Portfolio Yoga

Las Vegas attracts a whole lot of people to its casino’s. The mix is varied from the Superstars to the con man on the street and every one of them has only one reason to be there – an attempt to make money at the games. The thrill of making money via luck is not limited to casino’s either with Lottery tickets being there at the top for a long period of time.

In both the cases, it isn’t that the player does not know the adage of “the house always wins” or even the fact that the odds are very strongly aligned against you. But in both the cases, the lure comes from either knowing or actually winning on a casino or hearing about a person who bought a lottery ticket which fetched him millions.

Every one of them hopes that they shall come out with more money than they go in and while not everyone loses, over a long period every one of them would have contributed to the kitty of the casino in one way or the other. The odds aren’t totally skewed in favour of the casino (who would want to play if one cannot see one single guy making money) but the odds are always in favour of the casino. The odds are actually even worse in lottery tickets (with many a jackpot having odds of 1: a couple of million) but since the news program has the winner flushing himself / herself with the winning ticket, the attraction is far too much to ignore for many.

In the markets, I have seen enormous interest in options since the risk is said to be contained while profits unlimited. Charles M. Cottle in his book “Option Trading – The hidden reality” says that the best professional traders earn around 100% per annum which is about 6% after commissions. Most traders on the other hand expect to double their capital within a month if not less.

As a trader, if you want to survive long enough in the market, do remember that it’s not the small wins that count but the big outliers. Small wins may give you the happiness associated with making money, but it’s the big outliers that actually enable your capital to grow exponentially.

One of the often repeated arguments I have heard with regard to trading systems is to be keep it simple (K.I.S.S) with there being no reason for extra complication. To me, that is a lie of the n’th order. Think about it for a moment in the logical sense, if everyone could easily follow a method to endless riches, why should anyone bother to take any risk elsewhere or even strain muscles / brains by working for someone else. All you would need is a PC with Internet connection and you would be good to go.

In the world of Finance, nothing comes without risk. Risk is always lurking in the background, ready to pounce on at a moment’s notice. But since not all risks are evident, we tend to basically ignore that very important aspect.

While there is no such thing as Risk Free investment, some investments do come close in that regard. Bank Fixed Deposit is one of them. If you have placed a deposit in any PSU or even Private Sector bank, the probability of losing money is next to nil (but not nil). Even when private sector banks have collapsed, depositors have not suffered losses thanks to RBI which would force some public sector bank to take it up (remember Global Trust Bank for instance).But there is risk, just that the probability at the current juncture of something on those lines happening being very low.

Other than Bank FD, the simplest way to invest money elsewhere is in Gold and Real Estate. Since cycles in both these asset classes are long, for quite some time, it’s being felt that these are the only two asset classes to own. Unfortunately in the world of cycles, after a big run up, there is a big sideways action or worse a big downside action. Either way, the returns over a long term isn’t great especially if one invested at the top of the previous peak.  But for those who invested prior to 2005, returns have been magnificent to say the least. But the profits one is sitting on is notional and unless removed, the returns can actually dilute over time if prices move either sideways or downward.

So, that leads us to the markets. There are basically two ways to invest in the markets. One is via Mutual Funds who pool the money, hire a professional fund manager and who hopes to beat the market over an extended period of time.  Second is by way of direct investing where you decide what to buy, when to buy and how much to buy as well as when, how and where to sell. Once again, the attempt is to make more money than what can be achieved by either investing in a Mutual Fund or Fixed Deposit though neither is a good benchmark given that risks and returns are different for each of them and most importantly, both of them do not require a significant amount of personal time to monitor.

The set of investors who invest in markets directly can be further separated on the basis of what kind of analysis they do. Most either fall into Fundamental or Technical while quite a few do not have any analysis to speak of but are more or less dependent on their brokers or the talking heads on TV to give them something by which they can make a penny.

While there have been plenty of successful investors whose approach was based on picking up value stocks at a cheap price, the overwhelming fact is that we look at the winners and ignore the losers. Sanjay Bakshi in his interview with Safal Niveshak (Link: http://is.gd/txIPLX ). He says and I quote

“You just have to see how people have got rich in stocks. If you look at genuinely successful people in the stock market, you will find that an over-whelming majority of them bought stocks of good companies at attractive prices and just sat on them for a long-long time.”

Well, the point that is overlooked here is that if you bought a great share which subsequently tanked, you would not be rich by just sitting on it. It also brings to question as to how much part of the success can be allocated to skill and how much to Luck. As Nassim Taleb says “it’s so easy to confuse luck with genius” you may never know the lucky breaks they had which made them the persons they are now. And for a live example, one needs to go not too far but look at the picks of a guy who was once said to the Warren Buffet of India.

Value Investing requires a lot of work, determination, patience and a fistful to luck. Without one of the ingredients, you can always have value stocks but one that never seems to be noticed by the markets. There is nothing simple in terms of work and at the end of the day, you hope that the light you see at the end of the tunnel is the opening to freedom rather than headlight of an oncoming train engine.

That leaves me with only Technical Analysis to talk about. Being a practitioner of technical analysis for more than a decade now, it’s a field that has interested me a lot and one that has provided me the bread and butter over the years. Even among technical analysts, you can find a clear demarcation. There are one set of guys who trade based on discretion and another who wants to follow a tried and tested mechanical approach to trading markets. While there are quite a few guys who are good at reading charts, most of those I know aren’t actually full time traders in the sense that even if the markets provide them with nothing, life goes on as usual.

On the other hand, there is this set of traders (which includes me) who believe that while its acceptable to trade small money based on views, when it comes to managing money professionally or even if you want to take higher risks in anticipation of higher rewards, one cannot blindly bet on our reading of charts and instead would love to have something tried and tested to work with.

But mechanical trading system for many starts and ends with Moving Average Crossovers. It’s not that there is anything wrong with MA cross, many random numbers do somehow come out with positive outputs but the question is, is the positive output alone worth the risk and the efforts that go into making that effort.

Unlike fundamental investing where you buy the shares of a company and sit tight hoping you are right, technical trading requires more attention (depending on the kind of time frame one chooses). While technical analysis offers many tools, due to the ease of use, MA Cross seems to attract the highest attention of investors and traders alike.

But unfortunately the fact of the matter is that the probability of making big money using a MA Cross is very low and if one adjusts the risks taken to get that reward, it does not even start making any sense.

Every one of us has limited time but unlimited requirements and it’s important that the time we have is well utilized instead of being wasted in a venture where the net output was zilch.

I had recently tested out MA Cross on daily time frame and given the results in an attempt to show that it does not make sense. To make it even more hard hitting, I have now tested 19208 combinations under every time frame – starting at 15 minutes to Monthly. As can be seen in the results, nearly every one of them have under-performed the Buy and Hold which suggests that one would have done nearly as well by just sitting as Jesse Livermore is quoted as saying.

In addition to the normal back-test metrics, I have also calculated Expectancy (Link for more on that: http://www.tradermike.net/2004/05/trading_101_expectancy/ ) and if you were to take the best (which you would not possibly have known when you started to trade – Hindsight bias), you shall see that even that under-performs a normal Buy and Hold. And this despite me not taking into calculation any brokerage (since High and Low is taken as entries, slippage can be taken as being included).

The testing was done on Nifty since it absolves one of many biases which can ruin any test if done on any stock or a set of stocks.

You can download the results here (Link: https://dl.dropboxusercontent.com/u/19628087/EMA-Crossover-Intra-D-W-M.zip )- file size is around 40~MB

To conclude, if you are trading on a MA Crossover idea, I would urge you to think deep as to whether it’s worth the time and effort and whether you are better off investing the same into a Index fund and using the time for other pursuits.

When Infosys brought back NRN who tagged his son along, there was a lot of hue and cry about how he had abandoned his own principles. I for one thought otherwise and felt that he being the guy who gave up so much of his time and energy to create the company was attempting to save the company and there was nothing wrong in doing the same.

But having seen the affects of how companies which disrespect meritocracy gets nowhere over a period of time, I now believe that this was the biggest error made not by NRN but by the shareholders of the company who approved the said resolution.

Unlike America, our Institutions generally do not interfere with the running of the company and most of the times sides with the management and hence it’s difficult if not actually impossible to launch a hostile takeover on any company.

In case of Infosys, promoters hold just 16.04% of the stake while FII’s and DII’s combined hold the majority – 58% of the company shares. For them, jointly, it would have been as easy as 1-2-3 to overrule the Board of Directors who took the decision. But based on reactions coming from them, it looked like they actually welcomed the move.

But then again, most of them are concerned with their investments and if they feel that it’s the right step, so be it. But the question is, is it the right step? In India we repeatedly complain of how one family is able to rule us but do not question as to why majority of the big companies have no one other their own ilk to run the company. Is India so short of talent?

While a hue and cry was raised in case of Infosys, the pass over is seen as a normal occurrence in majority of the cases. Reliance got split and passed over to his sons, Birla is a family run enterprise and even Tata after making news about a global search finally settled down for the son of its largest shareholder.

There have been numerous case studies on Family run business and Professional run business and depending on how you arrive at the final set of data, you end up seeing one better than the other.  

If we were to look at our own lives and the things we use, majority of the cheap items we use today seem to come from China (as also nearly everything in electronics) or is the handwork of a company whose parent company is a MNC situated outside of India. And in the very few where its Indian companies that dominate, it has more to do with the laws than the ability to overcome competition.

The thing we seem to be missing and the key factor that has ensured that not many big companies have emerged from India is called “Creative Destruction”.  It’s in a way amazing that while the whole thought behind Creative Destruction is said to be taken from Hinduism “Shiva in the form of Nataraja”, we ourselves have decided that application of it is not something that is worthwhile.

The absence of competition has meant that many a company enjoy unbridled margins at the cost of the newcomer who is not allowed to compete against him with barriers placed at every corner.  Of course, where we have loosened the rules and let fair play, the results have been seen as vastly beneficial to the end customer.

Two industries / sectors come to the top of the mind – Telecom and Stock Exchange. While the telecom story is well known, the story of the stock exchange is not. Prior to 1996, there were around 27 active stock exchanges across the length and breadth of the country.  Each stock exchange was limited to the state boundaries beyond which they were not allowed to operate so as to ensure that there was no overlapping. This meant that arbitrage opportunities were plenty in number what with exchanges having their own settlement periods.  And despite that number, the depth was low owing to lack of transparency, high charges and outright frauds.

But things started to change when NSE came into the picture. Within 4 years, it ensured that all localized exchanges were more or less on the verge of shutting down with only BSE being able to survive the onslaught.

But that was 1996 and its now 2013 and as anyone connected with the financial markets saw when MCX tried to launch its own Equity exchange, it faced hurdles that would have stumped any other player but due to the fact that it already ran an exchange, it could wait the time.

One of the biggest complaints against Creative Destruction has been about how it will kill existing jobs. But as studies after studies show, in the long term, it improves the overall economic climate of the country as well as ensuing one constantly upgrades his skill sets to ensure that he is not left behind. Till that happens, it’s difficult to see companies emerge from India that is seen as dominators like many of the US / European companies have. There is only so much that cheap labour and a weak currency can provide for as China and India are fast finding out.