Category Archives: Money Management

An Elliott-Wave Cross-Section through a Crowd Build-Up

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At first, there’s smart money.

Behind this white-collared term are pioneering investors who believe in thorough research, and who are willing to take risks.

Smart money goes into an underlying, and the price of this underlying moves up. Wave 1.

At the sidelines, there are those who have been stuck in this underlying. As the price moves above their entry level, they begin to off-load. There’s a small correction. Wave 2.

By now, news of the smart money has perforated through the markets. Where is it moving? What did it pick up? Who is behind it? Thus, more investors following news or fundamentals (or both) enter. The price moves past the very recent short-term high of Wave 1, accompanied by a surge in volume.

This is picked up on the charts by those following technicals, who enter too. By now, there are analysts speaking in the media about the turn-around in company so and so, and a large chunk of people following the media do the honours by entering. Wave 3 is under way.

Technical trend-followers latch on, and soon, we are at the meat of Wave 3, i.e. the middle off the trend.

Analysts on the media then speak about buying on dips. All dips are cut short by a surge of entrants seeking to be part of the crowd.

The first feelings of missing the bus register. The pangs of these cause more people to enter.

Meanwhile, the short community has been getting active. Large short positions have been in place for a while, and they are bleeding. Eventually, the short community throws in the towel, and there’s massive short-covering, causing a further surge in price.

Short-covering is sensed by gauging buying pressure despite very high price levels. It is the ideal time for smart money to exit. That’s exactly what it does, without any dip in the price of the underlying whatsoever.

Short-covering is over. Smart money starts boasting about its returns of X% in Y days, openly, at parties, in the media, everywhere. This causes pangs of jealousy and intense feelings of missing the bus in those still left out. Some enter, throwing caution to the wind.

The price has reached a level at which no one has the guts to enter. Demand dries up. With no buying pressure, the price dips automatically. Bargain hunters emerge, and so do shorters. The shorters sell to the bargain hunters right through a sizable dip. This dip happens so fast, that most of the crowd still remains trapped. Wave 3 has ended, and we are now looking at the correcting Wave 4 in progress.

At this stage, technical analysts start advising reentry upon Fibonacci correction levels. Position traders buying upon dips with margin of safety enter, and so does the second-last chunk of those feeling they’d missed the bus. The price edges up to the peak of Wave 3 and past it. That’s the trigger for technical traders to enter.

We now see a mini-repeat of Wave 3. This is called Wave 5. Once Wave 5 crosses its meat, the last chunk of those still feeling they’d missed the bus makes a grand entry with a sharp spike in the price. These are your Uncle Georges, Aunt Marthas and Mr. Cools who know nothing about the underlying. They cannot discern a price to earnings ratio from an orangutan. They desperately want to be a part of the action, since everyone is, at whatever the price. And these are the very people that traders sell to as they exit. With that, the crowd is at its peak, and so is the price. There are no more buyers.

What’s now required is a pin-prick to burst the bubble. It can be bad news in the media, the emergence of a scandal, a negative earnings report, anything.

The rest, they say, is History.

Options 1.0.3

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Has your stop ever been jumped over?

Yes?

Did it make you angry?

Yes?

It might make you angrier to know that Mrs. Market couldn’t care less about you on a personal level. It’s you who has to adapt, not Mrs. Market.

So, next time you see Mrs. Market moving many points in one shot, you have a choice. Either you can choose to take the chance of having your stop jumped over in the hope of huge rewards, or you can use options as an instrument to trade.

In general, a stop getting jumped over is a non-issue with options, because you are pre-defining your maximum loss here. Your option-premium is the maximum loss you will incur on the trade. Once you’ve mentally aligned yourself with this potential maximum loss, you are actually then asking Mrs. Market to do all the jumping she wishes to do. It just doesn’t bother you anymore. You travel, do other stuff, and then take a sneak-peak at your position.

Once your position starts making money, you might decide to fine-tune your trade-management after achieving your target. If you then make sure that your trailing stop is wide-gapped, you can still relax and do other stuff. Maybe one time out of twenty, Mrs. Market will jump even your wide-gapped trailing stop. Even if she does, you are well in the money, and you do not forget to install a new stop. Also, a little while ago, you were mentally prepared to forgo your whole option-premium, so giving back a part of your profits seems a piece of cake to you.

Welcome to the world of options. We have plunged right in. I believe that the best way to learn something is to plunge right in. Gone are the days of bookish learning.

The options market in India is just about coming into its own. At any given time, there will be at least 20 scrips on the National Stock Exchange showing very high options volume for long trades, and at least 10 scrips showing heavy volume for short trades. Bottomline: you can get into a liquid trade on either side, anytime you want. The number of scrips showing this kind of liquidity is picking up. We are still very, very far away from the mature options market in the US. What can be said is that the Indian options market will offer you liquid trades, anytime, both on the long and the short side. Frankly, that’s all one needs.

On the flip side, options on commodities have yet to come to India. Also, only the current month options are adequately liquid in India. Regarding options, the Indian market is getting there. Well, as long as you get a liquid trade anytime you want, who cares if we’re not as mature as the US options market? I don’t.

Over the last few months, options have been the instruments of choice, with unfathomable volatility abounding. I was dying to have a go, but have been caught up in so much other distracting stuff, that I’ve not traded for two months now. I like sticking to my trading rules. One of them is to not trade if I’m distracted. I really stick to this one.

Those who did trade the options market over this period would have done exceptionally well, because ideal conditions persisted. Big and quick moves, like a see-saw. The scenario would look like this: Long options give quick profits, short options simultaneously becoming very cheap, especially the out of the money ones. One sells the now expensive long options (which were picked up cheap), and stocks up on the now cheap out of the money short options. The market turns around and leaps to the downside, giving quick and large profits on the short options. One sells the short options and picks up now cheap out of the money long options, again. The repeat trades according to this pattern can continue till they stop working. When they stop working, what have you lost? Just your premium on some out of the money options.

Wish I’d had the frame of mind to trade options over the last two months. But then, one can’t have everything!

Jumping Jackstops

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Recently, Mr. Cool and Mr. System Addict decide to get into a trade.

Yeah, surprise surprise, Mr. Cool is liquid again!

They’ve decided to trade Gold, and are pretty much in the money already. Their trades have come good first up. Both are leveraged 25:1, which is common with Gold derivatives. Mr. Addict has bet 5% of his networth on the trade, and Mr. Cool, true to his name, has matched Mr. Addict’s amount.

Gold prices jump, and Mr. Addict’s target is hit. He exits without thinking twice, and is pretty pleased upon doubling his trade amount within a week. He pickles 90% of the booty in fixed income schemes, and is planning a holiday for his girl-friend with the remaining amount. Instead of trading further, he decides to recuperate for a while.

Meanwhile, Mr. Cool rubs his hands in glee as the price of Gold shoots up further. His notional-profits now far exceed the actually booked profits of Mr. Addict. When’s he planning to exit? Not soon. He wants to make a killing, and once and for all prove to Mr. Addict and to the world, that he rules. He wants to bury Mr. Addict’s trade results below the mountain of his own king-sized profits. Gold soars further.

Mr Cool has trebled his money, and is still not booking any profits. He picks up his cell to call Mr. Addict. Wants to rub it in, you know.

Mr. Addict puts down his daiquiri by the poolside in his hotel in Ibiza. His girl-friend has at last started admiring him. They’ve been swimming all morning. “All right, all right, he’ll take this one call. Oh, it’s Mr. Cool, wonder what he’s up to?” Mr. Addict is one of the few people in the world who are able to switch off. He’s totally forgotten about Gold and his winning trade, and is really enjoying his holiday.

Mr. Cool tries to rub it in, but receives some unperturbed advice from the other end of the line. He’s being asked to be satisfied and to book profits right now. Of course he’s not going to do that. All right, fine, if he wants to play it by “let’s see how high this can go”, he needs to have a wide-gapped trailing stop in place, says Mr. Addict. Of course he’s got a wide-gapped trailing stop in place, says Mr. Cool. Mr. Addict wishes him luck, cuts the call, and forgets about the existence of Mr. Cool, dozing off into a well-deserved snooze.

As Gold moves higher, Cool starts to think about that wide-gapped trailing stop. Let alone having one in place, he doesn’t even know what it means. A quick call to the broker follows. The broker is ordered to install a trailing stop into Mr. Cool’s trade. Since Cool doesn’t know what “wide-gapped” means, he forgets to mention it. The broker doesn’t like Cool’s attitude and his proud tone. He installs a narrow-gapped trailing stop.

Circumstances change, and Gold starts to drop. It’s making big moves on the downside, falling a few percentage points in one shot. Cool’s narrow-gapped trailing stop gets fully jumped over; it doesn’t get a chance to become activated in the first place, because it is narrow-gapped and not wide-gapped. The price of the underlying just leaps over the narrow gap between trigger price and limit price. Happens. Cool does not install a new stop. Stupid.

Next morning, Cool’s jaw drops when he sees Gold down 15% overnight. On a 25:1 leverage, he’s just about to lose his margin. The phone rings. It’s the margin call. Cool panics. He answers the margin call. His next call is to Mr. Addict, asking what he should do. Mr. Addict is shocked to learn that Cool has answered the margin call. He asks him to cut the trade immediately.

Cool’s gone numb. Gold drops another 4%. Phone rings. Second margin call. Cool doesn’t have the money to answer it. In fact , he didn’t have the money to answer the first one. In the broker’s next statement, that amount will show up as a debit, growing at the rate of 18% per annum.

Mr. Cool’s not liquid anymore. Actually, he’s broke. No, worse that that. He’s in debt. Greed got him.

A Fall to Remember (Part 2)

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Part 1 was when Silver fell almost 20 $ an ounce within a week. Like, 40%. Swoosh. Remember? Happened very recently.

And now, Gold does a Silver, and falls 20 % in a few days. These are the signs of the times. “Quick volatility” is the new “rangebound move”. Put that in your pipe and smoke it.

The wrong question here is “What’s a good entry level in general?” Why is this question wrong?

When something new becomes the norm, there is too little precedence to adhere to. It becomes dangerous to use entry rules which were established using older conditions as a standard.

I believe there is one way to go here. The correct question for me, were I seeking entry into Gold or Silver, would be “Is this entry level good enough FOR ME?” or perhaps “What’s a good enough entry level FOR ME?”

Let’s define “good” for ourselves. Here, “good” is a level at which entry doesn’t bother YOU. It doesn’t bother you, because you are comfortable with the level and with the amount you are entering. You don’t need this sum for a while. It is a small percentage of what you’ve got pickled in debt, yielding very decent returns. If the underlying slides further after your entry, your “good” level of entry still remains “good” till it starts bothering you. You can widen the gap between “not-bothering” and “bothering” by going ahead with a small entry at your “good” level, and postponing further entry for an “even better” level which might or might not come.

If the”even better” level arrives, you go ahead as planned, and enter with a little more. If, however, your “good” level was the bottom, and prices zoom after that, you stick to your plan and do not enter after that. This would be an investment entry strategy, which sigularly looks for a margin of safety. Entry is all-important while investing, as opposed to when one is trading (while trading, trade-management and exit are more important than entry).

Trading entry strategies are totally different. Here, one looks to latch on after the bottom is made and the underlying is on the rise. Small entries can be made as each resistance is broken. It’s called pyramiding. Trading strategies are mostly the complete opposite of investing strategies. Please DO NOT mix the two.

Sort yourself out. What do you want to do? Do you want to invest in Gold and Silver, or do you want to trade in them? ANSWER this question for yourself. Once you have the answer, formulate your strategy accordingly. U – good level – how much here? U – even better level – how much there? U – no more entry – after which level?

Life is so much simpler when one has sorted oneself out and then treads the path.

Putting it all Together – The View from the Mountain-Top

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Remember getting into the driver’s seat for the first time?

It all seemed so difficult. You got the brake-clutch-accelerator coordination all wrong. Proper gear changes were a far cry. There was no question of looking into the rear-view or the side-view mirrors, since you were looking straight. And the shoulder-glance – just forget about it, you said to the instructor.

Slowly, it all came together, perhaps after a 1,50,000 km behind the wheel. Now, driving is a piece of cake. It’s all there in your reflexes. It’s as if the car is connected to your brain, and is an extension of your limbs.

It took time and effort, didn’t it? And why would it be any different in the markets?

Flash-back to 1988 – high school – our Chemistry teacher Frau Boetticher used to teach us to strive for the “Ueberblick”. Roughly and applicably translated, this analogical German word means “the view from the mountain-top”. In Street lingo, the Ueberblick is about life in the Zone. Frau Boetticher used to push us to get into the Zone. She knew that then, our reflexes would take over. She passed away before our A-levels, after a very fulfilling and successful lifetime of teaching. She was the best teacher to ever have taught me.

When your reflexes make you enter a market, or exit it, or decide on the level of a stop, or a target etc. etc., you’ve managed to put it all together. Doesn’t happen overnight, though. The ball-park figure of 1,50,000 km behind the wheel changes to roughly 7 years of market experience, before one can expect to put it all together on the Street.

Where does that leave you?

As a thumb rule, money-levels at stake in the first 7 years on the Street need to be low. When you’re getting the hang of things, you just don’t bet the farm. That’s common sense, a rare commodity, so I’m underlining it for you.

On the Street, you only learn from mistakes. They are your teachers, and they prepare you to deal with Mrs. Market. No books, or professors or college will make you fit enough to tackle Mrs. Market, only mistakes will. Make mistakes in your first seven years on the Street – make big mistakes. Learn from them. Don’t make them again. Get the big blunders out of the way while the stakes are small. Round up your learning before the stakes get big.

Once your reflexes all come together, you can start risking larger sums of money, not before. Also, in today’s neon age, it’s difficult to stay in the Zone for prolonged periods of time. Something or the other manages to distract us out of the Zone, whether it is internal health or external affairs. When you feel you’re out of the Zone, just cut back your position-size. When you feel you’re back in, you can scale up your position-size again.

It’s as simple as that. Useful ideas have one characteristic in common – they are simple.

Blowing up Big

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Derivatives are to be traded with stops. Period.

Stops allow you to get out when the loss is small.

Common sense?

Apparently not.

Who has common sense these days?

Also, the human being has embraced leverage as if it were like taking the daily shower. Bankers and high-profile brokers have free flowing and uncontrolled access to humongous amounts of leverage.

Apart from that, the human being is greedy. There’s nothing as tempting as making quick and big bucks.

Combine humongous amounts of leverage with large amounts of greed and brew this mix together with lack of common sense. That’s the recipe for blowing up big.

Every now and then, a banker or a high-profile broker blows up big, and in the process, at times, brings down the brokerage or the bank in question. In the current case at hand, UBS won’t be going bust, but its credibility has taken a sizable hit.

Bankers are to finance what doctors are to medicine. Where doctors manage physical and perhaps mental health, bankers are supposed to manage financial health. Bankers are taught how to manage risk. Something’s going wrong. Either the teaching is faulty, or the world’s banking systems are faulty. I think both are faulty. There exists a huge lack of awareness about the definition of risk, let alone its management.

Trained professionals lose respect when one of them blows up big. Such an event brings dark disrepute to the whole industry. Most or all of the good work to restore faith in the banking industry thus gets nullified to zilch.

A doctor or an engineer is expected to adhere to basics. I mean, the basics must be guaranteed before one allows a surgeon to perform surgery upon oneself. A surgeon must wash hands, and not leave surgical instruments in the body before stitching up. Similarly, an construction engineer must guarantee the water-tightness or perfection of a foundation before proceeding further with the project.

Similarly, a banker who trades is expected to apply stops. He or she is expected to manage risk by the implementation of position-sizing and by controlling levels of leverage and greed. Responsibility towards society must reflect in his or her actions. A banker needs to realize that he or she is a role model.

All this doesn’t seem to be happening, because every few years, someone from the financial industry blows up big, causing havoc and collateral damage.

Where does that leave you?

I believe that should make your position very clear. You need to manage your assets ON YOUR OWN. Getting a banker into the picture to manage them for you exposes your assets to additional and unnecessary stress cum risk.

In today’s day and age, the face of the financial industry has changed. If you want to manage your own assets, nothing can stop you. There exist wide-spread systems to manage your assets, right from your laptop. All you need to do is plunge in and put in about one hour a day to study this area. Then, with time, you can create your own management network, fully on your laptop.

Your assets are yours. You are extra careful with them. You minimize their risk. That’s an automatic given. Not the case when a third party manages them for you. Commissions and kick-backs blind the third party. Your interests become secondary. Second- or third-rate investments are proposed and implemented, because of your lack of interest, or lack of time, or both.

Do you really want all that? No, right?

So come one, take the plunge. Manage your stuff on your own. I’m sure you’ll enjoy it, and it will definitely teach you a lot, simultaneously building up confidence inside of you. Go ahead, you can do it.

The Power of Compounding

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At first, the power of compounding is a slow and steady trickle. Then, it starts gathering momentum. Finally, after a long time, it reaches epic proportions.

If you make the power of compounding work for you from as early an age as possible, you could well achieve financial freedom in your early- to mid- 40s. How does that sound?

Let’s say that your investment gives you a steady 8% per annum compounded. In 25 years, it us up almost 7 fold.

If the investment is giving 12% per annum compounded, in 25 years it will be up 17 fold.

15% per annum compounded – will be up almost 33 fold in 25 years.

20% per annum compounded – 95 fold.

27% (Warren Buffett’s average lifetime return per annum compounded, calculated some years before he donated his fortune to charity) – almost 394 fold.

42% (Rakesh Jhunjhunwala’s average lifetime return per annum compounded, that’s what they say) – 6415 fold.

What do you say to that? Don’t the figures speak for themselves and prove to you the power of compounding? Wouldn’t you like to start harnessing this power from like right now?

Let’s do another exercise. We are now looking at an investment term of 30 years. Other conditions remain the same.

An investment yielding 8% per annum compounded, in 30 years, will be up 10 fold, or a 1000%.

If the investment is giving 12% per annum compounded, in 30 years it will be up almost 30 fold.

15% per annum compounded – will be up 66 fold in 30 years.

20% per annum compounded – up 237 fold in 30 years.

27% – 1300 fold.

42% – 37038 fold.

Don’t the figures just blow you away? (They are so startling, that I have to ask myself if I’ve made some mathematical error. Why don’t you check these figures for me and inform me if there is an error).

The harnessing of this power of compounding is primarily the domain of the long-term investor. Nevertheless, the prudent trader uses it too. Such a trader ties up vast sums of money in fixed income investments for long periods of time, and then just trades on part of the yielded income, using the rest to live well and reinvesting what is still left.

It’s really time you start making use of the power of compounding. If not for yourself, then at least harness it for the futures of your children.

The Power of Leverage

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Apart from the D-word, the Street’s got the L-word too.

This L stands for L-E-V-E-R-A-G-E.

So, how much leverage do you enjoy from your spouse?

Or, do you have any leverage on politician so-and-so?

Or, bank so-and-so or brokerage so-and-so is offering a 10:1 or a 16:1 leverage on derivatives.

Just racking up the various uses of the L-word.

In colloquial terms, the amount of leeway your spouse allows you in your marriage is called leverage. Also, the amount of dirt you have on a politician to coerce him into following your wishes – that’s called leverage too. But for now, let’s get back to the Street.

On the Street, The L-word gives the D-word its power to destroy big.

Do you remember what the D-word was? D-E-R-I-V-A-T-I-V-E-S.

A derivative is a stink normal trade without the power of leverage. When brokerages start offering you leverage like 16:1, the stink normal derivative becomes lethal. Then, small amounts of volatility can wipe out the principal put up by you. If a down-turn continues, your loss can become many times your principal. People can go bankrupt like this.

You see, for every market move, your profit or loss is the move times the leverage. On a 5% move, a 16:1 leverage can result in 80% profit or loss. Leverage works on the upside as well as the downside.

The problem arises when the player doesn’t know how to play either side. Most players don’t know.

Leverage can be used to one’s advantage only when the down-side is protected with a stop. Most people don’t use a stop while deploying leverage. That’s why they lose, and lose big.

This singular characteristic of the average market player of not knowing how to use stops results in a spiralling bomb during market down-turns. As losses pile up, selling pressure increases due to dejection or the like as the market heads even lower. What if they’d taken a 2% or a 5% or even an 8% hit when a stop was hit? They’d be out and the market could stabilize near the stop level because of lack of further selling pressure.

Leverage is something that must not be used if one doesn’t fully understand how to use it. Unfortunately, almost everyone consumes leverage as if it were a bar of Snickers. Leverage is served to customers on a platter. Even a loan, or debt on the credit card is leverage.

Leverage is the driving force of consumerism and the modern industrialized world.

Just 40 $ Away…

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The first signs of greed can be sensed.

We’re talking about Gold.

A few months ago, serious players in Gold had identified Rs. 28,000 / 10 grams as their target for Gold.

This target has been achieved for a while now. Nobody’s booked their Gold.

Instead, the target has been revised to Rs. 30,000 / 10 grams, which is just another 40 $ an ounce away.

Please don’t tell me that nobody is going to book (meaning sell, as in booking profits) their Gold @ Rs. 30,000 / 10 grams. I’ve got this nagging feeling that they’re not.

Hmmm, greed is setting in. Nothing unusual. That’s how a bubble progresses.

Yesterday, an update from Reliance alerted me to the hypothesis that Rs. 40,000 / 10 grams was a real possibility in Gold.

Maybe, maybe not. As of now, Reliance is sounding like that fellow who predicted a Dow level of 36,000 some years ago. Today, 36k on the Dow seems impossible, even in one’s dreams.

Does it matter to you how high Gold can go? Or is your target more important? Both are valid questions.

If your target has been achieved, here’s one scenario. Book the Gold and put the released funds into debt. Debt in India is safe, and is giving excellent returns, especially to the retail investor.

If your stomach is full, do you dream about more food?

Seriously people, playing this by targets is a serious option.

It’s also ok if you wanna play it in a “let’s see how high this can go” manner. That’s just another way of playing it. Fine. In this case, you need to set trailing stops, and you need to stick to these if they get hit.

Either way, identify a booking strategy for Gold and stick to it.

Take greed out of the equation. There’s no room for greed in the career of a market player. There’s no room for fear either.

We’ll talk about taking fear out of the equation some other day, if and when unprecedented gloom and doom abounds.

Crowds Eventually Start Behaving in a Deluded Manner

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We’re human beings.

The majority of us likes forming a crowd.

Our crowd-behaviour eventually goes warped. History has shown this time and again.

In the market-place, I make it a point to identify crowds. The biggest money is to be made by capitalizing upon the folly of a crowd. That’s why.

So first let’s gauge very broadly, what the main aspects of market-study are, and then let’s see where crowd-behaviour fits in.

Market-study encompasses three broad areas. These are:

1). Fundamentals,
2). Technicals and
3). Sentiment.

You guessed it, crowd behaviour falls under “Sentiment”. Well, sentiment can knock the living daylights out of the best of “Fundamentals”. And, sentiment makes “Technicals”. Thus, for me, the most important factor while understanding market moves is sentiment.

A stock can exhibit the choiciest of fundamentals. Yet, if a crowd goes delusional, it can drive down the price of even such a stock for longer than we can remain solvent. Let’s write this across our foreheads: Delusional Crowds can Maraude Fundamentals.

Since we are now writing on our foreheads, let’s write another thing: Delusional Crowds can cause Over-Bought or Over-Sold conditions to Exist for longer than we can remain Solvent. There go the technicals.

A crowd thinks in a collective. All that’s required is a virus to infect the collective. A virus doesn’t have to be something physical. It can even be an idea. The space that we exist in is laden with disease-causing energies. Once a crowd latches on to a virus-like idea, its behaviour goes delusional.

Here are some examples of such behaviour. At the peak of the dot-com boom, in March 2000, a crowd of rich farmers from the surrounding villages walks into a friend’s office. They are carrying bags of cash. They tell my friend that they want to buy something called “shares”. They ask where these can be purchased, and if they are heavy (!). Since they are carrying their life-savings with them in cash, and plan to spend everything on this purchase of “shares”, they want to also effetively organize the transport of the “shares” to their homes in the villages. Thus they want to know if “shares” are heavy to transport!

In the aftermath of the dot-com bust, Pentasoft is down more than 90% from its peak. I think this legend is from 2001. A crowd of rich businessmen collects the equivalent of 20 million USD and buys the down-trodden shares with all of the money. The scrip goes down to zilch and today, one’s not even able to find a quote for it.

In the 17th century, people actually spend more than the price of a house for the purchase of one TULIP, for God’s sake.

You get the drift.

The current crowd is building around Gold. It’s behaviour as of now is still rational. In due course, it has high chances of going irrational.

Whenever that happens, we’ll definitely be able to see the signs, because both our eyes are OPEN.

And what was Mr. Fibonacci thinking?

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0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377… , … , …

What’s this?

A random set of numbers?

Nope.

It’s the Fibonacci series.

How is it derived?

Start with 0 and 1, and just keep adding a number to the one on its right to get the next number, and so on and so forth.

What’s so peculiar about this series?

As we keep moving from left to right, the result of dividing any number by the one on it’s immediate right starts converging towards 0.62.

Also, as we keep moving from left to right, the result of dividing any number by the second number on its right starts converging towards 0.38.

The series starts with a 0.

Another number to note is 0.5.

So, in a nutshell, these are the important figures to note, which this series generates: 0, 0.38, 0.5, 0.62. There are more, but these are the most important ones.

I’ve always wondered why the 0.5 is important. Actually, “half-way” is big with mankind.

What’s the significance of this series?

In any activity involving a large number of units, these Fibonacci ratios are said to be observed.

It is said that crowds behave as per these ratios.

It is said, that for example when many leaves fall from a tree over a long period of time, a Fibonacci pattern can be determined in their falling.

It is said that these ratios are ingrained in nature.

True or false?

Don’t know.

What I do know is that the trading fraternity has taken these numbers to heart, and looks for Fibonacci levels in anything and everything. Most commonly, entry into a sizzling stock is planned after the stock has corrected past a Fibonacci level and has once again started to rise.

In simpler terms, aggressive traders who buy on dips will look for a 38% correction of pivot to peak before entering.

Less aggressive traders will wait for a 50% correction and then enter upon the rise of the underlying.

Traders who like to value-buy will wait for a 62% correction, which might or might not come.

If the underlying goes on correcting past 62%, it is best left alone, because the correction can well continue beyond 0, the starting point of the prior rise.

A current example where you’ll most definitely see Fibonacci ratios in action is with Gold.

The million dollar question I have been hearing around me today is when to enter Gold now, especially because it is correcting heavily.

The immediate answer for me would be to enter at a Fibonacci level of correction.

Which level?

That depends upon your risk profile.

Understanding Loss and Reacting to it in a Winning Manner

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In the world of trading, we deal with loss everyday.

We have no option but to deal with it.

If we want our performance to improve, we need to deal with it in a winning manner.

What is loss? I mean, apart from its monetary ramifications…

A loss has the propensity to suck the living daylights out of you.

That’s if you allow it to.

You see, in the world of trading, losses have the propensity to grow.

You need to cut them when they are still bearable. Period.

If you don’t, they can become unbearable.

You then still have the option of cutting the unbearable loss as opposed to letting the loss eat into your gut and cause insolvency. Choice is yours. I’ve seen it happening with my own eyes.

You see, losses not only suck out money, they also suck out emotional energy from your system. Your mind loses focus, and instead of concentrating on your A-game, your mind focuses on the loss. The result is that your A-game becomes a B- or a C-game. Unacceptable.

Health deteriorates and one is snappy around the family. Totally unacceptable. Just cut the loss, stupid.

In FY ’08 – ’09, my senior partners walked into my office. I was being consulted, hurrah, a winning moment by itself for me.

Our company was entered into a derivative USD hedge at the time. The trade had turned sour, and was showing a loss of half a million USD. I was being asked what to do.

In a situation like this, a trader does not dilly-dally. I advised my senior parners strongly to cut the loss as it stood, no ifs, and no buts. That’s what we did.

Two other companies in our town were involved in a similar hedge. They chose not to cut their losses at this stage, but to hope, pray and wait for a recovery.

Well, recovery did happen ultimately. This was that swing when the USD first went up to INR 38 and then down all the way to INR 52.50. Before recovery occured, let’s see what else happened.

One company declared insolvency, because it could not repay the 22 milllion USD loss in the hedge, because that’s the amount the loss had ballooned to at a later stage, before recovery even started. The other company, I believe, settled its losses at 25 million USD, and enjoys a cash-strapped existence today.

So that’s what. My training as a small-time trader came in handy, and I was able to help our family run export business in a major way.

This was also a big test for me. It showed me that I had understood loss as a trader, and was able to react to it in a winning manner.

And that’s the prequisite required to understanding winning and reacting to it like a champion. More on that when I’ve mastered this myself!

Baby-Stepping One’s Way Up the Financial Ladder

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Everyday, without fail, I get a few opportunities to make this a slightly better world. I’m sure you do too.

And I’m ok with that. No further ambitions. Just doing what comes my way. I’ve always done what I believe in. Have never followed crowds. Have never joint someone’s battle which I don’t fully understand.

Baby-step contributions are drops in the ocean. Nevertheless, they are contributions. I’m proud of the fact that opportunities to contribute come my way regularly. I don’t act upon all of them. Have become very discerning of late. Don’t want to be involved with any frauds whatsoever. And India is brimming with frauds. For me, the world of contributing is about baby-steps. I’m content with that.

I believe that baby-stepping is the way up the financial ladder too, as far as one’s investing or trading activity is concerned.

In the world of trading, there exists the concept of position-size (developed to the nth level by Dr. Van K. Tharp). In a nutshell, this concept teaches one to scale it up one baby-step at a time as one’s account shows a profit. Also, one learns to scale it down a notch upon showing a loss.

Common-sense? Then why isn’t everyone doing it?

Why does everyone around me behave as if he or she is gunning for the big hit? The bringing down of institutions. Of governments. The desire to make it big and in the limelight in one shot. The desire to bring about sweeping change within a week’s time. Ever heard of speed of digestion and incorporation? Metabolism? Assimilation? Speed of evolution?

Life takes time to happen. Let’s give it that time. Let’s not hurry it up with our over-ambition. Do we want life to blow up on our faces because of over-ambition?

Frankly, I want to evolve with equilibrium. Really, really not in one shot. My system will explode if it tries to evolve in one shot. Many people are going to find that out the hard way on their own systems.

And I’m really satisfied with baby-stepping it up the financial ladder, using the concept of position-sizing. Slow and easy, little by little, tangible progress, day by day. No nuclear blasts, no tense situations or mood-swings, lots of time for the family, small quantums of realistic progress and its assimilation… what more can one ask for?

You should try it too.

Is it Over for the Long-Term Investor?

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Long-term portfolios are getting bludgeoned.

I can feel the pain of the long-term investor.

Is it over for this niche segment?

I really wouldn’t say that.

It’s not over till the fat lady sings, as somebody said.

What if someone trained hard so as to not allow the fat lady from starting her performance in the first place?

Well, for this breed, it’s not over by a long way. In fact, things are just getting started.

And what are the areas of training?

First and foremost, for the millionth time, one needs to understand what margin of safety is. In this era of black swans, one can fine-tune this area with the word “large”. So, simple and straight-forward: the long-term investor needs to buy with a large margin of safety.

This is a game of PATIENCE. Patiently wait for entry. Entry is the most important act while investing. If you cannot learn to be patient, change your line. Be a trader instead.

However scarce the virtues of honesty and integrity have become, keep looking. When you finally find them in a company, ear-mark the company for a buy. For you, managements need to be intelligent and shareholder-friendly too. They need to be evolved enough to take you into account as a shareholder. Keep looking for such managements, and you’ll be amazed at the unfolding potential of diligent human capital.

Before you enter this arena, answer another question please? Have you learnt to sit? If you don’t even know what this question means, you are by no means ready for the game.

So, when is one capable of sitting through some serious knocks, like now? If the money you’ve put on the line is not required for the next 5 to 10 years, you’ve totally helped your cause. Then, your risk-profile should fit the pattern. If a knock causes you an ulcer, just forget about the game and look for another game that doesn’t cause you an ulcer. Your margin of safety will help you take the knock. Knowing that your money has bought a stake with honest and diligent people who can work their way around inflation will help your cause even more.

If you are taking a very serious hit right now, you need to decide something. Are you gonna sit it out? Can you afford to, age-wise and health-wise? Yes? Fine, go ahead. I sat it out in 2008. If I could do it, so can you. It did take a lot. Taught me a lot too. I now know so much more about myself. Was a rough ride, is all I can say. Nevertheless, it’s a good option if age and health support you. If you decide to sit it out, please train yourself, from this point onwards, to do it right. Needless to say, don’t make the same mistakes again. Let’s be very clear about this point. If you are feeling pain at this point, it’s because you have made one or more investing mistakes. Don’t blame the market, or the times. This is your pain, because of your mistakes. Take responsibity for your actions. Do it right from here onwards.

If you can’t take the hit anymore, age-wise or health-wise, then you need to reflect. It’s none of my business to tell you to sell out. That would be inappropriate. All the same, as a friend, I would like you to ask yourself if you feel you are cut out for this niche segment. There are other very successful niche-segments. I know highly successful traders who started out as miserable long-term investors. So, just this one thing, get the questioning process started. Now. Then, listen to your inner voice and decide what you want to do.

There’s this one other point. Some people feel they can focus on both these segments simutaneously. You know, trade in one portfolio and maintain another long-term portfolio. Possible. People are doing it. I’m not about to start a discussion on focus versus diversification just now, because I’m leaving it for another day. Not because I don’t possess the mettle, but because I’m a little tired just now.

Wish you safe investing! 🙂

One Step Closer to the Gold-Standard?

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The gold-standard is an extreme scenario.

Imagine the world’s top currencies collapsing. For lack of a better alternative, the world resorts to gold for conducting international trade.

Probably a situation that’s not going to occur.

But then, are we doing anything to stop it from occuring?

Q: Is the US doing anything concrete to reduce its debt?

A: No.

Interpretation: USD will lose its stronghold as global currency at this rate.

Q: Does Europe have any concrete ideas about its financial future?

A: No.

Interpretation: Euro is nowhere near toppling USD from its global currency status.

Q: Is China doing anything concrete to increase transparency?

A: No.

Interpretation: Doesn’t make the Yuan a strong contender for top post.

Q: Is India doing anything concrete to reduce corruption?

A: Er…blah blah blah… No.

Interpretation: I’m not even trying to interpret the eyewash going on here.

Let’s move on to a country called Venezuela.

President Hugo Chavez just called all his gold home…!

Even if this is to taunt the US, it still is HOARDING.

Hoarding is infectious. The start of hoarding can trigger a “Domino-Effect”.

Whatever his ulterior motives were, Big Boy Hugo has taken the world one step closer to the gold standard.

To prevent hoarding from escalation, a counter statement needs to come, like NOW, from the major economic players of the world, something confidence-boosting. Don’t see that happening anytime soon. Seems that hoarding might escalate.

The gold-standard seemed to be a myth a few months ago. Now, at this stage, we seriously need to educate ourselves with regard to the gold-standard and position ourselves accordingly.

The Towering Value of Decisive Action

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Decisive action can’t just come outta nowhere.

There has to be a build-up to it, a kinda revving up of engines and stuff.

Point is, this category of action generates a lot of force, and is required to do away with situations that cause panic. As in not let a situation become panic-causing to you. As in the current situation. As in the Dow falling 512 points last night. Will they have a name for it, Black Thursday perhaps? I don’t think so. Because I don’t think we’re done just yet. Situation might get blacker.

Back in December 2007, there were those who were taking decisive action, i.e. they were booking profits. These were people who had been taught by the market to do so. Unfortunately, I didn’t belong to this category at that time. On the contrary, I was busy topping up my portfolio with more investments at the time.

Mayhem in the market should teach you for the next time. If it doesn’t, there’s something wrong with you.

By the fall of 2008, the new market players of the millenium had gone through with their first piece of decisive action – an oath to never be in a situation again that causes them to panic or to spend another sleepless night. The events of the first nine months of 2008 were more that enough to drive them to this.

An important part of peace in the market is hedging. Serious players chose Gold as their hedge, and started building up large positions in Gold. The world around them was screaming “how could they?” Gold was already touching a high back then. They possessed the spine to take this decisive action, because 2008 had taught them to hedge. That’s how they could.

Many worked their way towards zero US exposure. When the cracks in the Euro appeared in 2009-2010, they worked their way towards zero Europe exposure. People around them were screaming that the USD would continue forever as the world currency, and that Europe was under-valued and thus a screaming buy. All to no avail. These decisive players had started to mistrust Alan Greenspan from the moment he started urging his people to take loans against their homes and to put the borrowed money in the market. For me, the icing on the cake or the snapping moment was when Ben Bernanke had the cheek to announce more stimulus one day after the “debt deal”. That’s when I gave up on the US market. Very late, I admit. Yeah, yeah, I’m a real slow learner.

Then, serious new players started to buy on lows. And they got some big-time lows, especially the ones of October 2008 and March 2009. The world around them was screaming “how could they?” and that “we weren’t done yet” and that “economies would get bleaker”. They had the courage to buy. The market had taught them to.

And, finally, they started succumbing lesser and lesser to greed. They would finally book profits. They learnt to sit on cash for long periods of time. They learnt not to listen to tips. They learnt to have their own market outlook and to be self-reliant as far as the chalking of their own path was concerned. They decoupled themselves from their bankers and their market advisors. They got tech-savvy to a point when they could control their entire market operation from their laptops. Basically, they took control.

And, they slept peacefully last night.

US Treasury Bonds, Anyone?

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Panic is something I felt during 2008.

It was actually good that I did, because now I know what it feels like.

Meaning that if a similar situation starts to arise again, now there are internal warning signals in my system.

Investors learn from mistakes. That’s the good thing about mistakes.

It will not take a Moody’s rating agency to tell even an average investor that US treasury bonds don’t deserve a AAA rating. Most investors I know have shunned any investment product with US treasury bond exposure since 2008.

Didn’t such ratings agencies give CDOs a AAA rating? Frankly, I don’t even feel like acknowledging the existence of ratings agencies. I’d much rather just use my common sense.

So, one’s learning curve freed one up from dangerous exposure after 2008. Are one’s investments still going to be unaffected from the ongoing and critical developments in the US?

Globalization is in. Decoupling seems to be out for the moment. If the US economy crumbles, investments worldwide are going to be affected for the worse. To lessen such shocks, God created hedges.

The best known hedge to mankind over the last 100 years has been Gold. After 2008, central banks worldwide started scrambling to find an alternative to the USD to hold their wealth in. Only Gold is standing their test. More and more central banks have started converting their USD holding to Gold.

Much as I don’t feel like acknowledging the existence of ratings agencies, unfortunately, I have to. If there’s a ratings downgrade in the US, Gold purchases by central banks are going to escalate. The astute investor will need to position him- or herself accordingly if he or she has not done so yet, starting right now.

As we bathe in the glory of Gold, let’s not forget that it is just a safe haven, a crisis-hedge. If economic stability returns to the world this or next decade (or whenever), Gold is going right back to where it came from.

Something else used to enjoy the safe-haven status till a few years ago. I think one calls them US treasury bonds.

Seasons change. If Gold is the flavour now, it’s possibly a temporary flavour.

Keep your eyes open, and keep using your common sense.

Wishing you safe investing.

Fine-Tuning the Need for Action : A Dialogue

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It’s a multi-tasking world around us.

Things move.

We grow up with a need for action. Some with less need, some with more. Nevertheless, this need for action is here to stay.

And with this highly individualistic need for action, we enter the market.

So when does the conflict arise?

When one’s innate need for action is lesser or more than one’s market activity. Then, there’s imbalance, leading to market mistakes.

So how does one strike balance?

By fine-tuning one’s market activity with one’s need for action. These two need to be in sync for balance to exist.

And what kind of market mistakes is one looking at if imbalance exists?

Well, overtrading for one. Then there’s missed exits, early entries, missed stops, chart-related over-interpretation etc. to name a few.

And what was the key again, for striking this balance you are talking about?

Experience. There’s no substitute for experience. You’ve just got to go out there, put your money on the line, and trade. Ultimately, after some years, you strike balance.

And that’s it, is it?

Nope. Once you’ve struck balance, you need to maintain this balance.

That must be easy, right.

On the contrary, maintaining balance is one tough cookie. Here, everthing comes into play. Your family situation, relationship tensions, worldly problems…everything’s waiting to throw you off balance.

Man, sounds tough.

Naehhhh, you take it as it comes. One gets knocked off balance at intervals, and then one has to just find it back. It’s called Life.

And what’s your market activity like when you are off balance?

I’ll tell you a secret, listen up. When I’m off balance, I don’t trade.

Must be tough, going cold turkey, just like that?

Naehhh, it’s defintely better than the mistake-laden trading plays that one makes when off balance.

Oh, right.

Off with you, then, I’ve got work to do.

Ok, thanks and bye.

Bye.

Street’s got the D-word

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There seems to be an X-word in every avenue of life.

The Street has its own – the D-word.

It spells D-e-r-i-v-a-t-i-v-e-s.

Whatever reasons there are for a crisis to develop become secondary at the peak of the crisis, because derivatives take over. The crisis is driven to the nth level because of massive institutional leveraging in derivatives in the direction the crisis is unfolding. Recipe for disaster.

The human instinct is to maximize profit, irrespective of any consequences. When masses start shorting the stock of a company that’s already in trouble, its stock price can well go down to zero (and lead to bankruptcy), even if the company’s mistakes are not deserving of such a price / destiny.

Similarly, when masses start going long the futures of a company’s stock, the resulting stock price overshoots fair-value in a major way. Then come along some fools and buy the scrip at an extreme over-valuation. They are the ones that get hammered.

That’s the way this game has unfolded, time and again.

Does it need to be this way for you?

No.

Firstly, as a long-term investor, don’t buy into over-valuation. Make this a thumb rule. Control your animal instinct that wants a piece of the action. Leave the action to the traders. You need to buy into under-valuation. Period.

Unfortunately, most long-term investors (myself included) miss action. Then they fool around with their long-term holdings to get some, and in the process mess up their big game.

The animal instinct in the long-term investor can be channelized and thus harnessed. One way to get action is to play the D-game. Of course with rules. The benefit can be huge. Action focuses elsewhere and doesn’t mess up your big game.

So, play the D-game if you wish, but play it small.

Secondly, be aware that you’re only doing this to take care of the action-instinct. Any profits are a bonus.

Thirdly, keep the D-game cordoned off from long-term investment strategies. No mixing, even on a sub-conscious level.

Then, take stop-losses. DO NOT ignore them.

Also, when anything is disturbing you, DO NOT play the D-game. It DOES NOT matter if you are out of the D-game for months. Remember, this is your small game. What matters is your big game.

Categorically DO NOT listen to tips.

If you are down a pre-defined level within a month, press STOP for the rest of the month.

Make your own rules for yourself. To give you some kind of a guide-line, I’ve listed some of mine above.

A D-game played with proper rules can even yield bombastic profits. 95% lose the D-game. 5% win. Derivatives are a zero-sum play-out. 5% of all players cash in on the losings of the other 95%.

So, play in a manner that you belong to the winning 5%.