Category Archives: Risk

Is This Blood?

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When there’s blood on the streets, that’s when you should go out and invest.

That’s an ancient proverb.

The 64 million dollar question is, IS THIS BLOOD?

I’m going to focus on India, because that’s my playground.

So ICICI Bank breached the 700 mark, did it? The 2009 low was around 250 bucks. At 700, it’s not blood. True, the banking sector is down. However, we are nowhere near blood levels. State Bank of India might have fallen around 50 % this year, but it’s still double the price of its 5 year low.

The Sensex shows an average price to earnings ratio of around 14. Remember 2008 and 2009? Average PE of about 9? Well, in my opinion, those are blood levels. These aren’t.

True, the mid-cap segment has taken a hammering. Let’s take Sintex Industries. At 75 levels, this stock has fallen big. Nevertheless, it’s still double the price of it’s 2009 low. At 98 rupees, Jain Irrigation has really fallen too. The PE ratio has come down from 35+ to around 14, and this looks attractive. Even Sintex’s sub-5 PE ratio looks very attractive, also because the company is aggressively pursuing water-purification and “green-innovation”. Agreed, attraction to invest is present, especially in the mid-cap arena, where you’re likely to find quality in management too, as opposed to the small-cap area, where this is less likely. However, to say that there’s overall mayhem here would be going too far.

The BSE small-cap index has halved since late 2010, but is again at double the 2009 low. Many small-cap stocks are bleeding badly, though. Most small-caps haven’t proven their pedigree yet. Thus, people are letting them bleed.

Then there are stocks like Karuturi Global and KS Oils, that have been hammered down to penny-stock levels. One has problems getting into such stocks, because the underlying story can be shady. With penny stocks, there’s always the danger of oblivion, i.e. they might cease to exist down the line. Such stocks need to be traded at best, with small amounts and for the short-term. In their present conditions, they are not investment-grade stocks.

The picture that emerges is that there are selective attractive bets being offered by Mrs. Market. There are good investments to be made for long-term investors, if you possess patience and holding-power. I’m short on patience, so I like to trade India. That should not deter you. If you are a long-termer, and have what it takes, well, then you are a long-termer. And this market is offering you some good bets, so be very selective and go for it, but don’t bet the farm, since we’re not seeing all-out blood on the street yet.

Survival Basics – Building a Baseline

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Who are you?

Do you really know that?

What’s your core reaction to stuff, let’s say market stuff?

How do you react to a crisis? Do you freak out? How much do you plan to avoid a crisis? How do you feel after hitting a home run? Do you get over-confident and start doing irresponsible things?

What happens to you when the scenario is dull? Do you get depressed? Can you take it?

If you’ve dealt with these and more of such questions, well, bully for you, because you’ve already gone about building your market baseline. And that’s a really proper / solid approach to Mrs. Market.

A baseline is a basic point of reference. It tells you how you normally react to a particular situation. It also lists the emotions you went through, and the consequences you had to suffer owing to your actions. As experience piles up, the number of situations you can refer for also increases.

So, let’s say something unusual happens in the markets. Hmmm, let’s say Greece officially goes bankrupt, and let’s say that you are net-net long, and have been caught unawares. What do you do with your positions? With all the mayhem around you, right, what do you do?

Basics of survival in the markets – in a crisis, refer to your baseline.

Your baseline takes you back to the Lehman default. You remember being net-net long, being caught unawares. You remember ignoring your stops, waiting for a rally. Futures wiped out your principal, didn’t they, because you answered margin calls and waited? You remember the long period of depression after that. Worth it? Naehhh.

So, after referring to your baseline, you don’t ignore your stops. Taking the immediate loss, you bail out of your positions. A large portion of your principal is still intact, living to fight another day.

What about euphoria? How do you deal with euphoria? A position turns into a winner, and you are sitting on a 25% profit in a few days. You are feeling really kicked, and are walking with a swagger. What do you do next?

Basics of prosperity in the markets – at the onset of euphoria, refer to your baseline.

Your baseline tells you, that your behaviour during your last big-winning trade was far from exemplary. In your euphoric state of mind, you were already imagining all the things you would buy with your notional profits. Then, you panicked at the thought of losing any of those notional profits, and you squared-off the trade, taking those profits home, only to see the scrip soar another 80%.

Right! You snap out of your euphoria because of your baseline memory. Then, you install a trigger-stop 8% below the scrip’s current market price. Good. In an effort to capture even more profits, you have put a small part of your existing profits at stake. That’s exemplary behaviour, because now there’s a good chance of capturing a part of the scrip’s further rise.

And boredom? What do you do when Mrs. Market bores you? As in, stops being hit both ways, going nowhere, no market strategy yielding profits? Happens, sometimes for many months in a row.

Basics of maturity in the markets – when Mrs. Market goes nowhere, refer to your baseline.

Oh how you wished you hadn’t ruined that family holiday, right, by continuing to take pot-shots at Mrs. Market the last time she went nowhere. That’s what your baseline is saying.

You switch off, go on another (this time enjoyable) family holiday, and come back refreshed to see that Mrs. Market is now trending, ready to take you for a drive in one set direction.

There’s no limit to baseline referrals.

Systematic players build a baseline, and keep referring to it.

Later, we remember them as successful players.

A Matter of Pride

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Eurozone this, Eurozone that…

Man, it’s getting irritating.

Can we, for one moment, imagine a world without the Euro? Yes. Why is it so difficult? What would the cost of that scenario be?

Deleveraging, people, that will be required. All of those nations that leveraged themselves into quasi financial extinction will need to deleverage massively, once the Euro is discontinued, for as long as it takes to pay off their debts.

What does deleveraging mean? It means not using leverage for as long as it takes. It means paying off one’s debts by working overtime and saving.

Do you think the Italians or the Greeks et al. are liking such suggestions. Of course not. That’s the thing with debt. If you can’t pay it off, you’re in deep sh*t. Nobody thinks of that while taking on debt.

When the Eurozone was formed, sovereign debt of financially weaker countries was sold worldwide using the Eurozone tag. As in “C’mon, it’s all Eurozone now, and these Greek bonds give a premium return as compared to German ones!” Ingenious way to market junk bonds. Meanwhile, citizens of these financially weaker Eurozone countries borrowed left, right and centre to build houses and to consume. As 2008 approached, many lost the earning power to pay back their monthly installments. Now, as more and more of this debt matures, these financially weaker Eurozone countries need to conjure up billions of Euros they do not have.

You’ve got to hand it to the marketeers. Pure genius. They always get you, don’t they.

The reason things are not really working is the looming idea of uncalled for hard work that the process of deleveraging requires. Even if one wants to put in hard work, where does one put it in, if there’s no work.

Thus, the only option remaining involves massive cutbacks, like you’re seeing in Greece just now. Consumer spending down to zero. Pension cuts. Medicare cuts. All-round cuts. To one level above slowdown, till the deleveraging process is over. Scenario will take long to smoothen.

After enjoying a penthouse suite, a 1-BHK feels pathetic.

Eurozone wants to remain alive financially, but are they willing to pay the harsh price?

What you’ve been seeing since this crisis exploded is infinite artificial maneuvering. This might stall the situation. The goal is to stall long enough so that the deleveraging process is over before the stalling process can be weaned off. And that’s a fatal error. Nobody understands deleveraging properly, because the world has never done it properly before, at least in modern financial times. Correct me if I’m wrong.

Deleveraging is going to take longer than all the stalling moves put together. That is my opinion. Stalling results in a false sense of security because of all the maneuvering to show that the economy is doing well. Owing to this false sense of security, people continue to consume. Instead of deleveraging, people leverage. Instead of decreasing, debt increases.

What’s the deal here? You see, pride and egos are at stake. Eurozone doesn’t want to become the laughing stock of the world, the focus of all jokes. Thus, for the sake of their pride, and to fan their egos, European leaders feel the need to keep the Euro alive, even if it costs them their elections, and their financial survival.

Game-Changers

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Change.

The one factor that keeps us evolving.

Adapt or get left behind. Seems to be the Mantra of the times.

The management of money has seen some big game-changers over the last few decades. We want to speak about them today.

In the ’90s, Bill Gates wrote about business at the speed of thought. We’re kinda there, you know. Let’s say you have an idea. From idea to framework, it’s mostly about a few button-clicks, with the web being full of idea-realizing resources. See, we’re already discussing the biggest game-changer, which is the flow of information. Today, we live in a sea of information. It’s yours to tap. Delivered to you on a platter. Such information flow changes everything, from lead-time to middle-men. Best part is, almost all of the information available is free!

Then there’s technology. Cutting-edge software, everywhere. Now, there’s even a software to smoothly organize your contract notes and calculate profit or loss, and taxes due. It’ll give you the appropriate print-out, whichever way you want it. You don’t need to hire an accountant to audit your market play. You just click the contract note and the software extracts all relevant information from it, organizing it beautifully. Actually, that’s nothing. Market-play software is what we should be speaking about. Cut to the movie “A Good Year”. Just picture Russell Crowe motivating his “lab-rats” to go for the kill and short an underlying, only to short-cover a few points below. The technical software follow-up of the underlying’s price on the wall-panels is the image embedded in my mind, as the price gets beaten down, and then starts to rise again.

Market software allows you to run scans too. A common exercise I do at the beginning of a trading day is to narrow down the 4,537 active stocks on the BSE and the NSE to about 10 tradable ones. I do this with 2 back to back scans. Each scan takes a minute. Then, I study the charts of the tradable stocks and select two or three to follow. That’s another 5 minutes. Putting on trigger buys or sells for these stocks takes 2 minutes. So, assuming that a trade gets triggered in the first minute, I have arrived from scratch to active trade in 10 bare minutes, with no prior market preparation. That’s what technology can do for you, and more. Software is expensive. It’s mostly a one-time cost with a life-time of benefit. Worth it. The management of money is a business, and each business needs initial investment.

Numbers have changed the game. Volumes have grown for many underlying entities that were illiquid earlier. When volumes are healthy, the bid-ask spread is very tradable. Thus, today, you can choose to trade in almost any avenue of your choice and you are almost certainly going to get a liquid trade.

Our attitudes and lifestyles have changed too. Today, we want more. No one is satisfied with mediocricity or being average. We have tasted the fruit that’s to be had, and are willing to get there at any cost, because we are hungry. Luxurious lifestyles lure us to rush into the game, which we play with everything we’ve got, because as I said, we’ve tasted the fruit, and we want more. Our approach has made the stakes go up. We need to adapt to the high stakes with proper risk-management.

It’s never been easier to access funds, even if you don’t have them. Leverage is the order of the day. Of course that changes the game, leading to higher volumes and increasing the frequency of trading. We need to keep debt-levels under control. It’s never been easier to go bust. Just takes a few button-clicks and a few missed stops. The leverage levels take care of the rest.

Game-changers will keep coming our way. As long as we keep adapting and evolving, our game will not only survive, but also blossom.

Watch Out for Bottomless Pits

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A shareholder-friendly management?

Forget about it.

Very difficult to find, nowadays.

Gone are the days where you’d see an Azim Premji driving his 800, or a Narayana Murthy travelling economy class.

These legends believed in increasing the shareholder’s pie. And this they did, big time. Ask any Wipro or Infosys shareholder. These legends were very clear about one thing: there was no question of pumping in useless expenditure into their public limited company at the cost of the shareholder.

The norm, btw, is totally opposite. Public limited company managements live it up at the cost of the shareholder. Very few promoters are actually bothered about their shareholders. It is the norm to put medical bills, day to day living / wining / dining / entertainment costs, personal property purchases etc. into the company. Why should the promoter bear such costs when there is the public limited company to put these and such costs into? Logical?

Don’t expect too much from your average promoter. He’s not in the game for you.

Where does all this leave you, by the way?

Firstly, you need to look out for, and avoid bottomless pits. These are companies that bear huge amounts of expenditure emanating from the whims and fancies of the promoter. For example, the total sports sponsorship bill for Kingfisher Airlines is staggering. Then there’s this huge red flag in their balance sheet – the company is in under a mountain of debt. On top of that, this company just reported almost a 100 million USD Q2 loss. Math doesn’t add up for you to be investing in such bottomless pits, does it?

In your search for idealistic and shareholder-friendly managements, you might come up with a handful of names. Next you’ll find that it’s no secret. If there’s an idealistic and shareholder-friendly promoter around, people can see this in his or her deeds and of course in the balance sheet of his or her company. Savvy early investors make a beeline for such companies, with the result that by the time you get there, the concerned share-price is already quite inflated. You’ve identified a good investment, but you are not going to enter at an expensive price. If you do, you’ll not be able to sit on your investment for the long-term. Even slight volatility will shake you out of it.

Instead, you choose to wait for the right price to arrive, and then you enter. Well played.

The deal is, that more than 90% – 95% of managements don’t play it like an Azim Premji, or a Narayana Murthy, or an Anu Aga for that matter. However, shareholder-unfriendly promoters sometimes own companies that are lucrative investments. This can be due to niche, cycles, technology, crowd mentality, whatever. When do you buy into such companies?

As a long-term investor, you wanna be buying such companies at a deep discount to real value. My thumb-rule is a single-digit price to earnings ratio. You can have your own thumb-rule. You might have to wait a long time to get this kind of a price, but that’s what long-term investing is about.

As a trader, you buy into such a company with the momentum. You can buy after a resistance is broken. Or after a high is taken out. Or upon a substantial dip after the first burst of momentum. As a trader, what is far more important for you is to know when to let such a company go. Know the level by heart below which or at which you will exit such a company. In trading, exits are far more important than entries.

The mistake you don’t want to be making is to invest in a bottomless-pit, no matter how cheap the share price is.

So, … What Made Peter Jump?

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The buck generally stopped with Peter Roebuck in the world of Cricket journalism.

Professionally speaking, Peter was cutting edge.

Though he was described as a complex person outside of his professional sphere, the only blip that seemed to punctuate his 55 years was a 2001 common assault charge on some 19 year old cricketers he was coaching.

As per the media, Peter’s is a confirmed suicide; he jumped six floors to his death, from his hotel window. Just before he jumped, he was being questioned by the South African police on a sexual assault charge. A police officer was in the room when he jumped.

Was it extreme shame over something he’d done? Perhaps just one big blunder in an otherwise good, successful and recognized life? If that’s really the case, one needs to reflect on things.

Sometimes a good human being can make a huge blunder. Let’s cite excruciating circumstances that drive the person to such an act. For example, extreme loneliness can result in a moment of madness, in which one loses self-control and crosses the line between decent and indecent behaviour. Let’s please not behave as if this does not happen. Don’t know if this was the case with Peter. As of now I’m just looking at the general applicability and the consequences of such moments of madness in our normal arena of life. Also, I’m gonna try and apply this to market play.

Before I do that, let’s stay with Peter for a bit. If it turns out that Peter was pushed over the ledge, this whole discussion will need to be discarded and the investigation of match-fixing will come into play, since Peter had just finished reporting on arguably the most unusual Test match in the History of the game. As of now, murder is being ruled out, so let’s stay with our original discussion.

Who feels shame? A human being with a conscience does. Who feels so much shame, that he or she can’t face society, family, spouse, kids etc. anymore? A human being who has probably committed a grave folly and who has a conscience that is now powerfully confronting him or her.

The media has not reported any History of sexual assaults in Peter’s case, so we are probably looking at one grave act in a moment of madness that became the complete undoing of an acknowledged soul called Peter Roebuck.

How many of us are in the same boat, where one grave act can become our complete undoing? All of us are. Please be very clear about it. That’s how unpredictable life can be.

As of now, I’m going to focus on this one grave act unfolding during one’s career in the markets. All you have to do is to activate huge amounts of leverage (= few button-clicks), and then ignore a few stop-loss levels (= 0 button-clicks) while you answer the margin-calls, and you have already committed the grave act that is potentially life-threatening. If the resulting losses clean you out, that’s one thing, but if they put you deeply into debt, contemplation of suicide can well be on the cards if yours is even a slightly melancholy personality.

See, that’s a very short route to where someone like Peter Roebuck ends up, irrespective of one’s arena in life.

All I can say is (and I’m saying this to myself as well) that please let’s take that smug look off our faces, and let’s please reflect, because a moment of madness can trap and terminate the existence of any human being, no one excluded.

Moments of madness occur in everyone’s life. We need to train ourselves to not react to them. That’s easier said than done, but it’s better to say it out loud and activate one’s system to become aware of such moments of madness when they are happening.

Only if one is aware that such a moment is unfolding can one actively choose not to react.

As Ponzi as it Gets

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Charles Ponzi didn’t dream that he’d become one of the most copied villains in the History of mankind.

Ponzi was a financial villain. His ideology was so simple, that it was brilliant.

Lure the first set of investors with promises of huge returns. Transfer the first few return payouts. Lure more and more investors as the news spreads about the scheme with great returns. Transfer few more return payouts to old investors from the investment principal of new investors. Lure a peak level of investors ultimately. Then vanish with all the collections.

As Ponzi as it gets.

I hardly read the financial newspapers. Technical trading finds news to be more of a burden. Earlier, I used to gauge sentiment from the news. Now, my Twitter-feed is an excellent gauge for sentiment. Also, with time, one starts to gauge sentiment in the technicals. Candlesticks are a great help here.

Yesterday, in a loose moment, I picked up the Economic Times. Normally, it’s not delivered to our house. Yesterday, a supplement of the ET was included in our normal newspaper. Probably a sales gimmick. Anyways, I glanced through it. Was shocked to find that 25 recent Ponzi schemes had been unearthed in India alone.

What is it about us? Can we not understand what greed means?

The sad fact was that all the investors who were trapped were retail small timers.

Education, people, education. Are you financially literate? If not, please don’t enter the markets. No amount of regulation can save you from being duped if you are financially illiterate.

When you’re putting your money on the line for the long term, you’re looking for quality of management. A track record is something you want to see. Average returns are great returns if they promise safety of the principal.

Where there’s promise of huge rewards, there are also proportionate risks. If you really want the thrill of very high returns, all right, fine, go ahead and risk a miniscule percentage of your portfolio size in a risky, high yielding scheme. Tell yourself that the principal might or might not come back, and for heavens sake, don’t bet the farm here.

These financial times are as Ponzi as it gets, people, so TREAD CAREFULLY.

What U Gonna Do When They Come For U?

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“Bad Boys Bad Boys, what u gonna do…

what u gonna do…

… when they come for you?”

Lots of bad boys floating around.

They make a beeline for an underlying, for example Gold. Hike up its price. Entice you to enter at a peak. They cash out. You, the slow poke, are left high and dry.

Then the bad boys gang up and short the underlying simultaneously. Price tanks. From one day to the next, you are sitting on a large loss. You get out, disgusted.

Don’t make yourself vulnerable to such bad boys. Get your strategy right.

Buy at strategic points. If you are buying at dips, do so at pinpointed levels, like Fibonacci ones. You can also buy when a resistance is broken. Or, you can buy when a high is taken out with volume. Don’t buy above that. Meaning to say, that’s the vulnerability cut off. After that, you expose yourself to the bad boys, because you don’t have any margin of safety after that point. Through your actions, you activate bad boy zone.

On the short side, go short at strategic points in a rally. That’s where margin of safety is maximum. You can also short when a support is broken. Or, you may go short when a low is taken out with volume. Below that is bad boy zone.

At times, the human being likes the thrill of being in bad boy zone. Got me there, I like it too. Only sometimes. In bad boy territory, you need to be light. Don’t carry too much cash in your pockets when they come for you. In bad boy territory, do options. Options are your best friends here.

The advantage of operating in bad boy territory is that every now and then, there’s a jackpot for the taking. There’s no telling how far bad boys take an underlying in a particular direction. Where there’s risk, there’s reward. Out of ten option trades you put on, at least two or three should hit the pot if your research is good. That’s all you need.

In bad boy territory, the only position you want to be in is about showing the jackpot in the one hand and the finger from the other. By default, your losses must be small here, and they are, because you are doing options. Period. With that, you’ve shown the necessary aggression that is required in this territory, and you’ve also shown proper backfoot (defence) strategy. That is winning behaviour in bad boy territory. That’s the language understood by bad boys, telling them to lay off. Now, even if they try to come for you, they’ll not get you. Ever.

When Cash is King

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I don’t like crowds.

The last thing I ever want to do is to conform to crowd behaviour.

That’s one goal defined.

What does this mean?

Very clearly, for starters, it means singing one’s own tune, i.e. defining one’s own path.

It also means not listening to anyone. That requires mental strength, and the power to resist. Very tough.

In life, generally, one likes to be in tandem with the Joneses. And then, smart cookies that we are, we like to go one up on the Joneses, which would be the cue for the Joneses to catch up and then overtake us. Hypothetically, this is how the Joneses and the Naths could blow up all their cash.

It doesn’t stop there. To keep up, the average citizen doesn’t think twice before leaping into debt.

Bottomline is, when cash is king, hardly anybody has cash. In fact, most people owe money at that time.

This is the age of black swans. Crisis after crisis, then a bit of recovery, then another crisis, then some recovery, followed by a mega-crisis.

When a master-blaster crisis ensues, cash becomes king. Quality stuff on the Street starts to sell so cheap, that one needs to pinch oneself to believe the selling prices. Margins of safety are unprecedented. Now’s the time one can salt away a part of one’s cash in Equity, for the long-term.

That’s if one has cash to spare. This is report card time. How have you done in your REAL investment exam? Have you learnt to sit on cash? Have you learnt to buy with margin of safety? The Street doesn’t care for your college degree, in fact, it vomits on your college degree. Your college degree has no value on the Street, it’s just a piece of paper.

Learning on the Street happens everyday, with every move, every investment, every trade, every observation. Unless and until your own money is on the line, this learning is ineffective.

Get real, wake up, so that when cash is king, you feel like an emperor!

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.

Dealing with Distraction

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I’m a huge Sherlock Holmes fan.

The stand-out quality I admire about Holmes, apart from his mastery in observation and deduction, is his ability to switch off.

In the midst of the most engrossing case, Holmes will switch off for half a day or more, and will visit the museum, or will play the violin. While having switched off, there will not be a single thought on his mind concerning the ongoing investigation. He will be fully and totally involved in the recreational activity. Of course he switches off at a juncture where he knows that nothing of consequence is happening for the next so many hours, but that’s not the point.

The ability to switch off is a huge asset to the trader. It allows the trader’s mind and body to recuperate. Also, it does away with overtrading. If a position is showing good profit, the trader who installs a trailing stop, and then switches off, opens the window for still larger profits.

At many times, one is distracted. It is potentially dangerous to trade while distracted, just as it is dangerous to drive while communicating on the cellphone. While distracted, the trader needs to switch off. As long as it takes. Till the source of distraction is nullified, at least in the trader’s mind.

Just a minute, forget about the trader. Investors need to be experts at switching off too, after having entered into an investment. If they don’t have this ability, they’ll be thinking about their investment day in, night out, for years at a stretch. The investment will eat into their life. If we’re looking at the average investor with 10 to 20 investments and without the ability to switch off, we’re also looking at a mental and emotional wreck.

Traders and investors both need to learn how to switch off from Sherlock Holmes.

Taking Compulsion Out of One’s Trading Equation

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Mr. Cool’s next trading cameo starts a few months after his last blow-up. He keeps coming back, you’ve gotta give him that.

This time around, his girl-friend wants a fur coat. Cool is determined to buy a fur coat for her from his trading profits.

Thus, Mr. Cool has put himself in a position where he is compelled to trade. Compulsion adds pressure. A trader under pressure commits basic blunders. There’s no question of getting into the Zone while pressure mounts.

Sure enough, Cool overtrades. Apart from that, he fails to cut his position-size after the first run of losses. These are two basic mistakes. They are being caused by compulsion. Mrs. Market is ruthless with players who commit basic blunders. As usual, Cool blows up, yet again. The fur coat is not happening. In fact, there’s no girl-friend anymore.

Meanwhile, Mr. System Addict has been evolving. He’s achieved a large-sized fixed income by ploughing previous profits into safe fixed-income products. He’s under no compulsion to trade. His fixed income allows him to live well, even without trading. He has a lot of time to think. Often, he gets into the Zone, where he’s moving in tandem with the market, and is able to swing with the market’s turn. What makes him get into the Zone so often?

It’s the lack of pressure. He’s comfortable. A free mind performs uniquely. There’s no question of making basic mistakes, because full focus is there. Addict is a human being who is aware. He knows when he is in the Zone. That’s when he doubles up his position-size and logs his trade. His win : loss ratio is 70:30 by now. His trading income surpasses his fixed income for the year.

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!

The Short-Term History of Idealism

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1989, Konstanz, Germany.

I’m quietly eating a Nutella sandwich in the commom-room of our student-hostel. There’s a commotion near the TV area. The Berlin Wall is falling. A few students rush to pack their bags. They are off to Berlin. The one’s not going, including me, request them to bring back a few extra pieces of the Wall. That’s one Nutella sandwich I’ll never forget in my life.

Slowly, communist infrastructure in the Soviet Union starts to fall apart too. With the exception of a few strongholds, most of it is gone today.

The most repeated pro-communism argument I have heard after the fall of the Wall is this: Communism failed (wherever it failed) because it was too idealistic for mankind. So, according to this argument, mankind could not live up to the ideals of communism. All people were equal, but some were more equal than others, to analogically quote George Orwell.

Maybe, maybe.

And here is mankind again, trying to be idealistic. The epicentre of this idealism is, well, Germany. Its leaders, including the Pope, are asking its citizens to dig into their pockets and support the Euro against breakdown, come what may.

No other European nation is financially capable of bailing out the Euro. France’s economic problems are visible. It is now up to Germany. The question that remains is: IS THIS FAIR to the German citizens, who will have to take on pressurizing austerities for the follies of others to achieve this idealistic goal?

Well, what’s fair in life and the History of the world? Sacrifices have to be made for the greater good. Is the existence of the Euro “greater good”?

There exist discrepancies between the Euro nations regarding work-attitude and work-ethics. Europe is NOT one nation with one government. We are looking at diverse nations with diverse needs. Some hate to work overall. One likes its retirement age to be 57. The call to behave like one nation to tackle bankruptcy is the imposition of an artificial existence. History has shown mankind, that artificial existences tend not to last.

Left to sink or swim, people much rather decide to swim. Although a sovereign default will impose upon the concerned nations huge austerities in the short-term, they will opt to stay afloat rather than sink. Long-term work ethics will change. Attitudes will change.

Never-ending bailouts will tend not to affect faulty or wanting work-attitudes. That’s the danger here, a repeat loop mechanism, till the bulk of Germany’s resources are drained in supporting the Euro. That’s what we are looking at. First there’s 370 billion Euros for Greece to clear. The figures for Spain, Portugal and Italy are still unclear to the common-man. Figures are being revealed one by one in the media, from mini-bailout to mini-bailout. How long can this go on? Is Germany some kind of holy grail with a never-ending supply of funds and resources?

The questions Germany and its leaders need to address are these: Is the short-term mayhem after a possible Euro collapse the worst-case scenario for Germany’s industry and people? Or is it the slow, long drawn sucking out of its hard-earned life-time earnings and resources, drop by drop, possibly to the last few drops.

Only after answering these two questions will German leaders be ready to vote for or against the Euro in parliament.

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 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.

A Hedge is a Hedge is a Hedge

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U guessed it, this is again about Gold.

Why do I keep harping on Gold?

Situations crop up, questions arise, people ask stuff…whatever.

I’ve always treated Gold as a hedge. Luckily, I don’t suffer from any Midas affliction.

There’ll be a time in one’s investing timeline, when there’s no need to hedge. As of now, there is a need to hedge, seeing the uncertainty around us. This does not mean, under any circumstances, that you go around picking up your Gold for hedging at these rates. A hedge is best picked up cheap. Curretly, Gold is 2 or maybe 3 multiplied by cheap.

So, if Gold is your hedge of choice, this is not the time to pick it up. There is absolutely no margin of safety at these levels.

Once you’ve picked up your hedge cheaply, you can turn it into a double whammy and sell it really expensively. That option will always be with you.

You also have the option of not buying your hedge, whatever hedge it might be, if you don’t get a cheap enough price.

Exercise your options. Mrs. Market gives you lots of freedom till you act. Once you do act, you have to bear the consequences, whatever they are.

Don’ be in a hurry to act, especially if you are an investor. For the investor, the entry is of prime importance. Entry is the investor’s singular weapon.

And please, for heaven’s sake, treat Gold as a hedge. In good economic times, it’s going right back where it came from. The 100 year return on Gold has been 1% per annum compounded.

Whenever one gets into any underlying, one needs to be clear about what one is getting into.

Do you buy your car without doing the appropriate due diligence? No, right?

By the same right, investing demands proper due diligence too.