You must be Joking, Mr. Nath!

Ok, so there are aliens, so what?

I mean, is that so hard to believe? Which law says that Earth is the centre of activity in this universe?

Look around you. The horizon is full of scams. An honest management is most difficult to find. Honesty and integrity have become alien virtues. Scarce, don’t bump into them in normal life, and you might read an odd story about them in the papers.

So where does this leave you as an investor?

In a dishonest world, one needs to think in a warped manner to make money. You know, “two steps away from the norm” kinda thinking. So if the norm is to buy on a dip, in Kalyuga one waits to buy on a mega-dip. And these have started occuring more often than they used to. 10-Sigma or Black Swan events happen every now and then.

The thing I like about scams is that eventually, they explode. The one scam that is exposed (against the 20 that go unexposed) is enough to hit mass psychology. The common investor starts selling everything, even stuff that’s not affected by the scam. The market as a whole falls, sometimes cracking big.

Since we’re mostly down to buying scam-artist run corporations as investors, above-mentioned crack is the time to buy them, i.e. when they are hit badly. That’s when you are getting good value for your money. That’s when you are getting your margin of safety.

So, wait for the explosion. Buy in its aftermath. The interim period between explosions is to be used to pinpoint what you want to buy with a margin of safety, whenever that margin of safety abounds.

It is entirely within the realm of possibilities to live at peace with aliens. And it is equally possible for an investor to learn to live honestly but lucratively in a world full of corporate criminals.

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

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.

Anatomy of a Ponzi Scheme

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

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.

A Strong Case for Equity (Part 3)

What intrigues me most about the asset-class “Equity” can be described in two words.

Human Capital.

The human being: capable of the highest but also the lowest.

So, while pinpointing which scrip to purchase, one avoids flawed human capital.

Humans have many flaws which one’s antennae are scanning for here. Some are corrupt. Some are bad planners. Some lack management skills. It’s a big list.

What one’s looking for is integrity. Also the power to anticipate in advance. Alone this trait in the management of a company can make it grow beyond inflation and slow-down. Managers with good anticipatory powers hedge against loss in the future. For example, a company that uses Silver in its manufacturing process could use up its yearly profit to buy Silver in bulk @ 40 $ an ounce rather than buy it one year later @ 80 $ an ounce.

Honest human capital is transparent. Share-holder friendly. And if you can see any intelligence along with such characteristics, just go for the scrip at a decent valuation.

This one’s for You, Jesse!

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.

Is Silver in a Bubble?

When the chauffeur or even the doorman has an opinion, the underlying asset-class is in a bubble.

That’s my definition of a bubble.

And that’s not the case for Silver yet.

A bubble is something psychological. The mind gets twisted into believing that one’s found the holy grail. And then one can’t get enough of it.

Bill Bonner predicted in the year 2000, that Silver and Gold would be the trades of then commencing decade. What a prediction! He went on to say that in the last stages of its run, Gold would rise at the rate of 100$ an hour. You can proportionate that for Silver. That’s how a real bubble behaves. Just go back to first quarter of 2000 and observe the financial behaviour of dotcoms.

This is not a bubble yet. We are nowhere near bubble behaviour. The common households have not started selling off their household Silver. The man on the streets is not obsessed with Silver as of now. (I still look at common-man behaviour, even for Silver, because in a bubble, one forgets affordability. Apart from that, Silver can be bought by the gram).

So, where does one go from here?

Simple.

The trader keeps trading with the flow and an appropriate, risk-profile-tuned stop. For heavens sake, he or she needs to be long.

And the investor keeps buying small stakes on dips.

Nothing fancy or complicated. A simple, common-sense strategy is all that’s required.

Outperformers know how to Focus

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.

Just why is Embracing Risk so difficult?

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

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

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

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

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!