Where to, Mr. Nath?

Last month, I scrapped my market-play system.

Happens.

Systems are made to be scrapped later.

One can always come up with a new system.

I love working on a new system.

It’s challenging.

What I want to talk to you about is why I scrapped my last system.

I found four accounting frauds, as I did my market research, all online.

You see, my last system worked well with honest accounting.

It had no answer to accounting frauds.

Also, I got disillusioned.

Are we a nation of frauds?

How does one deal with a nation of frauds?

More importantly, how does one play such a nation?

Does one invest in it? Or, does one sheer trade it?

Questions, questions and more questions. These encircle my mind as I work to put my new system together.

I am in no hurry to come up with an answer. A country like India deserves a befitting answer, and that it will get, even if the sky comes down on me while I put my system together.

Slowly, I started to think. How many systems had I scrapped before?

Hmmm, four or five, give or take one or two.

I have an uncompromising market rule of going fully liquid when I scrap a system.

Full liquidity is a tension-tree state. It allows one to think freely and in an unbiased manner. Being invested during volatility impedes one’s ability to think clearly and put a new system together.

Ok, so what answer would my new system have towards fraud?

All along, it was very clear to me that future market activity would be in India itself. Where else does one get such volatility? I am learning to embrace volatility. It is the trader’s best friend.

Right, so, what’s the answer to fraud?

Trading oriented market play – good. Not much investing, really. First thoughts that come to mind.

Buying above supports. Selling below resistances. Only buying above highs in rare cases, and trailing such buys with strict stops. Similarly , only selling below lows in even rarer cases, and again, trailing such sells with strict stops.

Trading light at all times.

Fully deploying the bulk of one’s corpus into secure market avenues like bonds and arbitrage. You see, bonds in India are not toxic. Well, not yet, and with hawks like the RBI and SEBI watching over us, it might take a while before they turn toxic. If and when they do start turning toxic, we’ll be getting out of them, there’s no doubt about that. Till they’re clean, we want their excellent returns, especially as interest rates head downwards. In India, one can get out of bond mutual funds within 24 hrs, with a penalty of a maximum of 1 % of the amount invested. Bearable. The top bond funds have yielded about 13 – 15% over the last 12 months. So, that 1% penalty is fully digestible, believe me.

With the bulk of one’s returns coming from secure avenues, small amounts can be traded. Trade entries are to be made when the odds are really in one’s favour. When risk is high, entry is to be refrained from. A pure and simple answer to fraud? Yes!

You see, after a certain drop, the price has discounted all fraud and then some. That’s one’s entry price for the long side. On the short side, after a phenomenal rise, there comes a price which no amount of goodness in a company can justify and then some. That’s the price we short the company at.

Of course it’s all easier said than done, but at least one thing’s sorted. My outlook has changed. Earlier, I used to fearlessly buy above highs and short below lows. I am going to be more cautious about that now. With fraud in the equation, I want the odds in my favour at all times.

These are the thoughts going on in my mind just now. Talking about them helps them get organized.

You don’t have to listen to my stuff.

I’m quite happy talking to the wall.

Once these words leave me, there’s more space in my system – a kind of a vacuum.

A vacuum attracts flow from elsewhere.

What kind of a flow will my vacuum attract?

Answers will flow in from the ether.

Answers to my burning questions.

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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.