Category Archives: Trading

Enemies of the State

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What’s with me?

Why am I coming up with titles of songs or movies as headings for my blogposts?

Well, I need to grab your attention. It’s the age of minute attention-spans. I need to catch whatever window I have to make u interested in reading this stuff.

If investing is your territory, then hurry (which spoils the curry) is the enemy of your state. Innately, you will feel an urge to get into a winning investment. If you can overcome this urge, you’ll have come a long way. You’ll actually make proper investments, at pivotal points on the price versus time axis.

If trading is your territory, the enemy of your state is to be found within too. Here, it’s the lack of willingness to get out of a losing trade. If you can train yourself to cut a losing trade after a stop is hit, again you’ll have come a long way, and your account will reflect good trading profits soon enough.

Slowly, it’s becoming clear that trading and investing are two ends of a spectrum, mirror images with opposite domain rules.

Please don’t mix trading with investing, or vice-versa, or you’ll ruin whatever you are doing.

I’m not saying don’t do both. It’s a free world. Do both. Fine. But confined within separate portfolios please, both physically and in the mind. And slowly, one after the other, till you can handle both ends of the spectrum simultaneously.

Or do you think that you can build Rome in one day?

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.

A Fall to Remember

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Ok, these are big drops in the values of commodities. Especially Silver.

Actually, I’m liking it.

No, I am not short Silver, or short Oil, or short Gold.

As far as commodities go, I don’t trade in them, I invest in them.

And as Silver falls big time, I am buying shares of Silver mining companies. Small amounts, nothing big. One needs to tread carefully. Because one doesn’t know when prices will stabilize.

Prices were way too high earlier to go ahead with these purchases. But, as Silver falls, one starts getting a margin of safety in Silver mining companies. I feel this has just started happening. Which is not to say that Silver won’t fall more.

Which is when I’ll buy more.

This is long-term investing. Here, the ideology is the complete opposite of trading.

Trigger Mechanisms in Trading

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Trigger mechanisms can fine-tune one’s trading by leaps and bounds.

There’s the buy stop. It’s used to only get into a trade above a certain price level. Below that price level, one isn’t bullish, and doesn’t wish to enter the trade.

Then there’s the sell stop. It’s used to execute a short sale below a certain level. One is bearish below that level only; above the level one doesn’t wish to enter the trade.

A short-seller can also use the buy stop to square off a short sale going against him or her.

Similarly, a person who is long can use the sell stop to square off a buy going against him or her.

How does the trigger mechanism work? There are two components: the trigger price and the limit price. Once the trigger price is “triggered”, only then is the order activated. This triggered order is then carried out within the range defined by the limit price. If the trigger price is not reached, the order is not activated.

This gives the trader the added advantage of not having to watch the screen all the time. In fact, some traders use the trigger mechanism while punching in their orders, and do something else the rest of the day.

More importantly, the trigger mechanism allows the trader to be where the action is when the action happens.

Trigger mechanisms are how professionals do it. You can use them too, because they are available on any and every trading platform doing the rounds.

Managing Loss & Coming Back to Zero – 2 Star Qualities of a Successful Trader

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Heads or tails?

Theoretically, it’s a 50:50 chance.

And over a large number of coin flips, it works out to be 50:50.

On the other hand, over a relatively smaller number of coin flips, one can have many heads (or for that matter tails) in a row. Let’s say you flip a coin ten times. Chances are, you might get heads eight times in a row. I mean, it actually happens.

For a market participant without any edge, a given trade is like a coin-flip. It can go either way. So, eight losses in a row can happen. Losing trade after losing trade can come, longer than one can remain solvent. This needs to be understood.

Therefore, the need arises to cut losses when they are very small.

Also, one needs to understand, that the next trade has nothing to do with the last trade. The outcome of a new trade is fully independent of the past. There is no rule saying that the 8th trade after 7 losses has to be a winning trade.

The successful trader comes back to zero after each closed trade. He or she let’s go of any baggage from the last trade, and starts a fresh one with new and full focus. There are no expectations from the new position. If it doesn’t work, the loss will be cut very small, and the savvy trader will bring his or her mind back to zero-point, and then will initiate a fresh position.

It’s really not rocket-science.

This one’s for You, Jesse!

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Jesse Livermore – market legend.

Not with us anymore. Killed himself in a bout of depression.

Jesse’s life will be remembered. He was a pioneer, establishing the basic rules of trading for modern mankind. In the process he won many fortunes, and lost back a big part of what he won because of the hit and trial process he had to go through, to establish a basic trading map for mankind.

His was a colourful life. Pioneers, however, cannot be judged by the average person. An average human being doesn’t have the powers to comprehend the conditions under which a pioneer functions.

There were times when Jesse would swing a leveraged line worth several million dollars, and this is the first quarter of the 20th century we are talking about. He established the need and the rules for a stop-loss by losing money big time. He also won big, very big.

Jesse was the king of shorting. In the mega-crash of 1929, his unswerving short line won him a 100 million dollars. In 1907, JP Morgan (the man, not the investment firm) personally requested him to square off his shorts asap, or the US financial industry would go bankrupt. Jesse loved America, and the American way of life. He squared off his shorts.

Jesse had an eye for big market moves. He would watch a stock and get into its nervous system. Then, he would preempt its big move and would make a killing. He observed that stocks fulcrum around pivotal points, shooting up or down many notches from there within a short span of time. Making use of this insight was not enough for Jesse. He shared his knowledge with the world, so that others could benefit.

Then, another very lucrative trading insight – buying above highs – comes from Jesse. People are making serious money today in Gold and Silver for example, using this very knowledge. Others have used this strategy to their advantage by latching on to the runs of Cisco Systems, Walmart, Wipro etc. in the past. Above a high, there is no resistance, coz there is no presence of old buyers wanting to sell. Jesse was the first to recognize this.

In the early part of life, JL was impulsive. He would lose everything he made by not sticking to his own principle of stops, for example. Later, as he matured, he developed the principle of letting a winning trade run. His way of putting it was that the biggest money in the markets was made by sitting.

In his later years, Jesse started treating cash as king. When the opportunities would come, JL’s line with the bank was as deep as the pockets of Fort Knox.

I’ve shared four principles with you which Jesse Livermore actively used in his trading. These principles are priceless. I admire Jesse Livermore, and wish that he hadn’t fallen to the disease of depression.

Thanks so much, Jesse.

Outperformers know how to Focus

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Want to outperform the markets?

Then learn to focus.

Outstanding returns are the domain of focus investors.

If one is not a focus investor, then one is a diversified investor.

Diversification is not a negative trait.

It gives an average result. Over time, one’s performance matches the market average.

There’s nothing wrong in getting an average result.

It’s just that if you want something extra, here’s what you need to do.

You need to identify one or max two baskets.

And then you need to watch these baskets.

The Most Bugging Questions

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Where is this market going?

Should one buy xyz?

What kind of volume do you trade?

What are your predictons?

Frankly, wrong questions.

One doesn’t exactly go to watch Formula 1 to then ask how many runs someone needs to make to win, right? Similarly, all the above questions are irrelevant to a trader’s success in the markets.

It doesn’t really matter where the market is going. A successful trade can still be found.

It doesn’t matter what one buys. If one manages the trade well, ultimately and overall, one will make money.

It doesn’t matter what volume you trade, as long as you have a system and stick to it.

And, a successful trader doesn’t predict the market. To succeed in the market, one needs to ask the market where it wants to go, and then one needs to go along with it.

The critically important part about trading is to put one’s money on the line, and to feel the emotional stress in one’s system that goes along with this. One needs to do this again, and again, and again, and that’s how one learns trade management. No books can really teach this. One really needs to go out there and do it.

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?

The Difference between Investment & Speculation

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Investment is the low to medium risk art of conserving capital and protecting it against inflation, such that in the long run, capital appreciates. Speculation is the high risk art of trying to turn a small amount of money into a large amount.

Investment banks upon the power of compounding. It is an amalgamation of human, monetary and product capital, a combination that favours appreciation in the long run, not linear, but exponential appreciation, owing to the power of compounding. The key requirements are intelligence during scrip selection, patience and tolerance to allow multi-baggers to develop and blossom, and common-sense in handling one’s portfolio. Also, one needs to weed one’s portfolio at times, to remove poisonous scrips.

Speculation banks upon the power of leverage. This construct of finance is a double-edged sword. It can compound one’s profits, but also one’s losses. The speculator tries to cut losses and let profits run. This is easier said than done, because it goes against our natural instincts.

In the end, there are both successful and unsuccessful investors and speculators.

The key to deciding what line one should pursue here is a recognition of one’s own risk profile and appetite. What gives one sleepless nights? What is one’s pain threshold? How much loss can one bear without any effect on family life?

Such questions need to be answered before embarking upon either investment or speculation.