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.

Options 1.0.1

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Cricket’s great, but now back to business…

Today I’m gonna talk about options, so listen up.

For me, options are low-risk : high-reward instruments.

Hmmm, sounds utopic.

Well, it wasn’t always so. At first, I found them to be low-risk : even lower reward. It took a lot of losses and a lot of time to come up with a strategy that has turned options into low-risk : high reward. It’s a personal strategy, and works only with my own temperament and personal risk-profile. You’ll have to discover your own strategy. Bottomline is, that this is perfectly achievable.

Did you notice that all along, options have been classified as “low-risk” in this space?

Well, though that’s relative, mostly it is the case. Mostly, one sees small percentages of the porfolio being dabbled into options, so that makes most option premiums that one pays relatively low-risk when judged in view of one’s entire portfolio.

The Banoffee-pie moment is the fact that the option premium paid up is one’s stop-loss, if one enters an option and doesn’t actively monitor it. This allows one to do other things while the option works. It’s called value addition. One’s created a possible very short-term asset, and one is using one’s time after that to create more assets.

So, let us remember these two characteristics of options for now: low risk and possible very short-term asset creation.

I find options exciting. They challenge me. I don’t use mathematics with options, though many people do. The finance industry calls them “quants”. They use differential equations and calculus, and they calculate betas, gammas, rhos, thetas and what-nots. I don’t do all that. I keep it simple.

While playing options, I only use charts and gut-feel.

I can afford to, because the risk is small.

Waking Up

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It’s a new morning.

What’s changed?

This: last night, we saw self-belief in action.

Even if it was to be seen in a game of cricket. It was still self-belief. A rare commodity.

MS Dhoni walked in to bat, promoting himself up the order. Very brave. If this would back-fire, he’d never hear the end of it.

The singular thing that shone out in his batting was self-belief. He’d been out of form. His style was unique at best. Nothing copy-book. Just raw belief that he could do it. That he could win it for his country.

He just had one thing in mind: to dominate the bowling and not get dominated by it. And he translated that belief into a match and tournament winning innings of a life-time.

What one takes away from this glimpse of brilliance is that one can win if the desire is strong enough.

One is compelled to carry forward such a feat and translate it into one’s own professional pursuits.

Dhoni won a mind-game yesterday.

Whatever one’s profession is, at first it’s a mind-game.

The battle is won in the mind first. Then it is translated into the physical deed.

On that note, congratulations to the nation, and WELL DONE team India!

Why Japan?

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Exactly, why Japan?

Twice in 66 years. Holocaust, and now this.

Ok, there’s the seismic blubla. And the Nostradamus stuff. Don’t know what to believe.

And where does something like this leave one’s portfolio. (Sorry, have to ask this question, even at a time like this. It’s purely professional, and perhaps what I’m writing here will help someone.)

In the doldrums.

Unless one bought with a MARGIN OF SAFETY. That’s when one can sit pretty, even during a crisis.

Or, if u are a trader, and are long Japan before such a crisis, where does that leave u?

Broke.

Unless you trade with a STOP LOSS.

These 2 basic concepts are VERY IMPORTANT. And one only realizes this during a crisis.

I still don’t know why Japan, but am sharing with u what I have learnt.

It’s all a give and take. I have access to so much of free stuff on the web and otherwise in life. So it’s absolutely ok if u get this knowledge for free from me.

However, don’t forget to balance your own equation with nature. Set something solid in motion, for free, for others to benefit from. Balance your equation.

Otherwise, eventually, nature will balance it for you. In a way you might not necessarily like, but will be stuck with.

Don’t wait for that to happen. Balance your equation. Now. 🙂

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. 🙂

Flying Asset Class

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What’s an asset?

Ever thought about it?

If not, you need to, if you want to fly asset class.

An asset is something that generates income for you. Even while u r not looking. That’s my understanding.

So is your house an asset?

No! Unless it’s generating a rental. Otherwise it’s generating expenses, and is thus a liability.

Sound investing generates assets.

Over time, the accumulative income of all your assets allows you to fly asset class, i.e. gives you financial independence. Even while u r not looking.

That’s the whole idea.

A Strong Case for Equity (Part 2)

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Scams bother us. We panic, and then start cashing out of our Equities.

Can we stop and reflect?

There was some Jeep scam in ’57. Then Bofors. Fodder. Harshad Mehta scam in the ’90s. Dot cum bust. This century has been chockerblock with scams.

Let’s see how some holdings have performed over all these years. Reliance, ABB, Infosys, Wipro…these companies were microcaps at some stage in their lives. The long-term holders of these shares have raked it in big-time. Wipro has been a 300,000+ bagger over the last 31 years. The other three companies have been 1000+baggers. That’s BIG.

Some of today’s microcaps will make it as big or bigger over the very long term. They will be tomorrow’s blue-chips.

All of us want to set something aside for our kids. It’s human nature. So why can’t we think of holding equity for the very long-term, especially for our children?

What makes equity so special? Behind every scrip is human capital, which, if not involved in Scamonomics, fights inflation through innovation. The power to fight inflation is not inherent in other asset classes.

So let’s think seriously about very long-term equity holding.

What remains is the criteria for stock selection. That’s a deep topic, and we’ll delve into it some other day…

Gravity

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Markets correct.

That’s what markets do.

Why do we cry when something does what it’s supposed to do?

And, more importantly, why did we buy at an expensive valuation in the first place?

Are we traders?

If yes, fine, traders are meant to buy at expensive valuations, coz they like to sell at even more expensive valuations.

If we are not traders, then it is not fine.

If we are not traders, then most of us fall in the category “Investors”.

Investors are not meant to buy at expensive valuations.

So let’s not cry over the effect of something we were not meant to do in the first place.

Learning to Fly

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Pilots train in simulators.

No point putting many lives at risk by flying a real aircraft without proper training.

A simulator is next to the real thing. Actually, one up, they make these things worse than the real thing.

No such luck in the markets.

However much one simulates the markets, the real lessons learnt come from actual monetary involvement in the markets.

Books, theories, paper-trading, degrees, etc. don’t have it in them. They prepare you for something else, but not for the markets.

The silver-lining here is, that if we don’t want to, there are no real lives at stake here. We can keep it small in the beginning years, you know what I mean?

Small but real losses, leading to big life-time lessons. This would be the ideal result of one’s first few years in the markets.

Yes, it’s actually harmful to deadly for a newbie trader to make hot-shot profits in the beginning without having learnt the proper lessons.

Let’s see you figure out the why for this. No spoon-feeding here, right?

What Money-on-the-Line does for You

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Your system has a bio-chemistry.

This bio-chemistry is intricately coupled to the mind and the nervous system.

When your money is on the line, your mind and your nervous system start reacting.

Money-on-the-line means automatic emotional involvement. Period.

Many of those who talk about investing / trading do not have their own money on the line.

Thus, they are not qualified to talk about investing / trading. Do not listen to them.

Instead, listen to your own bio-chemistry. It will teach you.

That’s what money-on-the-line does for you.

A Level-Headed Approach to the Markets

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There’s lots to choose from in the market-place.

Many seek a profession in the markets. If you belong to this category, first spend as much time as possible trying out as much as you can from the vast choice this multi-faceted international trading fraternity has to offer. Develop a feel for things. Your first goal is to identify a niche-segment for yourself. It will take as long as it takes. Have patience. Are you more comfortable with equity rather than commodities, which are even more volatile? Are you just happy doing arbitrage? Or, do you prefer options? It’s questions like these you are trying to answer at this stage.

Remember, the markets don’t require an MBA or any other recognized degree qualification for one to be successful. Honestly speaking, degrees are a hindrance, since the teaching is done by professors who are mostly theoretically active.  One out of a hundred market-teachers actually plays the market with his or her own money. Thus most or all one learns about the markets in college is not really relevant.

Wanna learn to be successful at the markets? Then play them. With your own money. Day in, day out. Feel the pain of loss. Feel the pleasure of profit. Make all the mistakes you can at this stage while things are still small. Let’s see you taking small losses and letting profits run, the easiest thing in the world to say but the hardest thing in the world to do. Let’s see you starting to get the basics right at least and then building up from there.

Thus, slowly but surely, identify your A-game, i.e. your niche-segment. This is the area you are most comfortable moving in. And that’s why, when developed properly, this area will give you a regular income very soon. Since you are comfortable in the area you move in now, that’s your next goal: A Regular Income.

More on that some other day…

Mrs. Market goes to work

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Ben Graham gave us Mr. Market.

I’m sure you remember the polite but schizophrenic-manic-depressive-to-overtly-optimistic fellow.

Then, over the years, Mr. Market had a sex-change.

Meet Mrs. Market, the suave, canniving, multiply schizophrenic, cold-blooded and “efficient” ((she thinks she’s efficient))  global phenomenon.

If there’s one thing she wants, it is respect. Yes, she wants your full attention. Either that, or she wants you to lay off. Or, she’ll just pull your pants down. Period.

Her quantum of movement and also her frequency of movement nowadays has become nerve-wracking. Not to forget her speed of movement – play her if you can take her speed and if you have a sound heart condition.

She rewards some of those who look at her all the time. First she wants undivided attention, and then she wants you to know her levels. If she crosses a level, she wants you to join her. Then she rewards you.

But, she’s canniving, remember. Sometimes, she back-tracks on you. So, whenever you’re on a date with her, just carry some insurance with you. This insurance is called a stop-loss.

And now for her weak-point. Wanna pin her down? Well, she thinks she’s efficient. To be fair, though she was a disaster at efficiency earlier, she has become a little efficient now, but only sometimes. At these times, you don’t want to go out with her, because she’ll block your every pick-up line and trick in the book.

You actually need to take her for a spin when she’s inefficient. Then you’ll get to any base with her. In fact, you might even hit a few home-runs.

But careful, you’re not traveling without your insurance. Because, at any given time, she might turn efficient, and God help you if you are caught unawares.

There will be times when she will pull your pants down despite your every precaution. At these times, you’ll need to pick yourself up and live for another day. What’ll have helped is the fact that you didn’t give your everything into your affair with Mrs. Market before she ditched you. What you saved up can be used for another, this time lucrative fling with her.

She’s a relentless worker. On weekends, though, she rests. You need to catch your breath too, to get ready for her next ride. Wish you luck!

System Addict & Mr. Cool

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Mr. Cool starts his day.

He wants to know what other people are doing. To be more exact, what they are trading. He listens to tips. Actually, “listens” is an understatement. He’s hungry for tips. He shorts strong stocks, and goes long those that have corrected. He wants to be Mr. Johny-on-the spot where the action is.

Mr. Cool gets up late. Of course no preparation for the trading day is on the agenda. In fact, he has no agenda other than the format stated above. The day starts off with a call to the broker. What’s moving? What are the news projections? Any hot tips? What’s this analyst saying?

Mr. Cool doesn’t live long in the markets. His “strategy” of trading long into correcting stocks and shorting strong ones pays off 80% of the time, but when it goes wrong, it goes wrong big, in fact so big, that Mr. Cool doesn’t feel so cool anymore. He holds on to his losses. He’s scared of taking the hit. He hopes that prices will reverse to his entry price and then he wants to exit. This time around, it doesn’t happen, and his cheap options expire worthless, leaving him broke. By now the markets have scared him so much, that he nevers trades again.

Mr. System Addict is everything Mr. Cool is not. He has a system, and he sticks to it. No tips, no news, no rumours, no non-sense. If the system indicates a buy, he goes long. If it indicates a sell, he goes short. If an exit, he exits. No looking here and there. Belief in the system. Trade to trade system development and enhancement. Solid pre-market preparation and after-market analysis. The works.

Mr. System addict has been around in the markets and he’s going to stay. He’s doing well. Initially, he used to be Mr. Cool, but then he went bust. The only difference was, that he had the strength to lift himself up and become Mr. System Addict.

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?

And Now for the Most Useless Question

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For the trader, the most useless question regarding the markets is … …

“The Why of the Markets.”

Why is there a spike or a crash?

Frankly, who cares?

Just forget about it. The “Why” of the markets is baggage, it’s a load, and exactly this particular load needs to be abandoned.

When a trade is on, one’s got enough emotional overload to deal with anyways. Let the pundits bother themselves with this “Why”. It’s their bread and butter. Your bread and butter is the trade. Focus on the trade. Focus on entry. Focus on trade management. Focus on exit. Don’t focus on anything else. Blank the whole world out while you trade.

Then, when you reach home, focus on your family.

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 Thing with Gold

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Equity has a human face behind it. Gold does not.

The human face with its human mind is capable of the best and the worst, the highest and the lowest.

The intelligent investor selects Equity with benevolent and diligent human faces and minds behind it to garner multibagger returns.

Gold is a metal. Period. It doesn’t have a brain. It is not able to find a way around inflation. Its prices fluctuate as per demand and supply. In times of uncertainty, it goes up and up. In times of economic and financial stability, it goes down and down. The net result of Gold’s price fluctuations over the past 100 years has been a 1% annually compounded return, adjusted for inflation.

What you should not expect from Gold is more than a 2- or 3-bagger return over the medium term. If things go really sour for world economy, you might get a 5- or even a 10 bagger return (looking at a kind of a doomsday scenario). If you are hoping for anything more from Gold, dream on.

2-, 3-, 5- and even 10-bagger returns are quite common in Equity over the medium term, and over the long-term, there’s no limit. Wipro’s been a 300,000-bagger over 25 years. There are hundreds of examples of 1000-baggers, and thousands of examples of 20+-baggers in Equity. Meanwhile, over the long-term, Gold goes back to the median.

Why Equity behaves like this is because of the human capital behind Equity. We’ll go into the details of this some other time.

Bottomline remains that, realistically speaking, Gold functions best as a hedge. In case 80% of our portfolio goes for a toss, that 20% which is in Gold for example can save the portfolio with its 5-bagger return.

If we enter Gold with the desire to make a killing, we either have unrealistic expectations, or we need to play Gold futures or Gold Equity. These have their own nuances, about which, again, we’ll talk another day.

Investing is not about building a Consensus

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We are what we eat, as an ancient proverb goes.

Another one says that we reap what we sow.

And from what little I’ve seen, eventually, we fall in line and invest as per the wiring of our mental framework. Till we don’t do this, we are following someone. Eventually there’s a clash of personalities. This is a clash between the one leading us and our own beliefs. We now have to make a choice to either go it alone, or to keep following the leader.

Each day after this clash has taken place, the rift deepens. More of our beliefs are being violated. That’s because the leader is investing according to his or her own beliefs. Investment is a projection of one’s personality. Such an evnironment full of conflict leads us to wrong decisions, which result in losses.

Investment isn’t about building a consensus. It’s really not about x number of people coming together, agreeing upon an opinion, putting money on the line and making a killing. That’s an approach that may be part of a trading strategy, but it is far removed from comfortable and healthy investing.

Investing 1.0.1 is about understanding one’s own personality, because this is going to interfere with every decision and thought process one will make in this line. The identification of any investment target needs to be in line with one’s personality, otherwise the acquired target will continue to disturb one’s thought process and everyday life. Who’s best suited to bring about an alignment between investment targets and personality? You are, not a third party. An outsider can only second guess how your mental framework functions. You know yourself much better than anybody else.

Once a basic alignment between personality and investment strategy has been achieved, things start to fall in place, with investments yielding satisfaction and profits.

One doesn’t need to form a consensus with anyone to identify a successful investment and make money in it.

A Beautiful Concept called Margin of Safety

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The most beautiful, genius things in life are simple.

And therefore, they are difficult to implement.

We like complications. Sophistication. When something appears simple, our first impulse is that of rejection.

We get our families insured, our car insured, house, properties etc. etc. all insured, in fact, we are busy buying protection everywhere. During winter we wear protective clothing. Our children swim with protective gear. Our cars have seat-belts and airbags. The list of how mankind protects itself is endless.

Then why is it that when it comes to putting one’s hard-earned money on the line, all thoughts of protection go out the window, and one becomes malleable enough to jump into the next hot story at even seventy or eighty times earnings?

Why is it that here we are not clinging on to protection? Basic question – are there any protective measures prevalent in the world of investing? The answer is yes, and many. In this article, I’ll name two and address one.

There’s the protective stop-loss (to be differentiated from the trigger-stop). Let’s talk about this one some other day. Right now, let’s focus on the other major avenue for protection, called margin of safety.

Basically, what margin of safety says is “Buy Cheap”. Period. What it’s not saying is that one should buy any odd-ball, cheap stock. It’s referring to quality stocks and telling us to buy them as cheaply as we can. The result will be a buffer price-band, which in case of a major market-crash will still limit our losses and save us from the urge to abandon our investment at rock-bottom prices. So, this concept asks us to have patience and wait for opportunity, and not to be impulsive and plunge blindly.

Margin of safety is applicable while trading also. One can buy into market leaders upon dips. The dip gives one a short-term margin of safety.

The primary advocate of margin of safety is none other than Warren Buffett himself, from an investment point of view.

So, to implement this simple and beautiful concept, one requires the virtues of patience and discipline.

Wishing for you safe and lucrative investing!

Cheers!