Category: Trading

In recent weeks / months, quite of my friends have left trading to either start a new business or go back to college or taken up a job or changed their business. Its not that they were ill equipped to handle the markets, on the other hand, their education and experience would match the best of the best which set me thinking on why trading is such a tough business.

Trading is a challenge like no other with everyday proving for most to be a battle between them, their weaknesses and the computer and most days, the majority fails to achieve the goals they set out to achieve when they woke up in the morning.

Being in the brokerage industry for nearly two decades now and witnessing either directly or in-directly hundreds of traders, the one staggering fact of the business is the rate of failure is something that you will not see even in the Silicon Industry where companies churn over faster than you can imagine.

Most business have a known upside and a well known down-side on which things could be planned. For example if you were to open up a shop, you know that the down-side is equivalent to making no sales and yet needing to pay the rent, pay your workers among other fixed costs.

Trading is bit similar to trading in perishable items where on good days you end up selling everything you have and on bad days end up losing the whole capital deployed. But if you have ever been to the vegetable market, you don’t see a churn in the vendors like the way traders get churned over time.

There are a million things that  are reasons behind failures in trading, but to me, the following are the major criteria

1. Regular Income: Most people are used to regular income – Salary for example and anticipate something similar in nature from trading. When trading on the other hand, there is no guarantees. You may actually taking losses for months together before you find the edge and start gaining back your losses. Some one I know had a draw-down of 3 years before he was able to synthesize his strategy and was able to gain his losses back. Sustaining such a long period of time without a secondary source of Income is impossible for most which mean that they end up leaving the field rather than stay and fight it out.
2. Under Capitalization: Most businesses provide you with a fair idea on what is the minimum capital you need to start off with. You know that you cannot possibly take on rent a showroom with just 10K in the pocket. But when it comes to trading, some think that even 5K would do it (Nifty options anyone?). While no amount of capital can help someone on the wrong track, if you start off with too little, its equivalent to buying lottery and hoping you will win.
3. Short Cuts: I see a lot of traders believe in using short cuts in the hope of succeeding. While few spend thousands (and these days many charge in Lakhs) on so called education, others spend a few thousand per month to get  access to trading / investment ideas from guys who they hope are knowledgeable and will enable you to achieve your goals with the least effort. Great traders don’t have the time to spoon feed you their trading ideas for a small fee. They will rather clean you up in the markets than bother with passing the SEBI exams that are now required to be passed before you can sell advisory services.
4. Lack of efforts: Most traders are prompt when it comes to screen time, but can the same be said when it comes to reading books / testing strategies. Trading requires (not compulsory but preferably) expertise in markets, statistics and programming. While not everyone can be a expert in all three, you need to be able to tick mark two out of three to be able to risk money that YOU CANNOT AFFORD TO LOSE. Unless you are here for time pass, risking money you can afford to lose shall get you nowhere in the long run since as percentage of your net-worth, the addition will be too small (kind of rounding off error).
5. LUCK: Luck plays a large role – and I am not even talking about Individual trades. Regardless of your beliefs about Luck, it could be a major factor that determines whether you are a successful trader or a ordinary one and the worst thing is that there is little we can really do about it.

Its all nice to dream about trading for a living but if you are the sole breadwinner for your family, I seriously believe that the odds of your success is pretty poor to start with and will erode faster than the option premium over time. Most successful traders I have encountered had a secondary income that supported them as they learnt more about markets and trading more often than not by burning their fingers / hands or even entire bodies.

Jesse Livermore who is looked up by many who have read Reminiscences of a Stock Operator by Edwin Lefèvre will know that he went totally bankrupt twice in his career. Not every one can come back from one bankruptcy, let alone twice.

 

 

In the movie, Inception, there is a interesting dialogue which I quote below;

“Mal: Pain is in the mind, and judging by the decor we’re in your mind, aren’t we, Arthur?”

When investors / traders enter the market, they know that they shall experience some amount of pain – pain of draw-down is guaranteed. But its one thing to experience pain in back-testing / historical insights and quite another when faced with the real thing.

As a well quoted quote by Mike Tyson goes

“Everyone has a plan ’till they get punched in the mouth”

Most trading systems – Trend following or Mean Reversion experience strong draw-downs. Streaks of losses are fairly common as well.

But when faced with the uncertainty of every trade going to dogs and the fear of further losses make most investors and traders first behave like a Deer caught in the Headlights Syndrome and then at some point beg for them to be removed themselves from the trade, even if its at a big loss since the pain (of losing money) is just too great to bear.

As markets decline without there seeming to be a iota of support, blame is distributed across the spectrum – from the crony bankers to Raghuram Rajan to the broker who wouldn’t allow them to hold on to a few days more. But none and am sure I could include myself here, would blame oneself for the mess one finds himself in.

Most investors and traders just don’t have a Plan B. A plan that is to be put to action if Plan A fails – most hope that Plan A is so good that there isn’t even a need to put a Plan B in place let alone come to a point where its activated.

Everything is a give and take. When markets were rolling just a few months ago (which now seems like eons earlier), the place to be was the small and mid cap. Large cap investing wasn’t even considered a option.

But when mid caps and small caps crumble, its the large caps that seem rock solid (even after accounting for their own falls). In 2000, when Infotech stocks were going through what seemed to a never ending rally, most old favorites were languishing at multi year lows. But once the rally ended, the divergence suddenly started to collapse till we reached a point where brick and mortar was again the fashion and eCom (nearly every one of them) was out of fashion.

Fast forward a few more years and the survivors who stuck out did better than what even the most optimistic report at that time would have predicted.

Recent fall in PSU Banks have come on back of the troublesome NPA’s again rearing its head. But is every back going to dogs? At what price do they start making sense again? Which banks shall survive and thrive and which won’t?

Dr Raghuram Rajan made a interesting point during this CD Deshmukh lecture and I quote the same

The Finance Minister has indicated he will support the public sector banks with capital infusions as needed. Our estimate is that the support that has been indicated will suffice, especially when coupled with other capital sources that are usually available to banks.

Banks are going down but at some point they shall make sense as a investment yet again. The question though is, Do you have a plan and more importantly Do you have a plan B if plan A fails.

 

 

The world has become a smaller place thanks to technology which these day enables everyone access to quality information nearly at real time, something which in the older days played a great part in returns generated by professional investors / fund managers. In other words, it has become a great equalizer of sorts.

Twitter / Facebook / Whatsapp / Slack among other tools have become tools of collaboration and discussion resulting in better disbursal of knowledge and ideas. But what is also brings to the table is blind belief’s in some one elses ideas / trades and trying to follow them in the hope of easy money (easy give the fact that one doesn’t need to spend a lot of time doing the leg work himself).

When markets are good, these trading strategies / ideas are lauded as the next best thing, but markets being cycles are prone to excesses on either side and when things go wrong, its amazing how fast everyone is quick to blame the one guy who propogated the idea and hence is the person to blame for all the misery.

Following big investors / traders seems a nice idea if your intention is to pick up on the thesis behind their picks, but if its just the picks you are more concerned about, its just a matter of time before you will be sorely disappointed and will have parted with more money than you bargained for.

2015 seemed one such year when a strongly recommended and fancied stock (which manufactures pressure cookers) took a severe beating. Every one, whether he had a position or not, decided that the blame was to be laid at the door of the guy who felt it was a good pick with even suggestions that he was actually selling himself quitely while suggesting that other stay on.

2016 has started with a fancied textile company which is facing a rout similar to one the previous company faced. Unless the company turns out to be a complete fraud, the stock will stop falling and normalcy will return. But those who picked up the stock at much higher levels may need to wait for months or even years before they can get back to their high water mark.

At the beginning of last year, a famous analyst came up with a prediction for Nifty that suggested that 2015 will be the big year (in terms of returns) and while that call came nowhere close to being true, the said Analyst is still very much renowned and continues to be one of the talking heads at business channel. So much for accuracy of forecasts.

Profits and Losses are part and parcel of trading / investing. But if you are investing based on some one’s (paid or free) view, the risk quotient goes up even higher since you have no clue regardless of what happens and taking action is tougher especially when its not going the way one would have wished it would.

I see advisers regularly advising investors to invest only what they are willing to lose while at the same time claiming that only investing in equity can provide one with above inflation returns and its not prudent to invest into other asset classes for history has shown (not in India) that Equities beat others by a long yard.

The very term of being willing to lose means that you cannot risk enough to make a difference to your lifestyle should your selections work great. But if you risk more than what you are willing and do end up on the losing side, you will be faulted for risking too much. Heads I win, Tail you lose.

Warren Buffett has in the past talked about distinguishing between temporary draw-down and permanent loss of capital. When you invest in a ETF / Mutual fund, the risk is generally of the temporary draw-down nature. No matter how worse it looks, the probability is that it shall eventually recover (unless the country goes to dogs, but if that happens, you will have a lot more to worry than the value of your investments) while investing in stocks can result in serious and permanent loss of capital if you aren’t able to exit even as the stock continues to slide down on the slope of hope.

When you follow other people’s trades, you are in affect hoping that the other guy (the guy you are following) is not actually lost but knows the way. But it still doesn’t allow you to risk the kind of capital that will make a big win, a win worthy enough to retire upon. In one of my past blogs, I have written about my 1000 bagger – a kind of return that is very rare and yet, the fact that I risked so little has meant that even that amount I stand to gain should I sell now is too negligible. Forget about retiring, I cannot even go on a dream holiday and yet I have a 1000 bagger.

This year is my 20th year in markets and yet as far as I can remember, I know more people in markets whose biggest wins have come from Business / Real Estate than their wins in market. In fact for many of whom I know, what they risk even today is a small percentage of their total net-worth and this alone ensures that even if everything they touch goes to dust, they can still lead a comfortable life.

Coattail-ing is a interesting strategy only if you have complete knowledge of the guy you are trying to copy. Else, where he will be risking 0.01% of his money, you could end up risking 25% or more of yours. A loss won’t affect him anyways while a loss for you will wipe out a significant amount of your capital.

Social Media provides a interesting platform to learn from but if you were to try and use it as a short cut, you run the risk of getting caught in the middle of a forest with no clue as to where to go next as the light dims away.