The Power of Leverage

Apart from the D-word, the Street’s got the L-word too.

This L stands for L-E-V-E-R-A-G-E.

So, how much leverage do you enjoy from your spouse?

Or, do you have any leverage on politician so-and-so?

Or, bank so-and-so or brokerage so-and-so is offering a 10:1 or a 16:1 leverage on derivatives.

Just racking up the various uses of the L-word.

In colloquial terms, the amount of leeway your spouse allows you in your marriage is called leverage. Also, the amount of dirt you have on a politician to coerce him into following your wishes – that’s called leverage too. But for now, let’s get back to the Street.

On the Street, The L-word gives the D-word its power to destroy big.

Do you remember what the D-word was? D-E-R-I-V-A-T-I-V-E-S.

A derivative is a stink normal trade without the power of leverage. When brokerages start offering you leverage like 16:1, the stink normal derivative becomes lethal. Then, small amounts of volatility can wipe out the principal put up by you. If a down-turn continues, your loss can become many times your principal. People can go bankrupt like this.

You see, for every market move, your profit or loss is the move times the leverage. On a 5% move, a 16:1 leverage can result in 80% profit or loss. Leverage works on the upside as well as the downside.

The problem arises when the player doesn’t know how to play either side. Most players don’t know.

Leverage can be used to one’s advantage only when the down-side is protected with a stop. Most people don’t use a stop while deploying leverage. That’s why they lose, and lose big.

This singular characteristic of the average market player of not knowing how to use stops results in a spiralling bomb during market down-turns. As losses pile up, selling pressure increases due to dejection or the like as the market heads even lower. What if they’d taken a 2% or a 5% or even an 8% hit when a stop was hit? They’d be out and the market could stabilize near the stop level because of lack of further selling pressure.

Leverage is something that must not be used if one doesn’t fully understand how to use it. Unfortunately, almost everyone consumes leverage as if it were a bar of Snickers. Leverage is served to customers on a platter. Even a loan, or debt on the credit card is leverage.

Leverage is the driving force of consumerism and the modern industrialized world.

A Hedge is a Hedge is a Hedge

U guessed it, this is again about Gold.

Why do I keep harping on Gold?

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

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

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

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

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

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

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

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

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

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

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

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

Happy First Birthday, Magic Bull !

It’s been one year!

Writing’s been fun. Didn’t do it for reward, but there’s been a nice reward.

The flow of words through the system clears and solidifies concepts in one’s mind. Writing evolves the human being.

As I’ve said earlier, this blog helps balance my equation with nature. It’s a “give-back”. One has access to so much free stuff in life that one’s life-equation would remain unbalanced if one didn’t give some free-stuff away. That’s not to say that this blog absolves me from any other charitable duties that I consider worthy.

So, we’ve been through a lot. We’ve touched on many aspects of investment and trading. What’s stood out is the psychological angle. The central focus of the blog has been the human being. We’ve really spent a lot of energy analyzing risk-profile and one’s psychological approach to the markets, haven’t we?

All for the good. First up, markets are a psychological game. After that, fundamentals and technicals fine-tune the approach.

Another thing you needed to take away from the journey so far was the singular importance of money-management and the lack of its proper teaching in our society. It’s not taught in school. College teaching about finance is failing. Look around you. Must be the fact that professors lecturing on the subject have no street experience whatsoever, of course with very few exceptions. We’ve established the fact that parents need to first achieve mature money-management standards themselves and then they need to pass these on to their kids.

For us, street-smartness has been the name of the game. One’s actual money needs to be on the line, to learn this street-smartness. No bookish knowledge is of any help. That’s been one of our thumb-rules.

We’ve spoken of human capital and hedges, and have brought the machiavellian character of Mrs. Market to life. She’s a far cry from that boring fellow, what was he called…Mr. Market of course, with no disrespect to Ben Graham or to Warren Buffett.

We’ve met people like Mr. Cool and Mr. System Addict. There were Jimmy Bean and Jackie Daniels. These people have taught us. Even Disney’s hysterical villain Doofenschmirz made an appearance. The Ponzi scheme was deconstructed. El Helicoptro Ben Bernanke wasn’t spared. Nor was financial academia.

We’ve taken grit from the world of sport in an effort to channel it into our market-approach, and have studied whatever avenue we felt would add to our winning approach.

Thanks for riding with me this far. Please remain with me. I like your company and your comments.

On that note, happy first birthday, Magic Bull !

Just 40 $ Away…

The first signs of greed can be sensed.

We’re talking about Gold.

A few months ago, serious players in Gold had identified Rs. 28,000 / 10 grams as their target for Gold.

This target has been achieved for a while now. Nobody’s booked their Gold.

Instead, the target has been revised to Rs. 30,000 / 10 grams, which is just another 40 $ an ounce away.

Please don’t tell me that nobody is going to book (meaning sell, as in booking profits) their Gold @ Rs. 30,000 / 10 grams. I’ve got this nagging feeling that they’re not.

Hmmm, greed is setting in. Nothing unusual. That’s how a bubble progresses.

Yesterday, an update from Reliance alerted me to the hypothesis that Rs. 40,000 / 10 grams was a real possibility in Gold.

Maybe, maybe not. As of now, Reliance is sounding like that fellow who predicted a Dow level of 36,000 some years ago. Today, 36k on the Dow seems impossible, even in one’s dreams.

Does it matter to you how high Gold can go? Or is your target more important? Both are valid questions.

If your target has been achieved, here’s one scenario. Book the Gold and put the released funds into debt. Debt in India is safe, and is giving excellent returns, especially to the retail investor.

If your stomach is full, do you dream about more food?

Seriously people, playing this by targets is a serious option.

It’s also ok if you wanna play it in a “let’s see how high this can go” manner. That’s just another way of playing it. Fine. In this case, you need to set trailing stops, and you need to stick to these if they get hit.

Either way, identify a booking strategy for Gold and stick to it.

Take greed out of the equation. There’s no room for greed in the career of a market player. There’s no room for fear either.

We’ll talk about taking fear out of the equation some other day, if and when unprecedented gloom and doom abounds.

One-Pointedness Finds its Niche

At a certain stage in our market careers, the words “sounds like a plan” echo within the walls of our minds.

To reach this stage, individuals need to cross activation-barriers and pass tests. How many depends upon the individual.

These words are for those of you who have reached this point, or are in the process of doing so.

So, after suffering many losses and learning many lessons, suddenly, our market strategy becomes clear to ourselves.

And then, once one’s path has been painstakingly chalked out, one needs to follow it one-pointedly.

From this point onwards, all that’s required is sheer one-pointedness.

This focus of energy would be a waste if attuned to implement a faulty and immature strategy, and would lead to insolvency.

On the other hand, if this focus and burst of energy is utilized to push through a mature plan which is in sync with one’s risk-profile, then, dear friend, you are staring at financial independence in the face.

All the best!

Endgame

There, I’ve done it again.

Done what?

Endgame, you know, Samuel Beckett, theatre of the absurd, blah blah blah, siphoned off the title in typical UN style.

I don’t think Beckett was absurd at all. Rather, the absurd mask was absurd, but perhaps absurdly necessary.

Well, isn’t this the Endgame? Physically, politically, and, last but not least, financially.

For me, it is.

If it’s not the Endgame for you, please wake up. Which world are you living in? I mean, are you blind?

Play it like you’d play an Endgame. Give it all you’ve got. If you don’t do justice to this mother of all Endgames, my friend, you really are wasting your incarnation.

And, if Beckett wouldn’t mind that I’ve siphoned off his title, well, neither should you.

What are We, Really?

One bout of torrential rainfall and our infrastructure comes to a stand-still.

What are we, really?

Is India a golden investment?

Not with the current state of governance.

Is India an investment?

Yes, but only at single-digit price to earnings ratios.

Why?

Because while investing in India, one needs to factor in very bad governance, terrorism, and fragile infrastructure. That’s why the margin of safety required is huge.

Is India a good trade?

Yes.

Why?

Because of the pull and push between the shining private sector versus the apathetic government sector. This contrast causes big moves, both up and down. Ideal for trading.

So how should one play India?

Again, up to you. Invest in it at single digit PEs. Cash out when PEs hit the early 20s. Or, just sheer trade it. Suit yourself.