwards through the year.

No strategy has a 100% win ratio (other than Bernie Madoff ofcourse 🙂 ), but unless its thoroughly tested and its faults known, one is better off not using / knowing such a strategy rather than use something that just feeds our bias regardless of it working or not.

Taking advise from Strangers

There is a wonderful quote from the Oracle of Omaha wherein he says

Wall Street is the only place that people ride to in a Rolls Royce to get advice from those who take the subway.

Its amazing how true that statement is in the financial field while not being true in any other profession. For example, the other day, a friend complained about pain in the ear. My initial thought on that subject was that the probable cause was it being a infection and the remedy would be a cheap anti-septic ear drop. But my friend decided that he was better off consulting a specialist (and I do agree with that 100%) since I am no doctor to advise and we all have heard about how dangerous self medication can be.

If a light bulb burns out, generally some one in the house easily replaces it but if a switch got burnt or broke, more time than usual, a electrician is called in to change the switch despite the job being no risky than changing the electric bulb. The reason is simple – the probability of getting a electric shock if you are dealing with a open wire is much higher than one that can be caused when changing a bulb.

But when it comes to advise in the markets, its amazing how all and sundry can make an impact and how easily we fall prey to such advise. One reason for that I believe is that the pain that is caused by financial loss has a much lower impact than one caused by say a electric shock. If you try to do some thing and get a electric shock, the probability of you trying to do the same thing once again is much lower compared to doing the same thing in markets where we just tell ourselves a new story as to why the previous tip based trade failed and why the current should / shall work.

Statistics tell us that the probability of a failure for a trader is pretty high, yet that seems to make one more deterministic about how we are better than those other failures and why shall win this time around. Having been a full time active participant in the markets for more than a decade and a half, the one reason I can see for that is the fact that many are successful in their own fields and wonder why cannot they be here where the odds seems reasonably low in comparison.

For instance, to be a professional in any field, one needs to study and excel for at least 5 years while to be even worthwhile to enter the said field while to be a trader / investor, all one needs is a PC. Most have little knowledge about the company or even the methods they claim to follow. Have talked to many traders who claim to use technical analysis but cannot distinguish between RS and RSI let alone explain how they are constructed.

Of the guys who I have seen as having succeeded in markets, the one thing that has been common among all of them have been their devotion in terms of time and energy. All of them are full time traders / investors whose bread and butter is from their trading / investing activity and not Salary / Brokerage / Business or the trading being a part activity after retiring from full time service elsewhere. This in a way compels them to be either successful or find another profession (and as elsewhere, Survivorship bias does have its way even here with many who did devote full time too failing).

The reason for advisory services to have a field day in the stock markets as compared to elsewhere is that a lot of times, you just have to be lucky to be right and if markets are on a one way trip, it makes it even better if the markets are trending since then the odds of the stocks moving in favor of the trend remains high.

Of course, picking a few odd stocks cannot be a way to build wealth, but then again, who cares since the brain has this innate ability to think positive and multiply one good trade due to luck into a series of good trades. As Benjamin Graham said and I quote

In the short term, the stock market behaves like a voting machine, but in the long term it acts like a weighing machine

Luck can be of help in the short term, but over the long term, skill outclasses luck (think about the 10,000 hour rule made famous by Malcolm Gladwell. You can make some money i the short term by paying for tips / newsletters and seeing some of them succeed as well, but if you really want to succeed in the long run, the key requirement is that you are hungry for it and make it your business to know anything and everything there is to know about a business.

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