Category Archives: Risk

This is what it sounds like, When Kings Whine

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Back in the ’80s, musician genius Prince released the multi-generation blockbuster hit “When Doves Cry”. The song was unusual for its time, in that it gave R&B and rapping a pop twist. When something makes an impact, it sticks. The masses latch on.

The sound of whining coming out of Washington at S&P downgrading the US is something new. One’s not heard them whine before. It’s sounding unusual, but it’s provoking anger and dismay worldwide, and these feelings are catching on. S&P’s indication of further future downgrades are making the whining worse.

When Kings whine, their public loses faith in them. This new sound from Washington is dangerous for world markets. One likes to believe that one’s King has backbone. With that, one’s willing to die for one’s King. Which is something one is not willing to do for a spineless King. In that case, one would rather change one’s King.

If some resemblance of “spinefulness” doesn’t emerge from Washington very soon, the move from the Dollar to Gold is going to escalate even more.

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.

Financial Academia and the Street – A Comprehensive Disconnect

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1994 AD.

My friends in the Physics Department of the University of Konstanz, Germany, were busy trying to increase the number of holes on a silicon strip.

This was nanotech research in its advanced stage.

Nanotech saw successful implementation in the real world, though the explosion is yet to come. Nevertheless, the key words here are successful implementation.

Successful implementation on the street is only possible when a research model is practical.

Financial academia time and again delivers impractical models and is then surprised when they meet with failure on the street.

Let’s take the case of the Long Term Capital Management hedge fund. Nobel laureates ran it. They did not incorporate the possibility of a sovereign debt default in their model. So sure were they of themselves, that they went on to buy billions of dollars worth of derivatives, leveraging themselves to the hilt. Their total leverage in the end stood at 250:1. The sovereign debt default by the Russian government in 1998 triggered the LTCM fund to go belly up, and with it disappeared the life-savings of thousands of trusting investors. The ripple effects of this disaster almost knocked the world’s financial system off its platform. Talk about disconnect.

Currently, we are seeing the effects of another disconnect in action.

The Euro was conceived on the basis of hundreds of PhD theses and tons of post-doctoral research. What the researchers couldn’t possibly incorporate in their models were some basic human and emotional facts.

For starters, let’s try the Greeks. They like to retire early and work lesser than their Eurozone colleagues. Their bankers are gullible and not too street-smart, and have made some really bad bets.

Italians like to take short-cuts. They like to over-price and under-cut.

Germans like to go the whole hog. They are punctual and more environment-conscious. They do not like subsidizing those who don’t work for it.

French farmers want to sell their milk for its proper price. They and the majority of their nation dislikes subsidizing others who might not deserve subsidy.

One could go on. The list is endless.

How does one incorporate such realistic “human” stuff in mathematical models?

One can’t.

Mathematics doesn’t possess the language to reflect such human and emotional factors.

So what do these theses contain, upon which the Euro has been built. Other, disconnected stuff, no realistic, street-related emotional / human factors of value.

What we’re seeing is real disconnect in action. Financial academia is way out of its depth on the European street or for that matter on any other street. It should lay off from the street so that further disasters are prevented.

Let’s hope and pray that the Euro-chapter does not meet with a harmful end.

A Balancing Act Called Time

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Why am I so obsessed with the phenomenon called time?

Because time is the long-term investor’s secret weapon.

I believe that a portfolio comes into its own after 7 years of being built drop by drop.

In this initial period, the portfolio tries to find balance. Losers get established, but so do winners.

Once it has been established that a scrip is a loser, the portolio tells you to get rid of it every time you look at the portfolio. It’s the red ink on the losing portion of the porfolio that speaks to you. And the passage of time can even give you the opportunity to sell a loser for a lucrative price.

Eventually, winners stand out. Their black ink on the winning side of the portfolio asks you to buy into them again. And once again your dear friend time gives you the opportunity to buy into a winner at a reasonable price.

Finally, the portfolio has excreted all losers and now consists of candidates you’d consider rebuying into at the right price during the passage of time.

This is called a balanced winning portfolio. It is balanced because some winners are cheaply priced in it and some are expensive. You currently want to be buying into the cheap winners.

The moment your criteria point out that a winner is turning into a loser, you look for the next exit opportunity for this scrip. And time will give you this, i.e. a chance to sell this scrip at a great price.

So, use your secret weapon. Everyone knows about time but almost nobody uses it like a weapon. That’s why it’s a secret weapon. Use it.

While building up your portfolio and navigating it through, take your time.

Is the Middle-person History?

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Motivations…

are the propellors of life.

One can’t be an expert at everything. So one hires others to do stuff for one.

Of course one has to make it worth the other person’s while.

And the person you’ve hired needs to do the best possible job for you.

This used to be the pattern in the business of money. After the turn of the century, things started going haywire.

The middle-person in the business of money used to be a long-term wealth enhancer. His or her primary motivation was the creation and appreciation of your wealth.

Now, his or her focus is on the commissions generated by maximal short-term churning of your portfolio. This is dangerous for you.

I don’t know any wealth-manager who will share your loss with you. If earlier the loss would be felt only emotionally / morally by your wealth manager, even that is gone. So now, there’s nothing that’s stopping investment advice from becoming a function of the commission offered to the wealth manager. If a product offers more commission, that’s the product being recommended.

Where does that leave you?

Frankly, I feel that one is better off without an investment advisor. The web offers enough information on any and every investment product in existence. All you need to do is invest your time.

No time, you say? Who’s money is it? Yours, right? Then you need to jolly well take out the time. Only you can do justice to the proper, balanced and judicious investment of your funds.

So come on, snap out of any laziness. One hour a day to carve out a trajectory for your hard-earned money is all that’s required. If for nothing else, do it for your kids.

Are you a Pig?

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Pigs get slaughtered.

Are you a pig?

Don’t know the answer?

See if you fit into what the market defines as a pig. Be honest to yourself.

A pig is a crowd-follower. He (for convenience purposes, I’m using “he”) doesn’t use his God-given brain. A pig generally enters into an investment in the late stages of a trend. What pushes him into entering is that nagging feeling of missing the bus.

The pig is most interested in knowing what others are doing, and gets swayed by flashy headlines. He doesn’t have a market outlook and blindly follows tips. He panics at the bottom and sells for maximum loss. The pig doesn’t exercise any holding power, even if he might possess it.

If you find yourself fitting into any of these patterns, please get a grip on the situation before it’s too late. Slow down. Start getting to know yourself. Do your own research. Slowly build a market-view. And then invest according to this newly found but solid perspective.

There are many ways to limit risk. The stop-loss and the systematic investment plan are two, for starters. Incorporate such risk-limiting factors into your trading style. Slowly build up an indestructable approach through trial and error.

Yes, make mistakes, because they are the only teachers in this game. Make mistakes with small amounts. A mistake should not be able to slaughter you, because now you are not a pig anymore.

Investing in the Times of Pseudo-Mathematics

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First, there was Mathematics.

Slowly, Physics started expressing itself in the language of Mathematics with great success. Chemistry and Biology followed suit.

The subject of Economics was feeling left out. Its proponents wanted the world to start recognizing their line of study as a natural science. So they started expressing their research results in the language of Mathematics too.

Thousands of research papers later, it was pointed out that what mathematical Economics was describing was an ideal world without any anomalies factored in.

The high priests of Economics reacted by churning out a barrage of research papers which factored in all kinds of anomalies in an effort to describe the real world.

Where there’s money, there’s emotion. The average human being is emotionally coupled to money.

Either Economics didn’t bother to factor in the anomaly called emotion, or it couldn’t find the corresponding matrix in which it could fit human emotions like greed and fear.

And Economics started getting it wrong in the real world, big time. The Long-Term Capital Management Fund (run by Economics Nobel laureates as per their pansy and sedantry office-table cum computer-programmed understanding of finance) collapsed in 1998, with billions of investor dollars evaporating and the world’s financial system coming to a grinding halt but just about managing to keep its head above water. It was a close brush with comprehensive disaster.

The human being forgets.

The last leg of the surge in dotcoms in 1999 and the first quarter of 2000 did just that. It made people forget their investing follies.

What people did remember though was the high of the surge. Investors wanted that feeling again. They wanted to make a killing again. Greed never dies.

And Economics rose to the occasion. This time it was not only pseudo, but it had gotten dirty. Its proponents were not researchers anymore, they were investment bankers, who had hired researchers to develop investment products based on complex pseudo-mathematical models that would lure the public.

Enter CDOs.

For just a few percentage points more of interest payout, investors worldwide were willing to buy this toxic debt with no underlying and a shady payout source. People got fooled by the marketing, with ratings agencies joining the bandwagon of crookedness and giving a AAA rating to the poisonous products in question.

All along, the Fed (with the blessing of the White House) had been encouraging citizens to “tap their home equity”, i.e. to take loans against their homes and then to invest the funds in the market. (The Fed creates bubbles, that’s what its real job is). And the Fed, the White House, the leading investment banks, the ratings agencies and the toxic researchers were all joint at the hip, a very powerful conglomerate creating financial weather.

So, from 2003 to 2007, there was liquidity in the world’s financial system, and a lot of good money was invested in CDOs. Nobody really understood these products properly, except for the researchers who came up with them. Common sense would have said that something with no base or underlying will eventually collapse as the load on top increases. And there was no dearth of load, because the same investment banks that sold the CDOs to the public were busy shorting those very CDOs (!!!!!), with Goldman Sachs taking the lead. So a collapse is exactly what happened.

This time around, the now pseudo and very, very dirty economics (almost)finished off the world’s financial system as it stood. It was revived from death through frantic financial-mathematical jugglery and a non-stop note-printing-press, with the Fed looking desperately to bury the damage by creating the next bubble which would lure good money from new investors in other parts of the world which were less affected for whatever reason.

That’s where we stand now. Certain portions of the world’s finance system are still on the respirator. Portions are off it, and are trying to act as if nothing happened, shamelessly getting back to their old tricks again.

I get calls reguarly from Merrill Lynch, Credit Suisse, StanChart and other investment banks. The only reason why Goldman hasn’t called is probably because my networth is below their cold-call limit. Anyways, it doesn’t matter who let the dogs out. Point is, they are out. And they are trying to sell you swaps, structures, forwards, principal protected products, what-have-yous, you name it. I remain polite, but tell them in no uncertain terms to lay off.

As a thumb rule, I don’t invest in products I don’t understand.

As another thumb rule, I don’t even invest in products which I might eventually understand after making the required effort.

As the mother of all thumb rules, I only invest in products that I understand effortlessly.

That’s the learning I got in the 2000s, and I’m happy to share it with you.

Uncharted Territory : The Tough get Going

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These are unprecedented times.

I mean, you’ve got 10-Sigma events occuring at a frequency that’s nobody’s business.

It’s time for the tough to get going.

All other investors are gonna get slaughtered.

So what makes one a tough investor, someone who can take hits and still remain standing?

Firstly, there’s holding power. If you don’t possess holding power, don’t enter the markets.

Then there’s patience. A rare commodity.

Discipline. Play to a strategy. Pick a strategy that’s in sync with your risk profile.

That brings us to the most important point. Know yourself. Know your risk profile. Your strengths and weaknesses. Invest accordingly. This one might take a while.

With time comes the power to pinpoint buying opportunities. Just as the exit strategy is crucial for the trader, the entry point is all-important for the investor.

Wins give confidence to double up on one’s position size.

Sight of one’s goal keeps one away from noise and a dangerous thing called tips.

An otherwise balanced life keeps one occupied elsewhere so that one’s not tempted to try other stunts in the market.

You can complete this list. It’s really not rocket-science.

It’s time for the tough to get going.

Learning to Sit

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One of the first things a baby learns is to sit.

And sitting is probably the last thing that an investor learns. Some investors never learn to sit. Their long-term returns are disastrous.

Wanna make a killing? All right, first learn to sit.

To be able to sit, one needs to create proper conditions. One needs to take “jumpiness”, or volatility, out of the equation. This is done by buying with a margin of safety.

Having bought with a margin of safety, market blow-ups affect your bottom-line lesser. You can sit thru them.

And that’s all you need to do, to allow a multi-bagger to unfold.

Wish you lucrative investing!

Noose Just Tightened

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Petrol’s up 5 bucks.

This is gonna pinch the public.

Are we now clear on the fact that a beast is on the loose? And the fact that this beast has been active to hyper-active since World War I ?

This beast is called inflation. The number 1 infectious disease that inflicts modern financial society.

We are going to have to live with inflation. Period.

What is required is long-term policy-making that will minimize the affliction. That’s not happening.

Modern financial policy seeks to avoid an existence where inflation becomes hyper. That would be when food on the table costs more that a cart-load of cash. See Argentina during its currency collapse, or Germany after the first World War.

Let’s assume that human-kind is not capable of making better policies, ones that minimize (let alone eradicate) the disease. Where does that leave us?

What do we do with our money, that’s being eaten away at 8 to 9%, year upon year?

Avenues like fixed deposits pay out lesser after tax than what inflation eats away. The 100 year return in Gold has been 1% per annum compunded, after tax. Only two investment avenues have yielded more after tax than what inflation has consumed over the very long term. These are 1). Property, and 2). Equity.

The writing on the wall becomes clear. To immunize one’s money against the disease, one needs to be invested in one or both these avenues over the long-term. Both avenues come with pitfalls, where one can lose much more than what inflation eats away.

So, one first learns how to deal with the pitfalls, and perhaps one can specialize in either of these avenues, since it is not easy to focus on both.

Then, after having learnt the ropes, one can slowly start salting one’s money away.

Anatomy of a Ponzi Scheme

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Charles Ponzi came up with the brilliant idea of paying early investors dividends from the investment money put in by later investors.

It’s as simple as that, and it’s called a Ponzi scheme.

After the first few dividends, promoter disappears, having lured many investors into a fake scheme with no underlying business.

Latest famous example of a Ponzi schemer – Bernie Maddoff.

Or, if you’ve not seen Damages – Season III, that’s about a Ponzi scheme too.

So what lures the common investor into a Ponzi scheme?

Simple. It’s called greed.

What triggers the greed?

The Ponzi schemer concocts a scheme that promises a rather too lucrative return. This return does not look unrealistic, so the average investor’s alarm signals don’t go off. Nevertheless, it’s more than high enough to make the average investor’s mouth water.

And what’s normally promised is a quick return, mind you. The average investor buys smoothly into the idea of doubling his or her money fast.

Then there’s lots of advertisment. Billboards everywhere. The Ponzi schemer wants to hit the public with ads about the tremendous returns.

The sales-people who sell the scheme are glib-talkers. They are smart, wear expensive stuff, basically exuding sophistication. They want to rub it in that they’ve made it big in life.

A Ponzi scheme’s documentation generally cracks under close scrutiny. I mean, when something is being sold to you without any underlying business, all you have to do is your dose of due diligence. Just pick up the phone and start asking questions.

What works for the Ponzi schemer is human nature. The first investors (who get paid dividends from newbie investor money) start talking. Actually, they start bragging. The human being likes to show off. And, the human being hates missing the boat, even if the boatman is a disciple of Charles Ponzi.

The Dark Side of Private Equity

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Greed is the investor’s nemesis.

I’ve been guilty of greed at times.

Luck has been on my side, and I’ve been saved from losing money. I’d like to tell you about it.

In my experiences with private equity over the last four years, the one thing that stood out was the pitch of each scheme proposed. The average pitch just sucked one in by describing a world that would appear utopic to somebody in a balanced frame of mind. When greed sets in, balance and common sense go out the window. One gets taken in by the pitch, and without doing any due diligence, one is willing to bet the farm.

The private equity teams of today have a tool up their sleeve that creates pressure on the investor, and leaves little time for due diligence. It’s called the time-window. Most schemes are proposed to the investor with a very short time-window. Either the investor is in within the window, or he or she can sit out. Lesson learnt: if one’s due diligence is taking longer than the time-window, then the scheme can go out the window rather than putting one’s hard-earned money on the line.

One of the worst starts a newbie investor can make is a good one. This happened to me as a newbie private equity investor. I got involved with the Milestone group in the middle of the financial crisis, and I invested in their REITs (Real Estate Investment Trusts). These people were honest, and the investments have yielded steady quarterly dividends since, apart from the property appreciation. I started thinking private equity was the holy grail, and that all forthcoming institutions and schemes would be like Milestone.

Big mistake. When Edelweiss knocked on my door with an 8 year lock-in real-estate scheme, I was lapping it up. One thing kept going around in my mind – the 8 year cycle they were trying to make me believe in. Wasn’t convincing, but I wanted the profits they were promising. Before signing on, it occured to me to do at least some due diligence. I insisted on a conference call with the management. During the concall, I became aware of one wrongful disclosure. The pitch had spoken of a large sum of money from overseas, already invested in the scheme. In the concall, it became apparent that these funds were tentative and had not arrived yet.

A wrongful disclosure is a big alarm bell for me. I have programmed myself in such a way that when I come across wrongful disclosure during due diligence, I axe the investment. Luckily, the mind was not totally taken in, and I stuck to this rule.

Then came Unitech. Second generation real-estate magnate. Big money. Big leverage. In a joint venture with CIG, Unitech was redeveloping the slums of Mumbai, we were told in the pitch. Each slum-dweller would be relocated with ample compensation, we were told. The scheme had a multi-page disclaimer protecting the promoters against anything and everything. Alone that should have been an alarm bell. Of course I wasn’t thinking straight when I signed the documents.

In the next few months this scheme got a few investors interested, but its corpus wasn’t enough for the first leg of investments planned. Then, Adarsh exploded. I’m talking about the Adarsh real-estate scam. CIG / Unitech could not find a single new investor for their scheme. Everyone was scared of real-estate. Then there was another explosion: the 2G scam. Sanjay Chandra, CEO of Unitech, was one of the prime accused. What would happen to my money? Was it gone?

I got together with my bankers, and for more than a month, we steam-rolled the CIG / Unitech office in Delhi with emails and phone-calls, asking for the money to be returned with interest, since the scheme had not gotten off the ground. Luck was on our side, and after a thorough documentation process from their end, I received my entire amount with interest, one day before Sanjay Chandra was sent to jail.

Moral of the story: double your due diligence when you feel greed setting in. Don’t get taken in by fancy pitches. Don’t get pressurized into time-windows. Tackle the dark-side of private equity with a clear mind and full focus.

Just why is Embracing Risk so difficult?

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Sir Issac Newton : mathematics and physics genius.

Let’s cast a glance at his market record.

Bought 20,000 Pounds worth of shares in the South Sea Co. around the year 1720, when the scrip was at its peak. Company went bust.

After having bought into this company at a ridiculous valuation, Sir Issac chose to sit on his investment rather than embrace a small loss in the first leg of the decline. The loss became bigger and bigger, till all was lost.

In our society today, parents push their kids to emulate Newton as far as brain-power goes. Newton has been a classic winner in the eyes of society. Kids are taught to win from the beginning. Losing is taboo.

When a straight A candidate enters the market, he or she gets a rude shock. Here is a world where losing is bread and butter. The straight A candidate is likely to get hammered.

A winner in the markets knows how to lose. He or she loses many times. But loses small. Then come the wins. They are not booked small. They are allowed to run.

This concept goes against our basic programming. When we show a small profit, we want to book it and run. It is an ingrained reflex.

When we are losing, we wait to catch up and start winning instead of embracing the small loss and moving on. Also a natural reflex.

Thus, embracing risk is a very difficult thing to learn.

If one can’t do it after many losses, one should leave the markets alone.

The Willingness to Embrace Risk

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Any given market-play can only prove successful if one particular state of mind exists.

I’m talking about one’s willingness to embrace risk.

I mean, one can define risk all one wants, and one can understand it to the nth level.

But is one willing to embrace it?

The answer to this question is the singular deciding factor between a losing market player and a winning market player.

And what does embracing market risk mean?

Setting a stop is a physical act. One can do it mindlessly, without the actual willingness to accept a loss when it occurs.

Embracing risk means the attunement of every cell in the body towards accepting a loss when it occurs.

Accepting the loss and then moving on to the next market-play.
No psychological entanglements, no what-if scenarios, no why’s, no energy drainage due to mourning. Just sheer acceptance of loss. Period.

That’s the state of mind required.

Then, over time, as the sample-size grows, one starts winning.

That’s because one only plays the market with an edge.

The Meaning of Risk

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Market play revolves around one central factor.

It’s called risk.

Whether we want to deal with risk or not is up to us.

If we do not want to deal with risk, we should not participate in any market. Period. Let inflation eat our money away in the bank.

Don’t like that option?

Then deal with risk.

In my opinion, there are two ways of understanding risk.

One way is practical, and simple to understand and implement. I like this particular way.

The other way is complicated and mathematical. This method utilizes software to perform mathematical operations using calculus, and expresses risk in terms of greek alphabets. The software spits out an abstract expression of risk, which is then implemented in the trading strategy. I don’t like this method. It’s just a personal choice.

So let me just talk about the practical method of understanding risk.

For me, risk is the money that one can potentially lose in a trade at any given point of time, expressed in percentage terms of one’s total portfolio value.  Period.

Once the underlying risk has been clearly defined and understood, the management of this risk is implemented through a stop-loss which is outlined after considering total portfolio-size and after eye-balling relevant chart-patterns at hand.

This strategy makes risk something tangible, something one can deal with, in Rupee or Dollar terms. It makes market-play a matter of addition and subtraction. It’s practical, simple to understand and easy to implement.

Then, this understanding of risk needs to be coupled with a market-edge to constitute a complete market strategy.

Same story. An edge can be simple. Or complicated. Choice is yours.

Are u a Whiner?

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2 quick questions:

Do u play the markets? And r u a whiner?

If your answer to both questions is yes, third question: Do u want to change this condition?

If your answer to this third question is yes, please read on.

Whiners whine. They complain when things don’t go as planned. Also they don’t have any backup strategies. Mostly, they don’t have any front-up strategies either.

So, before moving into any market, formulate your strategy thoroughly. Define acceptable levels of loss. Define a strategy to implement if these levels are hit.

Also define a profit-taking strategy.
Define the tenure of investment.

Basically, define yourself. Have a very clear idea about what your risk-profile looks like.

Play it small initially, till you gain confidence.

And stop whining. 🙂

Holy Grail, Anyone?

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What’s the big secret, anyways?

Secret to what?

You know, making big bucks and all…!

Why are you asking me?

You look like you know things, and you talk the talk, so I presumed you walk the walk too.

Well, now don’t be surprised, but there’s no secret.

What?

You wanna make big bucks?

Yes, yes, of course I do.

Ok, then first define your risk profile. Know how much loss you can stomach.

Oh.

Then trade.

That’s it?

When you trade, your money goes on the line. And that’s a game-changer.

Why?

Coz when your money’s on the line, your emotional framework switches on.

So?

That’s when you get to know yourself. That’s when you can define your risk-profile.

And then?

Just manage your trades properly, according to the rules of your trading system.

That’s it?

Yup, just stick to your system. Cut losses when they are small. Let profits run.

I’ve heard that one.

Then have you also heard that it’s very easy to say, and most dificult to follow?

Why’s that?

Because when your money’s on the line, it is most difficult to take any loss.

Right!

And when you show a small profit, you badly want to book it.

True!

Our natural instincts go against what we need to do to succeed as a trader.

I see now.

That’s why most traders are unsuccessful, and they eventually go bust, or quit.

Hmmm, dunno if I want to be a trader.

You could try your hand at investing, though. There, one proceeds in an opposite manner.

Hey, why don’t you tell me about it, like right now?

Maybe some other day. First digest all of this, ok?

A Time for Things

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You don’t normally have dinner at breakfast time, do you?

Of course not.

Similarly, you don’t buy into a State Bank of India with a 5 year horizon when 6 years of earnings growth has already been factored into the price.

There’s a time for things.

You do buy into the same State Bank of India with a 2 week horizon when it’s shooting off the table and giving clear-cut up-moves as it makes its way into no-resistance territory.

And that’s about it. You’re in it for the short-term because that’s how the environment has defined itself. It’s a trading environment, not really meant for investors, whether conservative or unconservative. Thus, you have a stop-loss mechanism in place, in case there’s a down-swing, because up-moves can go hand in hand with down-moves. Where there’s a big money to be made, there’s chances of making a big loss too.

Oh, are you asking why you can’t enter into such stocks at this time with a long-term perspective? I see. Do you fly first class? No? Why not? Because it’s expensive, right? Similarly, such stocks are expensive just now. That’s not to say they won’t rise further. What you need to understand is that when you wake up five years from now, such a stock will have peaked and could possibly be heading for its trough. So your net returns over the long-term could even be negative.

Really wanna be a successful investor? Then you need to learn to buy cheap, with a margin of safety. You need to be patient enough to wait for lucrative entry levels.

Not getting your margins of safety anywhere in the markets just now?

Ok, just trade till you get them. Then you can stop trading, and start investing. Fine?