And Now For The Most Useless Question

“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.”

magic bull

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.

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Are You a Whiner?

magic bull

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. 🙂

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You must be Joking, Mr. Nath

Folks, I am sooo not joking!

magic bull

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…

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That Secret Ingredient called Gut-Feel

… failure – retry – failure – retry – failure – retry – success – – – – – over time, and with effort and perseverance, the path to success gets embedded into one’s system, and coupled to one’s gut-feel…

magic bull

Birds fly. And, they fly in flocks. When a flock turns, it does so in unison. There seems to be a connection between each bird in the flock. It’s as if each can feel the others in its gut. Each bird is in the “Zone”.

Heard one about a famous artist. He was asked by a rich businessman to paint a rooster for a hefty fee. A year passed. Upon no word from the artist, the businessman got fed up and went to collect the painting. Seeing the artist basking in his lawn with not a care in this world, the businessman enquired about the painting. “Oh, you’ve come to collect your rooster, is it?” asked the artist casually. He then lay out his canvas, painted the perfect rooster, and handed the painting to the businessman, who was stunned and demanded an explanation. Which is when the artist took the…

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Can Anyone Match Our Financial Sentinels?

It was the aftermath of ’08.

There was blood everywhere.

In my desperation to get a grip on things, I was about to make yet another blunder.

The Zurich International Life pitch had found its way into my office through a leading private bank.

The pitch was fantastic.

I got sucked in.

Access to more than 150 mutual funds world wide…

No switching fee…

Switch as many times as you want…

Joining bonus…

Premium holiday after 18 months…

I quickly signed the documents.

What remained cloudy during the pitch was the 10-year lock-in.

Also, nobody mentioned that the exit penalty was exorbitant. I mean, as I later found out, the level of the exit penalty would make Shylock look like JP Morgan.

In the pitch, I found myself hearing that one could exit after 18 months upon payment of 9% interest p.a. on the joining bonus.

Nobody mentioned the full management fees, which I later calculated to be a staggering approximate of 7.75% per annum for myself, since I had opted for a premium holiday as soon as I could.

I mean, when about 7.75% was being deducted from your corpus each year, what in the world was the corpus going to generate? I found myself asking this question after four years of being trapped in the scheme.

I had soon realized that the pitchers had lied in the pitch. In the fine-print, there was no such clause saying that one could exit after 18 months upon payment of 9% interest p.a. on the joining bonus. If I escalated the matter, at least three people would lose their jobs. Naehhh, that was not my style. I let it go.

When I would look at interim statements, the level of deductions each time made me suspect that there were switching fees after all. I could never really attribute the deductions to actual switches, though, because the statements would straight-away show the number of mutual fund units deducted as overall management fees. If there were switching fees, they were getting hidden under the rug of management fees. Since the level of overall fees was disturbing me totally, I had this big and nagging suspicion that they were deducting something substantial for the switches, and were not showing this deduction openly in their statements.

When I compared all this to how Unit-Linked Insurance Plans (ULIPs) were handled in my own country, I was amazed at the difference.

In India, customer was king.

The customer had full access to the investment platform, and could switch at will from his or her own remote computer. Zurich did not allow me such direct access.

The expense-ratio in India was a paltry 1.5% – 2.0% per annum. Compare this to the huge annual deductions made in the case of my Zurich International Life policy.

Lock-ins in India were much lesser, typically three odd years or so.

Some ULIPs in India allowed redemptions during lock-ins, coupled with penalties, while others didn’t. Penalties were bearable, and typically in the 2 – 5 % (of corpus) range. Those ULIPs that did allow such redemptions only did so towards the latter part  of the lock-in, though. Nevertheless, lock-in periods were not long when compared to ten whole years, during which the whole world can change.

The debt-market funds paid out substantially larger percentages as interest in India when compared to the debt-market funds encompassed by Zurich International Life.

In India, deductions from ULIP premiums in the first few years (which were getting lesser and lesser each year due to legislature-revision by the authorities) were off-set by absence of short-term capital gains tax and entry/exit equity commissions upon excessive switching. This meant, that in India, short-term traders could use the ULIP avenue to trade without paying taxes or commissions. Whoahh, what a loop-hole! [I’m sure the authorities would have covered this loop-hole up by now, because this research was done a few years ago.]

ULIPs in India allowed at least 4 switches per annum that were totally free of cost. After that, switches would be charged at a very nominal flat rate of typically about the value of 2-9 USD per switch, which, frankly, is peanuts. I was suspecting that the Zurich fellows were knocking off upto 1% of the corpus per switch, but as I said, I didn’t see the math on paper. Even if I was wrong, their yearly deductions were too large to be ignored. Also, was I making a mistake in furthermore deducing that Zurich was deducting another 1% from the corpus each time the corpus changed its currency? I mean, there was no doubt in my mind that the Indian ULIP industry was winning hands-down as far as transparency was concerned.

In India, people in ULIP company-offices were accessible. You got a hearing. Yeah. Zurich International Life, on the other hand, was registered in the Isle of Man. Alone the time difference put an extra day (effectively) between your query and action. Anyways, all action enjoyed a T+2 or a T+3 at Zurich’s end, and the extra day made it a T+4 if you were unlucky (Indian ULIPs moved @ T+0, fyi & btw). Apart from the T+x, one could only access officials at Zurich through the concerned private bank, and as luck would have it, ownership at this private bank changed. The new owners were not really interested in pursuing dead third-party investments made by their predecessors, and thus, reaching Zurich could have become a huge problem for me, were it not for my new relationship manager at this private bank, who was humanitarian, friendly and a much needed blessing.

By now, I had decided to take a hit and exit. It would, however, be another story to get officials at Zurich to cooperate and see the redemption through. On her own level, and through her personal efforts, my diligent relationship manager helped me redeem my funds from Zurich International Life.  I am really thankful to her. Due to her help, my request for redemption was not allowed to be ignored / put-off till a day would dawn where really bad exit NAVs would apply. Zurich did have the last laugh, knocking off a whopping 30 odd percent off my corpus as exit penalty (Arghhh / Grrrrr)! Since I had managed to stay afloat at break-even despite all deductions made in the four years I was invested, I came out of the investment 30% in the hole. The moment it returned, the remaining 70% was quickly shifted to safe instruments yielding 10%+ per annum. In a few years, my corpus would recover. In less than 4 years, I would recover everything. In another two, I would make up a bit for inflation. Actually, the main thing I was gaining was 6 remaining years of no further tension because of my Zurich International Life policy. This would allow me to approach the rest of my portfolio tension-free.

The Zurich International Life policy had been the only thorn in my portfolio – it was my only investment that was disturbing me.

I had taken a hit, but I had extracted and destroyed the thorn.

It was a win for the rest of my portolio, i.e. for 90%+ of my total funds. Tension-free and full attention heightens the probability of portfolio prosperity.

Yeah, sometimes a win comes disguised as a loss.

When I look back, I admire the Indian financial authorities, who ensure that the Indian retail customer is treated like a king.

Retail customers in other parts of the world receive very ordinary treatment in comparison.

I know this from first-hand experience.

I don’t plan to invest overseas as long as our financial authorities continue to push such discipline into our financial industry.

I don’t often praise too much in India, but where it is due, praise must emanate from the mouth of a beneficiary. We are where we are because of our fantastic financial sentinels!

Three cheers for the Securities and Exchange Board of India, for the Insurance Regulatory and Development Authority, and, of course, three cheers and a big hurray for the Reserve Bank of India.

The Concept of Satmya

The concept of Satmya (habituation) is one of my favourite concepts, when it comes to trading. Here, one sees how a vital aspect, belonging to a different territory altogether, can apply so holistically to your own territory. This only proves that it pays to be broad-minded. Important ideas can develop in other cultures, areas and professions. Such ideas can be so vital, that they fully deserve to be implemented into one’s own system. 🙂

magic bull

This one’s from the world of Ayurveda, folks.

We’re not geeks.

We move around amongst all segments of life, grab whatever is useful, and then try and apply its usefulness into our world of applied finance.

And that’s exactly what we’re going to do with the concept of Satmya.

Imagine in your minds a first-time smoker. The first puff breaks him or her out into a coughing flurry. A new stimulus is choking the respiratory system. The body rejects it.

That’s roughly the story for any first-time stimulus which is disturbing.

Upon repeated exposure to the stimulus, the body slowly gets habituated. Ultimately, rejection recedes. One’s tissues are now not only bathing in the stimulus, they are enjoying it. In fact, they want more.

Habituation is where we want to keep it at, no further. That’s the point of Satmya. At the point of Satmya, you enjoy the stimulus without…

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Mrs. Market goes to Work

People, I can’t help reblogging this one – it is a defining article with regards to my understanding of Mrs. Market. The language used is provocative – on purpose – so that the message imprints itself in the mind of the reader. Believe me, the insinuations are innocent and harmless, and if the essence of Mrs. Market becomes a concept to you, my purpose is solved. For heaven’s sake, people, focus on the message and not on the language. The message is noble, and is supposed to help you win at investing or trading. Cheers 🙂

magic bull

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…

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A Chronology of Exuberance

The biggest learning that the marketplace imparts is about human emotions.

Yeah, Mrs. Market brings you face to face with fear, greed, exuberance, courage, strength, arrogance … you name it.

You can actually see an emotion developing, real-time.

Today, I’d like to talk about the chronology of exuberance.

In the marketplace, I’ve come face to face with exuberance, and I’ve seen it developing from scratch.

When markets go up, eventually, fear turns into exuberance, which, in turn, drives the markets even higher.

What is the root of this emotion?

The ball game of exuberance starts to roll when analysts come out with a straight face and recommend stocks where the valuations have already crossed conservative long-term entry levels. As far as the analysts are concerned, they are just doing their job. They are paid to recommend stocks, round the year. When overall valuations are high, they still have to churn out stock recommendations. Thus, analysts start recommending stocks that are over-valued.

Now comes the warp.

At some stage, the non-discerning public starts to treat these recommendations as unfailing cash-generating  opportunities. Greed makes the public forget about safety. People want a piece of the pie. With such thoughts, the public jumps into the market, driving it higher.

For a while, things go good. People make money. Anil, who hadn’t even heard of stocks before, is suddenly raking in a quick 50Gs on a stock recommendation made by his tobacco-seller. Veena raked in a cool 1L by buying the hottest stock being discussed in her kitty party. Things are rolling. Nothing can go wrong, just yet.

Thousands of Anils and Veenas make another 5 to 6 rocking buys and sells each. With every subsequent buy, their capacity increases more and more. Finally, they make a big and exuberant leap of faith.

There is almost always a catalyst in the markets at such a time, when thousands make a big and exuberant leap of faith into the markets, like a really hot IPO or something (remember the Reliance Power IPO?).

Yeah, people go in big. The general consensus at such a time is that equity is an evergreen cash-cow. A long bull run can do this to one’s thinking. One’s thinking can become warped, and one ceases to see one’s limits. One starts to feel that the party will always go on.

Now comes the balloon-deflating pin-prick in the form of some bad news. It can be a scandal, or a series of bad results, or some political swing, or what have you. A deflating market can collapse very fast, so fast, that 99%+ players don’t have time to react. These players then rely on (hopeful) exuberance, which reassures them that nothing can go wrong, and that things will soon be back to normal, and that their earnings spree has just taken a breather. Everything deserves a breather, they argue, and stay invested, instead of cutting their currently small losses, which are soon going to become big losses, very, very big losses.

The markets don’t come back, for a long, long time.

Slowly, exuberance starts dying, and is replaced by fear.

Fear is at its height at the bottom of the markets, where maximum number of participants cash out, taking very large hits.

Exuberance is now officially dead, for a very long time, till, one day, there’s a brand new set of market participants who’ve never seen the whole cycle before, supported by existing participants who’ve not learnt their lessons from a past market-cycle. With this calibre of participation, markets become ripe for the re-entry of exuberance.

Wiser participants, however, are alert, and are able to recognize old wine packaged in a new bottle. They start reacting as per their designated strategies for exactly this kind of scenario. The best strategy is to trade the markets up, as far as they go. Then, you can always trade them down. Who’s stopping you? Shorting them without any signals of weakness is wrong, though. Just an opinion; you decide what’s wrong or right for you. The thing with exuberance is, that it can exercise itself for a while, a very long while – longer than you can stay solvent, if you have decided to short the markets in a big way without seeing signs of weakness.

At market peaks, i.e at over-exuberant levels, long-term portfolios can be reviewed, and junk can be discarded. What is junk? That, which at prevailing market price is totally, totally overvalued – that is junk.

Formulate your own strategy to deal with exuberance.

First learn to recognize it.

Then learn to deal with it.

For success as a trader, and also as an investor, you will not be able to circumvent dealing with exuberance.

Best of luck!

Three Ways to Double Down

To win big as a trader, one needs to understand and implement a strategy of doubling down when things are looking good.

The difference between mediocre success and mega-success as a trader is linked to a trader’s ability to double down at the proper time.

We’ve discussed position-sizing. That’s one way to double down.

A day-trader, or a very short-term trader has the luxury of seeing one trade culminate and the next trade start off after the first one culminates at its logical conclusion. For most longer-term traders, many trades can be occurring simultaneously, because started trades have not yet come to their logical end, and new opportunities have cropped up before trades commenced have come to their logical end.

What do such traders do? I mean, they do not know the final outcome of the preceeding trades.

Yeah, how could such traders position-size properly?

Well, a trade might not have come to its logical conclusion, but you do know how much profit or loss you are sitting on at any given point of time. The calculation of the traded value for the next trade is simply a function of this profit or loss you are sitting on. Simple, right?

Well, what if you don’t like to position-size in that manner?

What if you say, that here I am, and I’ve finally identified a scrip that is moving, and that I’m invested in it, and am sitting on a profit. Now that I know that this scrip is moving, I’d like to invest more in this very scrip.

Good thinking. Nothing wrong at all with the thinking process.

You now pinpoint a technical level for second entry into the scrip. Once your level is there, you go in. No heavy or deep thinking required. As a trader, you are now accustomed to plunging after trade identification and upon setup arrival.

Question is, how much do you go in with?

Is your second entry a position-sized new trade? Or, do you see how much profit you are sitting on, and enter with the exact amount of profit you are sitting on? The latter approach is called pyramiding, by the way. Pyramiding is a close cousin of position-sizing. Normally, one speaks about pyramiding into one very scrip, when the trader buys more of that very scrip after showing a profit in that scrip. Once could, however, also pyramid one’s profits into different scrips.

When you’re pyramiding into one very scrip, you’re putting many eggs in one basket. Right, the risk of loss is higher. The thing going for you is that this risk for loss is higher at a time when your profits are up in a scrip that’s on its way up. Therefore, the risk during a downslide is higher, but the probability of that risk’s ability to result in an overall loss for you is lower than normal. You understand that you have balanced your risk equation, and with that understanding, you don’t have a problem putting many eggs in the same basket. After all, it’s a basket you are watching closely. Yeah, you know your basket inside out. You are mentally and strategically prepared to take that higher risk.

There’s yet another way to double down. I’d like to call this the “stubborn-bull trading approach”.

Let’s say you are sitting on a profitable trade. Yeah, let’s say you are deep in the money.

Now, a safe player would start raising the stop as the scrip in question keeps going higher and higher.

On the other hand, a trader with an appetite for risk could risk more and more in the scrip as it keeps going higher and higher – by not raising the stop, till a multibagger is captured. On the other hand, this trader would also be setting him- or herself up to give back hard-earned profits. Yeah, no risk – no gain.

What’s the difference between the stubborn-bull trading approach (SBTA) and investing?

When you’re adopting the SBTA, you’ll cut the trade once it loses more than your stop. You’ll sit on it stubbornly only after it has shown you multibagger-potential, let’s say by being up 20-50% in a very short time. You’ll keep sitting on it stubbornly till your pre-determined two-bagger, three-bagger or x-bagger target-level is reached. After that, you’ll start raising the stop aggressively, as the scrip goes still higher. Eventually, the market will throw you out of your big winning trade. You see, the SBTA strategy is very different from an investment strategy. For starters, your entry into this scrip has been at a trading level, not at an undervalued investment level. Undervalued scrips normally don’t start dancing about like that immediately.

Let’s be very clear – to reap big profits in the long run, you, as a trader, will need to adopt at least one of these doubling down strategies – position-sizing, pyramiding and / or the stubborn-bull trading approach.

Have a profitable trading day / week / month / career! 🙂

How Does One Position-Size?

What is the singular most lucrative aspect of trading?

Any ideas?

Want a hint?

Ok, here’s the hint. It is also the safest aspect of trading.

Give up?

Here’s the answer. It’s called position-sizing. (The pioneer of position-sizing is Dr. Van K. Tharp, @ www.iitm.com, and I have learnt this concept through him).

Surprised? I would be surprised if you weren’t surprised.

Yeah, trade selection is important too, but other things are more important while trading.

For example, trade management is more important than trade selection. So is exit. Entry might be paramount to an investor, but to the trader, entry is run of the mill. It happens day in, day out. The trader … just enters a selected trade. There’s no deep thinking involved. The trader knows this. Crux issues are to follow. The trader is saving his or her energies for the crux issues.

So far, we’ve spoken about the chronology of a trade, i.e. entry – management – exit.

Before entry, you decide how much you want to trade with, and how much you want to risk. That’s the size of your position, or your position-size. Remember, for the concept of position-sizing to make any sense, your stop-loss percentage must remain constant from trade to trade. Only your traded value goes up or down.

What does the level of your traded value depend upon?

It depends upon HOW WELL YOU ARE DOING.

If you’re on a roll, your traded value for the next trade goes up. The increment is proportional to the profits you are sitting on. Since the stop is a constant percentage, the amount risked is also higher. Return is proportional to the amount at risk, and the long-term net return of such a trade will also be higher. All this means, that the more you make, the more you set yourself up to make even more…!

Take a coin. Flip it millions of times. There will be a stretch, where you’ll flip tails 5 times in a row, or six times in a row, or maybe even ten times in a row. The 50:50 trade called “coin flip” can well result in a series of back to back losses. You are an experienced trader. Your trade selection ratio could be 60 winning trades to 40 losing trades, or perhaps a little better, let’s say 65:35. Even a trade selection ratio of 65:35 will result in back to back losses. As a trader, you need to take large drawdowns in your stride, as long as you are confident, that in the long run,  your system is working. What’s working in your favour during the large drawdown?

Your position-size is.

You see, as trade after trade goes against you, and your losses pile up, your position-size KEEPS GOING DOWN. Your stop percentage remains constant. This means, that the more you lose, the more you set yourself up to lose lesser and lesser, trade after trade. Yeah, position-sizing gives you the safety of losing less. Nevertheless, because of this safety assurance from your position-sizing strategy, you keep yourself in the market by just taking the next trade without too much deep thinking (and with no melancholy whatsoever), because your next trade could be the one decent trade that you are looking for. Yeah, your very next trade could cover all losses and then some. TAKE IT.

Now, two things can happen.

Firstly, if you keep losing, and hit your loss cut-off level for the month, well, then, you just stop trading for the rest of your month. You then spend the rest of the month reviewing your losses and your system. You tweak at whatever needs tweaking, and come back fresh and rested the following month. Position-sizing kept you in the market, ready to take the next opportunity to earn big. The auto-cut takes you out of the market for a while. That’s why, in my opinion, while position-size is still activated, it provides more safety, because it keeps you in the market to recover everything and then some, starting with your VERY NEXT trade. Having said that, auto-cut is auto-cut. It overrides position-sizing.

The second thing that can happen is that your losing streak ends before your month’s cut-off is reached. Yayyy, position-sizing is still activated! You’ve lost lesser and lesser on each losing trade as long as you were in the losing streak, and now that you are winning again, each win sets you up to win more in the trade that follows.

After many, many trades, just cast a glance at your trading corpus. It will boggle your mind!

Your position-sizing strategy has kept raising your corpus, because your system is 60:40+, and you win more than you lose. Ultimately, your corpus has become substantial. Its size exceeds your expectations BY FAR.

All thanks to position-sizing.

And How Are You This 20k?

20k’s knocking on our sensory index.

How are you feeling, this 20k?

I remember my trading screen, the first time 20k came. Lots of blue till it came, and when it came, the screen just turned into a sea of red.

Sell orders hit their auto-triggers, as if it were raining sell orders along with cats and dogs.

What is it about round numbers?

Why do they engulf us in their roundness?

I don’t think I am making a mistake in stating that the first person to recognize the significance of round numbers in the game was Jesse Livermore, the legendary trader. Jesse developed a round number strategy that he pulled off repeatedly, with enormous success. It is because of Jesse Livermore that a trader takes round numbers … seriously.

So, what is it about the roundness of 20k?

Plain and simple. The 0s engulf the 2. You don’t see the 2 anymore, and the 0s scare you. Or, they might excite you. Round numbers make the human being emotional.

Big question for me, to understand my own mindset – how am I reacting to 20k?

I would like to share my reaction with you, because it could help you understand your own reaction.

Also, writing about it makes me understand my own reaction better. Thoughts get assimilated.

Yeah, it’s not all social service here, there’s some selfish element involved too.

Besides, I have a bit of a guilty conscience about the amount of research the internet allows me to do, free of cost. I mean, I can get into the skin of any listed company with a few button-clicks. All this writing – is a give-back. You’ll get your calling soon enough. Nature will tell you where you need to give back. When that happens, don’t hold back – give freely. It’s a million dollar feeling!

Back to the topic.

I’ve seen 20k twice before, I think, perhaps thrice. Oh right, between late September and December ’10, it came, was broken, then it came back, to be again broken on the downside, all within a few months.

The aftermath of the first time I saw it (in November ’07) hammered me, though, and taught me my biggest market lessons. I’m glad all this happened in my early market years, because one doesn’t normally recover from huge hammerings at an advanced stage in one’s market career.

The second / third time I saw 20k, I was profiting from it to a small extent. A vague kind of strategy was developing in my mind, and I was trying all kinds of new trading ideas so as to formulate a general strategy for big round numbers.

This morning, I saw 20k for the fourth time, for a few minutes.

By now, I was on auto-pilot.

A human being will have emotions. A successful market player will know how to deal with these emotions.

I bifurcated my emotions into two streams.

One was the fear stream.

The other was the exuberance stream.

The former helped me decide my future investment strategy.

The latter helped me decide my future trading strategy.

In my opinion, a good investment strategy in times of market exuberance would be to not look for fresh investments anymore. This morning, I decided to stop looking for fresh investments, till further notice.

Sometimes, when you’re not looking for an investment, you might still chance upon a company that sparks your investment interest.

If that happened, I would still scrutinize such a company very, very thoroughly, before going ahead. After all, these were times of exuberance.

Yeah, fresh investments would be on the backburner till margins of safety were restored.

Now let’s speak about the exuberance stream.

Market looked ripe for trading. Fresh market activity would take the shape of trading.

Trading is far more active an activity, when compared to investing. We’ve spoken a lot about the difference between trading and investing, in previous posts. Investors enter the market when stocks are undervalued, because the general market is unable to see their intrinsic value. Traders take centre-stage when stocks are overvalued, because the general market is repeatedly attributing more and more value to stocks, much more than should be there. Traders ride the market up, and then short it to ride it down.

Yeah, till further notice, I would be spending my energies trading. After a while, I would re-evaluate market conditions.

That’s what I thought to myself this morning.

Due Diligence Snapshot – IL&FS Investment Managers Ltd. (IIML) – Jan 14 2013

Price – Rs. 23.85 per share ; Market Cap – 499 Cr (small-cap, fell from being a mid-cap); Equity – 41.76 Cr; Face Value – Rs. 2.00; Pledging – Nil; Promoters – IL&FS; Key Persons – Dr. Archana Hingorani (CEO), Mr. Shahzad Dalal (vice-chairman) & Mr. Mark Silgardo (chief managing partner) – all three have vast experience in Finance; Field – Private Equity Fund managers in India (oldest), many joint venture partnerships; Average Volume – around 1 L+ per day on NSE.

Earnings Per Share (on a trailing 12 month basis) – 3.55

Price to Earnings Ratio (thus, also trailing) – 6.7 (no point comparing this to an industry average, since IIML has a unique business model)

Debt : Equity Ratio – 0.35 (five-year average is 0.1); Current Ratio – 1.05

Dividend Yield – 4.7% (!)

Price to Book Value Ratio – 2.1; Price to Cashflow – 5.1; Price to Sales – 2.2

Profit After Tax Margin – 32.85% (!); Return on Networth – 35.24% (!)

Share-holding Pattern of IL&FS Investment Managers – Promoters (50.3%), Public (39.2%), Institutions (4.9%), Non-Institutional Corporate Bodies (5.5%). [The exact shareholding pattern of IL&FS itself is as follows – LIC 25.94%, ORIX Corporation Japan 23.59%, Abu Dhabi Investment Authority 11.35%, HDFC 10.74%, CBI 8.53%, SBI 7.14%, IL&FS Employees Welfare Trust 10.92%, Others 1.79%].

Technicals – IIML peaked in Jan ’08 at about Rs. 59.50 (adjusted for split), bottomed in October of the same year at Rs. 13.60, then peaked twice, at Rs. 56.44 (Sep ’09) and Rs. 54.50 (Aug ’10) respectively, in quick succession, with a relatively small drop in between these two interim high pivots. By December ’11, the scrip had fallen to a low pivot of Rs. 23.30 upon the general opinion that the company wasn’t coming out with new product-offerings anytime soon. A counter rally then drove the scrip to Rs. 32, which is also its 52-week high. During the end of December ’12, the scrip made it’s 52-week low of Rs. 23. People seem to have woken up to the fact that a 52-week low has been made, and the scrip has risen about 4 odd percentage points since then, upon heavier volume.

Comments – Company’s product profile and portfolio is impressive. No new capital is required for business expansion. Income is made from fund management fees and profit-sharing above designated profit cut-offs. Lots of redemptions are due in ’15, and the company needs to get new funds in under management by then. If those redemptions are done under profits, it will increase company profits too. Parag Parikh discusses IIML as a “heads I win (possibly a lot), tails I lose (but not much)” kind of investment opportunity. His investment call came during the mayhem of ’09. The scrip is 42%+ above his recommended price currently. What a fantastic call given by Mr. Parikh. Well done, Sir! Professor Sanjay Bakshi feels that IIML has a unique business model, where business can keep on expanding with hardly any input required. He feels, “that at a price, the stock of this company would be akin to acquiring a free lottery ticket”. I opine that the price referred to is the current market price. Before and after Mr. Parikh’s call, the company has continued to deliver spectacular returns. The company’s management is savvy and experienced. They made profitable exit calls in ’07, and fresh investments were made in ’08 and ’09, during big sell-offs. Thus, the management got the timing right. That’s big. I have no doubt that they’ll get new funds in under management after ’15, alone on the basis of their track record. Yeah, there’s still deep value at current market price. Not as deep as during ’08, or ’09, but deep enough.

Buy? – Fundamentals are too good to be ignored. They speak for themselves, and I’m not going to use any more time commenting on the fundamentals. Technicals show that volumes are up over the last 3 weeks. People seem to be lapping the scrip up at this 52-week low, and the buying pressure has made it rise around 4% over the last 3 weeks. If one has decided to buy, one could buy now, preferably under Rs. 24. The scrip seems to be coming out of the lower part of the base built recently. There is support around Rs. 23 levels, so downside could be limited under normal market conditions.

Disclaimer and Disclosure – Opinions given here are mine only, unless otherwise explicitly stated . You are free to build your own view on the stock. I hold a miniscule stake in IIML. Data / material used has been compiled from motilaloswal.com, moneycontrol.com, equitymaster.com, valuepickr.com, safalniveshak.com and from the company websites of IIML & IL&FS. Technicals have been gauged using Advanced GET 9.1 EoD Dashboard Edition. I bear no responsibility for any resulting loss, should you choose to invest in IIML.

Stock-Picking for Dummies – Welcome to the Triangle of Safety

Growth is not uniform – it is hap-hazard.

We need to accept this anomaly. It is a signature of the times we live in.

Growth happens in spurts, at unexpected times, in unexpected sectors.

What our economic studies do is that they pinpoint a large area where growth is happening. That’s all.

Inside that area – you got it – growth is hap-hazard.

To take advantage of growth, one can do many things. One such activity is to pick stocks.

For some, stock-picking is a science. For others. it is an art. Another part of the stock-picking population believes that it is a combination of both. There are people who write PhD theses on the subject, or even reference manuals. One can delve into the subject, and take it to the nth-level. On the other hand, one can (safely) approach the subject casually, using just one indicator (for example the price to earnings ratio [PE]) to pick stocks. Question is, how do we approach this topic in a safe cum lucrative manner in today’s times, especially when we are newbies, or dummies?

Before we plunge into the stock-picking formula for dummies that I’m just about to delineate, let me clarify that it’s absolutely normal to be a dummy at some stage and some field in life. There is nothing humiliating about it. Albert Einstein wasn’t at his Nobel-winning best in his early schooldays. It is rumoured that he lost a large chunk of his 1921 Nobel Prize money in the crash of ’29. Abraham Lincoln had huge problems getting elected, and lost several elections before finally becoming president of the US. Did Bill Gates complete college? Did Sachin Tendulkar finish school? Weren’t some of Steve Jobs’ other launches total losses? What about Sir Issac Newton? Didn’t I read somewhere that he lost really big in the markets, and subsequently prohibited anyone from mentioning the markets in his presence? On a personal note, I flunked a Physical Chemistry exam in college, and if you read some of my initial posts at Traderji.com, when I’d just entered the markets, you would realize what a dummy I was at investing. At that stage, I even thought that the National Stock Exchange was in Delhi!

Thing is, people – we don’t have to remain dummies. The human brain is the most sophisticated super-computer known to mankind. All of us are easily able to rise above the dummy stage in topics of our choice.

Enough said. If you’ve identified yourself as a dummy stock-picker, read on. Even if you are not a dummy stock-picker, please still read on. Words can be very powerful. You don’t know which word, phrase or sentence might trigger off what kind of catharsis inside of you. So please, read on.

We are going to take three vital pieces of information about a stock, and are going to imagine that these three pieces of information form a triangle. We are going to call this triangle the triangle of safety. At all given times, we want to remain inside this triangle. When we are inside the triangle, we can consider ourselves (relatively) safe. The moment we find ourselves outside the triangle, we are going to try and get back in. If we can’t, then the picked stock needs to go. Once it exits our portfolio, we look for another stock that functions from within the triangle of safety.

The first vital stat that we are going to work with is – you guessed it – the ubiquitous price to earnings ratio, or the PE ratio. If we’re buying into a stock, the PE ratio needs to be well under the sector average. Period. Let’s say that we’ve bought into a stock, and after a while the price increases, or the earnings decrease. Both these events will cause the PE ratio to rise, perhaps to a level where it is then above sector average. We are now positioned outside of our triangle of safety with regards to the stock. We’re happy with a price rise, because that gives us a profit. What we won’t be happy with is an earnings decrease. Earnings now need to increase to lower the PE ratio to well below sector average, and back into the triangle. If this doesn’t happen for a few quarters, we get rid of the stock, because it is delaying its entry back into our safety zone. We are not comfortable outside of our safety zone for too long, and we thus boot the stock out of our portfolio.

The second vital stat that we are going to work with is the debt to equity ratio (DER). We want to pick stocks that are poised to take maximum advantage of growth, whenever it happens. If a company’s debt is manageable, then interest payouts don’t wipe off a chunk of the profits, and the same profits can get directly translated into earnings per share. We want to pick companies that are able to keep their total debt at a manageable level, so that whenever growth occurs, the company is able to benefit from it fully. We would like the DER to be smaller than 1.0. Personally, I like to pick stocks where it is smaller than 0.5. In the bargain, I do lose out on some outperformers, since they have a higher DER than the level I maximally want to see in a stock. You can decide for yourself whether you want to function closer to 0.5 or to 1.0. Sometimes, we pick a stock, and all goes well for a while, and then suddenly the management decides to borrow big. The DER shoots up to outside of our triangle of safety. What is the management saying? By when are they going to repay their debt? Is it a matter of 4 to 6 quarters? Can you wait outside your safety zone for that long? If you can, then you need to see the DER most definitely decreasing after the stipulated period. If it doesn’t, for example because the company’s gone in for a debt-restructuring, then we can no longer bear to exist outside our triangle of safety any more, and we boot the stock out of our portfolio. If, on the other hand, the management stays true to its word, and manages to reduce the DER to below 1.0 (or 0.5) within the stipulated period, simultaneously pushing us back into our safety zone, well, then, we remain invested in the stock, provided that our two other vital stats are inside the triangle too.

The third vital stat that we are going to work with is the dividend yield (DY). We want to pick companies that pay out a dividend yield that is more than 2% per annum. Willingness to share substantial profits with the shareholder – that is a trait we want to see in the management we’re buying into. Let’s say we’ve picked a stock, and that in the first year the management pays out 3% per annum as dividend. In the second year, we are surprised to see no dividends coming our way, and the financial year ends with the stock yielding a paltry 0.5% as dividend. Well, then, we give the stock another year to get its DY back to 2% plus. If it does, putting us back into our triangle of safety, we stay invested, provided the other two vital stats are also positioned inside our safety zone. If the DY is not getting back to above 2%, we need to seriously have a look as to why the management is sharing less profits with the shareholders. If we don’t see excessive value being created for the shareholder in lieu of the missing dividend payout, we need to exit the stock, because we are getting uncomfortable outside our safety zone.

When we go about picking a stock for the long term as newbies, we want to buy into managements that are benevolent and shareholder-friendly, and perhaps a little risk-averse / conservative too. Managements that like to play on their own money practise this conservatism we are looking for. Let’s say that the company we are invested in hits a heavy growth phase. If there’s no debt to service, then it’ll grow much more than if there is debt to service. Do you see what’s happening here? Our vital stat number 2 is automatically making us buy into risk-averse managements heading companies that are poised to take maximum advantage of growth, whenever it occurs. We are also automatically buying into managements with largesse. Our third vital stat is ensuring that. This stat insinuates, that if the management creates extra value, a proportional extra value will be shared with the shareholder. That is exactly the kind of management we want – benevolent and shareholder-friendly. Our first vital stat ensures that we pick up the company at a time when others are ignoring the value at hand. Discovery has not happened yet, and when it does, the share price shall zoom. We are getting in well before discovery happens, because we buy when the PE is well below sector average.

Another point you need to take away from all this is the automation of our stop-loss. When we are outside our safety zone, our eyes are peeled. We are looking for signs that will confirm to us that we are poised to re-enter our triangle of safety. If these signs are not coming for a time-frame that is not bearable, we sell the stock. If we’ve sold at a loss, then this is an automatic stop-loss mechanism. Also, please note, that no matter how much profit we are making in a stock – if the stock still manages to stay within our triangle of safety, we don’t sell it. Thus, our system allows us to even capture multibaggers – safely. One more thing – we don’t need to bother with targets here either. If our heavily in-the-money stock doesn’t come back into our safety zone within our stipulated and bearable time-frame, we book full profits in that stock.

PHEW!

There we have it – the triangle of safety – a connection of the dots between our troika PE…DER…DY.

As you move beyond the dummy stage, you can discard this simplistic formula, and use something that suits your level of evolution in the field.

Till then, your triangle of safety will keep you safe. You might even make good money.

PE details are available in financial newspapers. DER and DY can be found on all leading equity websites, for all stocks that are listed.

Here’s wishing you peaceful and lucrative investing in 2013 and always!

Be safe! Money will follow! 🙂

So, … … , When’s Judgement Day?

The “fiscal cliff” thingie has come and gone…

Gone?

People, nothing’s gone.

If something is ailing, it needs to heal, right?

What is required for healing?

Remedial medicine, and time.

Let’s say we take the medicine out of the equation.

Now, what’s left is time.

Would the ailing entity heal, given lots of time, but no medicine?

If disease is not so widespread, and can be expunged over time, then yes, there would be healing, provided all disease-instigating factors are abstained from.

Hey, what exactly are we talking about?

It is no secret that most first-world economies are ailing.

Specifically, the US economy was supposed to be injected with healing measures, which were to take effect from the 1st of Jan., ’13. Financial healing would have meant austerity and a more subdued lifestyle. None of that seems to be happening now. The healing process has been deferred to another time in the future, or so it seems.

You see, people, no one wants austerity. The consumption story must go on…

So now, since the medicine’s been taken out of the equation, is there going to be any healing?

No. Disease-instigating lifestyles are still being followed. Savings are low. Debt with the objective of consumption is still high. How can there be any healing?

Under the circumstances, there can’t.

So, what’re we building up to?

We’re all clear about the fact that consumption makes the world go round. What is the hub of the world’s consumption story? The US. That part of the world which does save, and where there is real growth, well, that part rushes to be a part of the consumption story. It produces cheaply, to sell where there’s consumption, and it sells there expensively. Yeah, like this, healthy economies get dragged into an equation with ailing economies. Soon, the entanglement is so deep, that there’s no turning back for the healthy economy. It catches part of the ailment from the diseased economy. Slowly, non-performing assets of banks in such healthy economies start to grow. The disease is spreading.

Hold on, stay with me, we’re not there yet. Yeah, what are we building up to?

Healthy economies take time to get fully diseased. Here, savings are big, domestic manufacturing is on the rise, and there a healthy demographic dividend too. Buffers galore, the immune system of a healthy economy tries to fight the contagion for the longest time. As entanglement increases, though, buffers deplete, and health staggers. Non-performing assets of banks grow to disturbing levels.

That’s what we are looking out for, when we are invested in a healthy economy which has just started to ail. Needless to say, we pulled out our funds from all ailing economies long back. Our funds are definitely not going back to economies which refuse to take medicine, i.e. which don’t want to be healed. Now, the million dollar question is …

… what’s to be done with our funds in a healthy economy which has just started to become diseased due to unavoidable contagion?

Nothing for now. Watch your investments grow. Eventually, since no one is doing enough to stop the damage and the spread, big-time ailment signs will invariably appear in the currently “healthy” economy, signs that appeared a while back in currently ailing economies. Savings will be disappearing, manufacturing will start to go down, and bad-debt will increase. Define your own threshold level, and go into cash once this is crossed. You might not need to take such a step for many years in a row. Then again, you might need to take such a step sooner than you think, because the ailing mother-consumer economy is capable of pulling everyone down with it, if and when it collapses. And it just stopped taking its medicine…

Let’s get back to your funds. In the scenario that you’ve gone into cash because you weren’t confident about the economy you were invested in, well, what then?

Option 1 is to look for an emerging economy that gains your confidence, and to invest your funds there.

Not everyone is comfortable investing abroad. What if you want to remain in your own economy, which you have now classified as diseased. There’s good news for you. Even in a diseased economy, there are pockets of health. You need to become a part of such pockets, just after a bust. So, remain in cash after a high and till after a bust. Then, when there’s blood on the streets, put your money into companies with zero-debt, a healthy dividend-payout record and a sound, diligent and honest management. Yeah, at a time like that, Equity is an instrument of choice that, over time, will pull your funds out of the gloom and doom.

You’ve put your funds with honest and diligent human capital. The human capital element alone will fight the circumstances, and will rise above them. Then, you’ve entered at throwaway prices, when there was blood on the streets. Congrats, you’ve just set yourself up for huge profit-multiples in the future. And, the companies you’ve put your money with, well, every now and then, they shower a dividend upon you. This is your option 2. Just to share with you, this is my option of choice. I like being near my funds. This way, I can observe them more closely, and manage them properly. I suffer from a case of out of sight, out of mind, as far as funds are concerned. Besides, when funds are overseas, time-differences turn one’s life upside down. This is just a personal choice. You need to take your own decision.

At times like this, bonds are not an option, because many companies can cease to exist in the mayhem, taking your investment principal out with them.

Bullion will give a return as long as there is uncertainty and chaos. Let there be prolonged stability, and you’ll see bullion tanking. Yeah, bullion could be option 3 at such a time. You’ll need to pull out when you see signs of prolonged stability approaching, though.

One can use a bust to pick up cheap real-estate in prime localities. Option 4.

You see, you’ve got options as long as you’re sitting on cash. Thus, first, learn to sit on cash.

Before that, learn to come into cash when you see widespread signs of disease.

Best part is, widespread disease will be accompanied by a big boom before the bust, so you’ll have time to go into cash, and will be ready to pick up quality bargains.

You don’t really care when judgement day is, because your investment strategy has already prepared you for it. You know what to do, and are not afraid. If and when it does come, you are going to take full advantage of it.

Bring it on.