Uncategorized | Portfolio Yoga

Capital Requirement for a trader

When one starts any business, one has a pretty clear idea as to what would be the cost of starting the business. This may go from a few thousands (if you are starting a web based company) to a few crores (say to get a start in the construction business). But when it comes to trading, there is not much of clarity on what capital is required. This post is a attempt to calculate what you will need if you want to get into the business of trading for a living.

The biggest negative of trading for a living is the fact that the number of failures are humongous in number. I have been in the Industry for nearly 17 years now and I do not know of a single trader who was active when I started off and is still active as a trader now. Of course, there will always be folks who have been active for even more a period of time, but the numbers will be pretty small in nature.

One of the key reason why many a trader cannot sustain this venture is due to lack of a viable strategy. It does not matter how big a capital you start with, if you are chasing the wrong end of the stick, you will end up suffering total capital loss.

A second reason for many a trader to be unable to sustain this business is due to them starting with insufficient capital and then hoping to make a living of it. Markets are not a cow that will provide milk every day or a tenant who shall provide the landlord with a monthly income. Even the best of traders go without having a income (or even worse, having a loss) for months together.

Stress for the trader is guaranteed regardless of the methodology he follows if he has a payment to make and markets are not providing him with the moolah. Many a advise I have heard is to keep 3 years of expenses in a separate account so that you are not troubled by the lack of ability to buy milk the next day because you are having a streak of loses and cannot afford to withdraw capital at this juncture.

I constantly keep meeting traders and the one thing that is constant among many is that they are very well capitalized. This with a decent strategy assures that one will be able to survive the thrills and spills that accompany a traders life.

So, what would be the ideal capital for a trader?

The answer actually is dependent on a lot of factors including the style of trading. For example, capital requirements of a intra-day trader is very small compared to a positional non leveraged trader.

I did a small exercise as to what is the optimal capital requirement for a trader and the results are as shown in the pic underneath.

The above expenses sheet are based on my assumptions on what would be the cost that one needs to account for.

While the costliest data feed would be having a Bloomberg Terminal, I have assumed that not many a trader would actually go for that and instead based it on eSignal. I personally use Global Data Feeds and the amount I pay comes closer to the Average.

So, considering the above expenses, what is the capital requirement if one assumes that the system will over time generate X% / year (not consistently, but on a long enough time frame).

Most simple strategies do not beat the markets and this means that while its nice to be optimistic and think of generating 4 – 5% per month (48 – 60% per annum), in reality you shall find the returns somewhere between 1 – 2% per month (12 – 24%).

Assuming that you are a Average spender, that would mean that you would need a minimum capital of 2 Million to start with. And since we cannot be pulling out money month on month, you would need to store away half a million so that you do not have to worry about your expenses for a year at least. Totaling that up, you will need around 2.5 Million Rupees for one to get started.

The biggest disadvantage for a trader who needs to dip into the capital for expenses (removal even every year) is that he literally misses out on the Eight wonder of the World – Compounding.

Without compounding of capital, there is really very little of wealth generated over time and while you may feel confident that you can continue to do this till the end of your life, it does put a pressure on one to be correct as far as possible.

The biggest advantage of a trader is the ability to lead a life without having to stick to one place. You can travel around the world and yet continue to make a living. In fact, a guy whose website I recently stumbled upon seems to do the same thing and has claimed to have traveled more than 80 countries even as he day trades for a living. (Link)

At the same time, I have first hand witnessed financial destruction and even death of traders who were not able to sustain themselves. As I wrote in my previous post, the probability of survival for a trader (if this is his only source of Income) is pretty low. Just like not everyone can make it to the IIT, so is the ability to earn a living just through trading.

But if you can succeed, there is nothing more satisfying out there. No clients to argue with, no payments overdue, no employees to worry about. Hell, one is truly one’s own boss and driver of his destiny 🙂

Travails of a Trader

Trading is not just a risky business to be in with a survivor rate of less than 5% but a expensive one as well. Most traders are engaged with the markets on a full time basis which means that they cannot earn a living elsewhere. Of course, a lot of guys do trade from their office, but most of them are there for the thrill rather than engaging in the act of earning substantial returns from the investment they make. Of course, like any other field there will always be outlier’s who are not only able to trade successfully but also hold a good paying job elsewhere.

The whole playing field is actually loaded against the trader. Take taxes for example. A investor who holds a share for more than 1 year can enjoy the gains without paying a cent in taxes, traders pay taxes at multiple levels.

Whenever a trader transacts, not only does he pay the brokerage charges but also pays Service Tax on it and Security Transaction Charges. While a investor may deal very few times, a trader by nature is active on most days (depending on the strategy he follows) and hence ends up paying a pretty packet under these accounts.

While earlier, it was essential for a trader to sit at a brokers place, with the advent of internet trading, this is no longer necessary though even today, you shall find clients sitting behind the dealer and placing their trades at may a broker’s office. But if one were to trade outside the broker’s office, it requires a place where you can sit and trade without being disturbed.

While many a trader works from home, professionals generally prefer a quieter place since unless the house is empty during the day (trading time), its tough to avoid disturbances from family members no matter how much one tries to avoid. Add to that, trading not being recognized as a activity in itself, a person at home is generally seen as unemployed rather than self employed.

Once you have a place of your own, the next in line is the investment one needs to do to ensure access to a trading terminal through the day. This means a UPS to ensure that power failure does not affect one’s trading as well as Internet connection to be able to connect to the brokers server.

While a single laptop + a broadband connection may be good enough, most traders prefer to have some redundancy build in for that rainy day when one suddenly finds that not only is his system switching on, but a damaged cable has meant that he has no access (virtual)
to the outside world.

Building redundancy is expensive but can save one’s butt when things go awry right from the world go. Just to recount a personal experience I had recently, my main system suddenly crashed and my system guy informed me that I will need to reformat and re-set up the whole thing right in the middle of a trading session.

Since I have a secondary system, I did not bother much at that time and continued working from the other system. A hour into that, the SMPS of the back-up system literally went up in smoke. Talk about coincidence.

Most traders use Technical Analysis as their trading tool and this means investment in Charting Software + Live Data Feeds. Of course, you do have internet based charting data providers as also free live data providers, but if you really want to test ideas, you would need to invest in them. And even there, one may need some redundancy. Today for example, right when the market was crashing, Global Data Feeds server crashed. If I were to have had a big long position during that time, I would have had no way to know whether to hold the position or exit and short the market.

While most traders I know trade with only one broker, bigger trading friends of mine actually trade at multiple places to ensure that in case a broker’s server goes down (for any umpteen reason), they are able to hedge themselves somewhere else. After all, if you were holding 10000 Nifty (400 contracts), you cannot wait for the brokers server to be reset even as the market starts to move against your position.

Trading as a hobby (which is what its for many) is a pretty expensive sport to be in. Above are some of the issues that needs to be thought into before you jump into a trade. And even after doing that, you may end up having the worst luck and getting killed because you could not get out of your positions fast enough.

Most traders get killed not just because they lack a strategy worth trading but also because they are highly under-capitalized while at the same time trying to earn a full time living out of it. In a future post, I shall detail what I think is the minimum capital a trader needs to start off with if he wants to survive for a period longer than the average trader.

The Truth About Investing

A good read.

Whatever works!

My twitter timeline for the last two days has been inundated with accusal and counter statements between a noted value picker and someone who claims (claim since I do not know him personally) a Financial Planner. I know neither of them but its interesting to see the reactions of others.

One reaction I keep hearing whenever such dog fights break out is that one should follow any strategy that suits him and should not demean any other just because he believes his strategy is better than the other. Man, am I amused to hear this from guys who laugh at the very concept of Technical Analysis. But first things first – I agree that what I do and use for my trading / investing is based on what I believe is best for my kind of philosophy

The problem starts though when I make tall claims about its ability and worse of all, use those claims to sell stuff to other people. The easiest money that can be made in the markets is by selling tips to gullible investors / traders who hope to cut down the amount of research they need to make on their own and yet be able to take advantage of market opportunities.

When a Ayurveda practitioner claims to be able to treat and worse cure Cancer by usage of his medicine, we laugh at his claims and at best ask for proof that is acceptable to the scientific community. Serious folks will approach courts to ensure that non sense is not peddled to save the gullible from being taken for a ride.

But when it comes to the financial world, we have not many such safeguards. SEBI has only recently started to register those who want to peddle advise, but once done, they are free to do whatever they chose to and this makes the whole effort futile.

For years, PMS returns that were generated by fund managers for their clients were not available to the general public. Thanks to Moneylife, we now have them disclosing the same (at least most of them) and this provides a equal playing field for the investor as to who is good and who is not.

In the field of Advisory, claims are tall by nature. So, we have websites that claim 90 – 95% success ratio. Anyone with any bit of market experience knows this is bunkum, but then again, the target for these sites is the general public who wish to make money without having to invest time and resources.

On one hand, we have evidences (mostly from US) that shows us that the failure rate of any trader is very high and that majority of investors are not even able to beat the market indices and on the other, we have site after site peddling systems / strategies that seem to make the whole statistic look like a pumped up number.

Personally I am sketpic about guys who claim to have understood and digested the markets and yet need to sell you stuff (SMS Tips). The big money lies not in selling tips to clients (and many of them have to be really goaded to try it out) but by helping manage money for clients (either as direct fund managers or as Certified Financial Planner). But then again, that exposes one to risks that never come up while selling what is essentially DIY stuff.

As a wonderful quote goes, “When it comes to Success, There are no short cuts”. If you are looking for a easy way to achieving profits in the market, do remember another quote that comes from the poker world

“Listen, here’s the thing. If you can’t spot the sucker in your first half hour at the table, then you are the sucker.” – Rounders, 1998

Don’t be a sucker. It really Sucks 😉

Interpreting the Nifty Candle

The big reaction we saw on Friday in the markets has provided us some interesting candlestick formations on multiple time frames. Since such convergence is rare, I felt that this could be a good way of explaining the importance and the interpretation of such candlestick patterns.

Candlestick patterns first came to the limelight when Steve Nison wrote the book, Japanese Candlestick Charting Techniques: A Contemporary Guide to the Ancient Investment Techniques of the Far East in 1991. Candlestick charts are now the main stay of most Technical Analysts due to the simplicity with which one can interpret what has gone through the day without even having to look at the prices.

Just like most other things, a candlestick pattern provides one with a probability of what did happen as the bar was getting created and what can happen based on the reading of that bar.

Friday’s big fall in Nifty has meant that we got some interesting pattern formation for the day (Friday), for the week and for the month (since that day was also the last day of the month).

First, lets look at the day Candle

The Red bar is the candlestick for the price action we saw on Friday. The bar being red in color indicates that the markets opened at the higher level and closed at the lower level. But what interests us is not just that but the fact that this bar was able to engulf the previous bars. The pattern thus is known as Bearish Engulfing pattern.

This pattern has the highest weight when it comes on top of a bull rally and that is what we have seen happen. A simple reading of the bar is that markets opened normally and went up higher on buying, but the buying was not sustained and selling reversed the course of the action. But since markets are at a new high, the selling should have got absorbed and the lack of absorption is suggestive of the fact that everyone who wanted to buy has already bought and there is none left to buy and hence hold up the prices.

Since most candlestick patterns require a confirmation signal, what we shall be looking for on Monday would be a break of the Friday’s low.

Now, lets move to the Weekly Candle

The above pattern is called “Gravestone Doji” and once again, the candlestick pattern has formed at a place with very high significance. The pattern is pretty suggestive of the fact that bulls have not been able to force their hand and the bears after being banged up pretty bad seem to be getting their mojo back.

The high of the weekly bar is now crucial. As long as that is not broken, bears can hope to see some reversal in the offing.

And finally the Monthly

The Monthly file is a reverse of the daily. While on the daily time frame we saw a Bearish Engulfing pattern, on Monthly we are seeing a Bullish Engulfing pattern. But then again, the way to interpret candlestick patterns is based on where they are placed and in that sense, this pattern is not something that adds value.

To conclude, both the daily and the weekly candle seems to be suggestive of a top in the offing. The current high hence becomes the key area. If that is broken and markets closes above that, both the patterns can be treated as invalid and we may see a continuation.

February has generally been a bullish month while January was usually a bearish month. Will we see a reversal in that pattern? What about the Budget Rally? On Feb 3, we have the RBI policy as well, how will that pan out for the markets? Lots of questions with no real answers unless on is a Astrologer 🙂

Mirror Mirror on the Wall, Who Is the Fairest of Them All

One of the ways of identifying which sector to invest is by comparing the sector’s performance with that of the main Index (Nifty / Sensex in our case). Here are a set of charts where the concept is simply dividing the Index by the value of Nifty and plotting the same.

Market Cliches

Switch on the Idiot Box or scan through the Analyst reports, you can find ‘n’ number of cliches that are theoretically meaningless but made to seem like the verse of God himself. While this article was prodded by hearing some one say that markets having gone up too much, its better to be Cautiously Bullish (whatever that is supposed to mean), there are quite a few articles on the web that have explored the same. So, without much further ado

How to be a stock market expert, or sound like one

Climbing A Wall Of Cliches

14 Meaningless Phrases That Will Make You Sound Like A Stock-Market Wizard

As a Analyst who is asked to perform a certain duty to make it seem that he is working for the benefit of the client, he has to be able to explain every other move. This has resulted in one seeing reports that stretch for pages together with the Analyst finally coming to a conclusion that after doing all that work, I am not sure what the hell is happening and hence stay “Neutral” on the same (Not Rated is another word used to more or less describe the same thing).

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