Commentary | Portfolio Yoga

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.

Of Perma Bulls, Bears and Investors

Last month, I competed 10 years as a Stock Broker and while I am not sure about what lessons I have learnt other than the fact that I have somehow survived the tremulous times, it has given me a opportunity to observe and understand the mind set of people who walk in a broker’s office either as a Investor or as a Trader. This blog is more or less about categorizing them based on my observations

One of the key observations is that most investors are bullish (both of the right kind of bullish and the wrong kind of bullish, but that is for later) while most traders seem to be happy going short vs going long. Its these charlies who are generally caught like sitting ducks when markets move as it is doing now.

While Investors as a group are treated under a single umbrella, we can actually see that there are different classes of them. Some of them are categorized here-under

The All knowing Investor: This guys knows everything there is to know under the Sun. You talk about any company and he has a opinion about it. While the old chaps belonging to this category spend much of their time in the broker office / exchange exchanging views or rather forcing their views on others, the younger generation spends more time on FB / Twitter and Money Control Message Board where they ensure that they provide a opinion on a host of topics and stocks.

Most of these guys have a big portfolio to boot. When I say Big, I mean not in terms of money (as % of their networth invested) but in terms of number of stocks they have a position in. After all, what is the point in knowing so much without having a bit of skin in the game. So, while he studiously avoids the high priced stocks (with the mearage allocations, they can quickly clog the portfolio), they have positions (mostly in single and at most double digits) in a host of stocks. This ensures that regardless of what sector is moving, they have something to showcase.

The Nervous Investor: You can spot this guy from afar. After all, every time the market dips a couple of percentage points, he is the one who keeps asking, how much further shall it fall. Come bull market or bear market, this guy is constantly on his toes & gets rids of his stock the moment he thinks markets shall fall for whatsoever reason.

This is also the guy who explains to anyone who cares to hear about how he had bought Eicher when it was in double digits and MRF when it was in three digits. If only he had held on to them, he would have been a rich man by now.

The swinging Investor: These guys are known for their ability to talk about how India will do great during the next 50 years and how one should follow the buffett philosophy of holding for ever. But since they have this small trait of also being interested in trading, they feel that if markets going down, there is no point in holding onto good stocks. After all, the experience of 2008 showed that even good stocks can fall. So, why not take advantage of the same and reduce one’s average price.

The favorite stocks of these guys are the red hot stocks that are on every traders table. So, you find them talking about how the revival of Suzlon is just round the corner and whether GMR will be able to place its shares to that big investor. After all, there is no glory in holding onto boring stocks that move nowhere na.

The Conspiracy Theorist: These are generally perma bull investors who have invested in all the wrong shares to start with. But then again, that was not their fault to begin with. Its either that the promoters turned out to be sloppy or its just that the operators are still accumulating what they want and once done, the share will shoot up like a rocket.

They are able to find conspiracy everywhere. So, every rise is due to factors A, B or C and every fall is due to factors X, Y or Z. They have more or less boxed out everything there is to box.

The time pass Investor: You would be surprised as to how many a investor belongs to this category. For a lot of them, passing time at home is tough and this means that they come to the broker office after having breakfast and stay till lunch time when they quickly exit so that they reach home to have lunch and then a good nap.

But since brokers will not allow you to sit there, have Chai and do nothing, they have a active account with the major activity being placing orders for small quantity of shares to buy or sell prices so far away that they rarely execute. Most of their time is spent talking to other investors / traders / dealers (in other words, whomever is free to talk). Spending time in a brokers office is easy, what with accesss to news papers and television.

The Invisible Investor: And then, there are guys who are never seen in the brokers office but always talked about in the hush hush tone. The dealer who punches the order believes that this investor is a very well connected guy (Bombay Info?). After all, unlike other investors, this guy rarely bothers to call up but if he does, its a order to buy something big. Fast forward to the future and this stock has more than doubled (when the hell did that happen) and still the guy rarely is interested in selling other than on his own terms.

Brokers generally hate such clients for the single reason that not only do they make plenty of money in the market (more than what the broker usually does in his own investments), but also is a guy who does not pay much. A order once or twice a month cannot provide for the Coffee / Tea that is served daily, leave out other expenses.

And so, that ends the different classes of investors. Most guys easily fit into one box or the other. And then there is the big trading category, the guys who actually are key to running a brokerage office. Without then, it makes more sense to shut the office and give it on rent.

The thing about traders is that most of them are perma-bears. There would be a few perma bulls, but they are often the stray cattle. One reason for traders generally being bearish may owe to the fact that markets spend way less time on the way down than they take on the way up. So, if market moves X% in 3 months, it could take as less than a fortnight to level the whole rise. Making money when everyone else is loosing can be addictive. After all, it does not take one to be a genuis to make money in a bull market, but make money in a bear market and you are in a different league altogether.

While most of them lack any strategy to talk of, most have a basic understanding of charts (never mind the fact that they shall go against it most of the time). Breakouts / Opening Range Breakouts are among the few many a trader prefers. But its what they talk that is more interesting. Most are looking at the Big Picture and know for a fact that this macro event has a large impact and hence even though the markets are looking bullish right now, its time to Sell and not to Buy.

Its amazing the kind of contradictions they hold and the ability to talk their way through pure bull shit. If you were to meet the talented trader (not one who makes money), you shall be astounded by his information process and ability to place them right where it belongs (generally in the bearish camp). The fall in Crude prices for most is not a boon to the markets but a sign that the world markets are collapsing and we may see a collapse of a nature similar to 2008.

The rise in Gold is seen as a confirmation of how the big daddies of the world are preparing themselves for the imminent collapse. And boy, do they love conspiracy theories. Most know far better about the happenings in other countries (especially the troubled ones) that even the citizens of those countries themselves.

But the life of a trader is very short. More often than not, he exits the brokerage house after taking a total loss on his capital. But that in itself does not stop him. Beg, Borrow or Steal, he somehow manages to find capital (for most, its from Salary / Other Income) and start a new account at a new brokerage house (the reason for his previous loss lay in the inability of the dealer to punch in his orders remains his new thesis).

All in all, most brokers see clients as cows to milk since they know for sure that 5 years down the lane, its tough to find even 1% of the original lot. So, why bother with education goes the thinking. Advent of the online brokerage houses such as Zerodha has ensured that many a trader does not even have to move out of his house and yet get the best rates possible. But if one has no job or business, it’s insulting to be seen sitting at home and trading and hence even today, you find that most brokerage houses have a constant number of investors / traders sitting behind the dealers.

This post turned out to be way lengthy than I intended it to be. Hope you liked it 🙂

Howard Marks critique of Technical Analysis

Technical Analysis is a nice punching bowl for most seasoned analysts and fund managers. Howard Marks in his book, “The Most Important Thing” suggests that its not a worthwhile strategy in not more than 300 words.

I myself despite being a follower of Technical Analysis for quite some time do not take at face value all the bull shit that goes by its name. Switch on any television channel and you shall be saturated with calls based on so called “Predictive Technical Analysis” with most analysts trying to predict where the markets / stocks may go from here on the short term.

And almost everyone who comes on TV espousing technical analysis is either working for a firm or runs his own tip providing company. When was the last time you saw a person who used Technical Analysis but was managing a fund?

What this has meant is that even Quantitative analysts (an area from which we derive a lot) look upon Technical Analysis as some sort of vodoo science fit to be ignored. But is there really any value in Technical Analysis or are we blindly following a belief that is not worthwhile?

Its a question that has been asked several times by several eminent folks and the answer I have found is that while there is merit in some forms of technical analysis, it does not mean that all the non-sense that is peddled in its name has value.

To me, any logic that is based on some sort of mathematics and can be created using a system has value. This is because by using a systematic logical process, one is able to over-ride our inherent difficulty that comes to pass as several biases showcase.

The very fact that there are hundreds of successful CTA’s who use one or the other form of Technical Analysis (Trendfollowing based) again tells me that the science is not Vodoo as many seem to think it is.

Do take a look at the performance numbers of a few of such folks here (Link) and tell me how could they achieve those returns if the market is random in nature.

Coming back to the book I am reading, Howard Mark says and I quote

Another form of relying on past stock price movements to tell you something is so- called momentum investing. It, too, exists in contravention of the random walk hypothesis. I’m unlikely to do it justice. But as I see it, investors who practice this approach operate under the assumption
that they can tell when something that has been rising will continue to rise.

Momentum investing might enable you to participate in a bull market that continues upward, but I see a lot of drawbacks. One is based on economist Herb Stein’s wry observation that “if something cannot go on forever, it will stop.” What happens to momentum investors then? How will this approach help them sell in time to avoid a decline? And what will it have them do in falling markets?

I am yet to read his latest book, but I do hope that he has in the mean time seen the evidence that has come out to showcase the fact that momentum trading has some value to it. (Link for a search).

And as to getting out when the bull market stops? Is it not as simple as just using the reverse analogy of the buy to get out. Should not be too hard, ain’t it?

Like any other form of investing, Technical Analysis is not easy too. The ease at which it captures trends seems great in hind-sight, but without putting the effort required to understand and apply the same, the ability to do that in real time is pretty low.

Technical Analysis like any other form of Analysis asks for thinking out of the box. Just like the probability of gains is low that you shall gain just because a stock is cheap, so is with most known ways of using Technical Analysis to identify entry / exit points.

So, ignore the pundits on TV and put some work to understand the nature of the markets and how you can apply a theory that enables you to capture as much of it as possible without having to take the risks that come with a pure Buy & Hope strategy.

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