Sunday, May 31, 2009

Someone Loses When Someone Gains: Do You have This Belief about Stock Markets?

There is a theory or belief particularly in the minds of intelligent people who do not easily enter into stock trading. These people not only think that someone loses when someone gains, they also try forcing that belief on to others. Their perspective about the stock market is no different from a gambling casino. You need to clear yourself off this belief before you can become a successful stock trader.

gambling casino and stock marketImage Source

In my experience as a trader, I have met people with several different perspectives on the stock market. Some people think of it as a better place to invest and earn money in the long term. Some people are not even aware of it. Some people know there is one but don’t know much about it and do not even try to remember when they are given little information. These kind of people, lacking focus, waste a great deal of my time and I often avoid giving any information to them.

Intelligent People too Tend to have False Beliefs

There are other people who know more about the market but they have their own in built theories about them. These people are intelligent in their professions but can’t appreciate the variety and uniqueness of other professions. They go with their own assumptions without taking a step further to understand the reality. It was such a person when I met I had to dwell upon this theory.

The stock market is very different from a gambling casino. The simple fact, that gambling casinos are illegal in many countries but not the stock markets are, can tell a whole lot about their difference. The gambling is made illegal simply because this theory works at its root. You cannot make profit without somebody paying for it. You may have luck or whatever you say the reason for it, but that must be compensated by bad luck or whatever on someone else.

Stock Trading is No Closer to Gambling

Stock trading is not at all closer to this principle. No one needs to lose to make someone gain from the market. The beauty of stock market is that everyone can make money at the same time. The other way is also true. That is everyone can lose money at the same time as it happened last year, if you can remember the great falls (of blood) in Dalal Street ;).

When you plainly look at the simple way the market works it appears to be true that someone has to lose when some has to gain. For example, you bought a stock for a certain price at one time and sold that at a higher price for another person later. Now you made a profit. The other person whether makes a profit or loss is not immediately known because he/she has yet to sell the stock. But it is easy to see that we assume the market price of the stock to be your buy price and the other person’s buy price. So we conclude that this new entrant bought stock at a higher price than its true value, eventually bound to make a loss.

The Stock Market is Not a Simple Independent System

People also take a broader look at the market and validate this belief for themselves. For examples in gambling if someone wins someone else loses. On the overall no money is coming extra into the system, so this looks like a closed system and works well with the principle. When they look at the stock market as a system, they also see it in the same perspective. There is no money that is coming in from elsewhere which does not take it back. Hence this theory should apply well to stock market as well, right?

No. What they miss to see is that stock market is not just a simple closed system like a gambling casino. It is not independent of our society. But it is a highly complex system working in basic principles and completely dependent on the modern society, culture and lifestyle for its foundation, survival and till the end of current civilization.

The stock market movements closely correlate with the industrial development or progress of the companies that are listed on the exchanges. And the companies pump money into the system in the form of dividends at regular intervals without asking any return from the stock market. They do this till the company is delisted from the exchange. Till then the shareholders are partners of a company and not just gamblers.

The Money Flows Into and also Out of the System

The companies when getting listed at stock exchanges actually borrow money from potential investors for their expansion or any purpose related to further growth of the company. This is done through IPO (Initial Public Offer). This is where the company takes the money from shareholders. Or from the stock market if it were a simple independent system.

But every time the company announces dividends (atleast once in a year), the company pays as much as 10% on the borrowed capital. The company continues to pay this much of money till it is acquired by a different firm or goes bankrupt or gets delisted. In all these actions except bankruptcy, shareholders still stand to gain unimaginable profits because offers for these events are more than the market price at that time and even far beyond the price at which the stock is sold through IPO to investors.

The only time when the stock market gets worse to investors is when the modern civilization turns in reverse direction for whatever reason. This happens when the world’s countries fight for natural resources and natural resources get depleted enough. For any development in a society what is the extra thing that is needed is the availability of a resource. When that is there development of industries, agriculture and everything manifests. The workforce is a secondary thing but that is determined my human nature.

When the stock markets do mayhem, when companies go bankrupt, still this principle does not apply. Because this time every investor or trader holding the stock loses money. There is no one gaining when everyone is losing. Of course the company may be what you think but when it is bankrupt what does it stand to gain. You may think of even more losers who have lent money to the company in other ways but that is all outside of the stock market as a simple independent system.

Don’t worry about bankruptcies and all. Generally when they happen you will lose in someway even if you do not trade stocks. This is part of the risk that trading entails and you agree when you signup for your trading account. But because it is risk it also implies great rewards for traders with proper strategies. Except bankruptcy case all other events in the stock market hold gains for the shareholders who hold it till gain.

The True Beliefs You Should have About Stock Trading

There is nothing like someone must lose so that someone else can gain when it comes to stock trading. The true beliefs a stock trader should have are these:

Every one makes profits at the same time
Every one makes losses at the same time
But everyone stands to gain over a long period of time.

That is, the money comes into the system in the long term. The fundamental belief here is that our civilization continues to advance and it did so for many centuries in the past.

People who believe in this myth never enter the stock market. It works like a blockade for them. And who have already been trading, never be able to become successful trading making consistently right bets. Because this belief will continue to influence their decisions and learning.

This is high time you too should get over this. Learn the right belief as I mentioned. That will give a paradigm shift which enables you to gain when there is sunshine and cut losses when there is bloodbath.

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Friday, May 29, 2009

How You Should Use Diversification in Trading Stocks?

Diversification is not just about reducing risk as has been popular thought. As I explained earlier in The Myth of Diversion in Trading Stocks, it is not applied best by many traders. It in fact ruins them. Here I explore the right intent of diversification and also the right application.

stock trading: how to use diversificationImage Source

The generally known use of diversification of portfolio is across a spread of stocks. Many people diversify across a set of four to five stocks. Some traders do within their comfort limit and some beyond that limit. Some traders and even institutional investors alike go to the extent of diversifying across as many stocks as 30 to 70.

Many noted mutual funds from fund houses like HDFC Mutual Fund, ICICI Prudential, DSP Merril Lynch (now name changed to DSP BlackRock) Mutual funds etc., all diversify to show the kind of effort they put in managing those funds. I don’t see any special value in doing so. But I believe it is the rule of the fund house not to scale a position too high into a single stock.

There is no such thing limiting on an individual trader. You can have your own limits. Why don’t you explore the best strategies for diversification?

The Right Intent of Diversification

The intent of diversification is not just about safety or reducing the risk of a bet. It is also about making things certain. Apart from making the risk more certain it also makes the profit more certain. This can mean that you can adjust your success rate by adjusting your bets going in a particular direction with diversification.

You can think of diversification from several dimensions. When you look at diversification from time perspective which is not generally known to every trader, your awareness about your long term trading increases. Raising awareness in any endeavor is very important. That will help do well consistently and focus on what really matters in your journey towards success.

The general diversification of portfolio too can be helpful in certain situations. When you follow a certain strategy to select your next stock (or your next good bets), you are sure that it will do well most of the time than other stocks. This works well because you are consciously using a strategy to filter out stocks that have potential for a move. To increase the success rate further you can diversify here with the best two stocks or best three stocks from the top of the list.

As explained above, knowing the right intent of diversification helps you become a consistently successful trader. The long term success of a trader is determined by consistency of good bets.

The Right Application of Time Diversification

Raise your awareness beyond a single bet and think of the way how different trades in succession can reduce the risk. If you look at only one trade you know there is only one chance for success or failure. If you look at multiple consecutive trades, you can see that even if the first trade goes wrong there is a chance for the second trade. The second trade or third trade and so on. The successive trade can either compensate the loss or the gain as well.

But the important thing to note here is that the time diversification also works for the same reason as the stock diversification. You may be thinking that if the first bet is loss then the next bet even if goes right, it may not fully compensate the first loss. Here it does look little different than a fixed weight diversification across stocks. But when you fix your allocation of capital for successive time periods then it will be the same thing as the other case. If your time horizon is for five successive trades, then allocate a capital as much as 70% of your portfolio for fixed capital trading on successive bets.

The advantage of this time diversification comes from the fact that it matches with the way the market behaves and also your trades rule based. When the market moves in one direction it continues to move in that successively for certain period of time. This successive nature will glue well with this technique.

When you can find trading entries based on a particular strategy and if the first one goes well, you will continue with the next. If the trend of the stock is intact, then the successive bets will go in your favor. Even if the last bet were to fail you will still have more profits than with the other diversification because you are allocating more than 50% of your capital on each of these successive bets.

Though it takes courage to allocate such an amount of capital, raising your awareness beyond the first bet and thinking of this time diversification technique will give that courage.

The other advantage of this type is that you can control the losses in a losing streak. As often the market continues its spiral of movement until it breaks the spiral after a certain point, it becomes clear. when one of your successive bets changes direction to make a loss. that the trend is changing. Here the important thing is to be willing to sacrifice the next bet as well to confirm the change in trend. You should be cautious after first failure. But you will be certain of the change in trend after another successive failure. This is because the trend’s change is not confirmed unless it happens in atleast two successive events.

From your first failed bet you can be cautious and reduce the capital for the next bet which is for test purpose only. If the trend change is confirmed you will reverse your strategy to go short if you were going long earlier. Otherwise you will continue with the trend.

If it happens that the market appears to play games with you by making fail-pass-fail-pass pattern, you should take the lesson that market went into a swing mode. Generally this is the classic case of range trading. This time you should change your trading strategy to suit this type of market. Here you should also increase your awareness beyond the successive bets into market trends and cycles.

The Right Application of Stock Diversification

This is how I apply this concept to my trading. I often follow a strategy to select stocks based on certain criteria. This is generally after checking the market statistics where stocks making new highs, new lows, top gainers, top losers, concurrent gainers or losers etc. are listed in order.

I may select any type of strategy I know well at any point of time. But when betting, I pick up more than one stock from the same criteria. If I pickup a stock which I feel will go up, then I can pickup another one that will do the same but with lesser chance. So I bet on both at the same time.

This will increase the chances of atleast one bet going right. As I use stop-loss the other one, if goes wrong, will be limited in loss. This of course also works to reduce the chances of atleast one bet going right. So I will now have a lesser profit than what I would have had if I had bet whole amount on a single stock. But the certainty of the bet going right is increased.

I also find this more successful because the choice of both the stocks is not random. Both are selected from the same criteria. The failure probability can be only because of any unexpected events implying very less failure rate. But the chance of atleast one going right is almost certain as they are picked only for that reason. And this coupled with a stop-loss is what makes it a wonderful strategy to consistently play with!

This had worked very well with my trading and it is one of my powerful and simple strategies. But I too forgot this sometimes. By noting down in the checklist this will not be a problem.

Start Applying in Your Trading…

I believe it will help you as well to apply diversification in your trading from these new dimensions. So don’t go about myths even when experts speak out. Analyze, understand and apply diversification in the right sense.

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Wednesday, May 27, 2009

The Myth of Diversification in Trading Stocks

For a long time a theory has been taught for reducing the risk in investing or trading stocks. But this theory is taught only in one dimension when it could be applied in several dimensions. Everyone takes diversification in its literal sense and does not go beyond its obvious meaning. Come with me on my journey to explore diversification in its true dimensions, meaning and implication.

diversification myth in stock tradingImage Source

The Diversification Theory in its Popular Sense

Diversification of your portfolio certainly reduces the risk. But let me tell you it also reduces the profit potential of your portfolio. You are into the stock market to make money at a faster potential than any other way. When you reduce this potential for the fear of risk then what is the point of taking risk at all. Remember when there is no risk there is no great reward.

This is where many traders fail to understand the implication of diversified portfolio. They only learn about reducing the risk but not about the reduced profit potential. They do not even take a step to think that the risk does not always mean you will lose.

When you bet on a risky stock two things can happen. You will either lose some money or gain some money. Depending on that risk or reward is decided. Stock traders, who diversify their portfolio, look at the risk aspect only and they are certain of making a loss only. What if you gained instead of a loss. That will even work like a cushion for the next bet.

This is Diversification for the First, Last and Single Bets

Raise your understanding beyond single bets. You are in the market to trade again and again, bet after bet till you reach your financial goals. It is not about one run. It is only through consistent trades that you will reach your ultimate goals. You cannot think of making your first bet the best bet and go away after that. That just is not going to happen atleast in the stock market for its variegated trends occurring at different periods of time.

Certainty of Risk with Diversification

One thing these traders miss to understand is the importance of risk certainty. It actually boils down to probability and I found stock market to be a wonderful place to apply all probability theories. When you bet on a single stock at any time your probability of making a loss is not certainly ‘1’ but when the loss is made it is a certain amount.

When you diversify to bet on multiple stocks, the probability of all stocks going broke at the same time is certainly reduced but the probability of atleast one bet going broke is greatly increased! How does this sound?

Did you notice that it is almost always common to see that some of your stocks do best and go green while some do badly and go red? Well, it happened to me all of the time I had diversified. Sometimes I had to close those failed bets at a loss that is half or even 90% of the bet amount. If I had bet on a single stock I would never let more than a 10% loss for short term trades.

By diversifying it is easy to lose this percentage picture at the stock level. When you almost certainly lose such a big amount on the part of your total amount, how is it safer than my type of bet where I may or may not lose 10% on total amount on a single bet?

Probability Plays Well with Diversification

This certainty of the loss increases with diversification because you are increasing the number of samples for a random event. Of course the certainty of a bet giving profit also increases but then again it is a lot less on the whole capital that is diversified on several stocks. Think of it this way. The statistics are calculated based on set of data which is extracted from certain number of samples. What every statistician knows to improve the accuracy of this data is to increase the number of samples. At some point the saturation limit is reached and the percentage of failed samples beyond this is always fixed.

If you take too less samples you will not get the right number of samples that can fail. This is because this sample number is close to 1. That makes it uncertain and random. The randomness is high with one sample. There is no randomness with large number or enough number of samples. That is when we calculate statistics and probability of certain results.

Not only is the loss a certain thing now but due to a lack of education on how to handle these losing bets, it manifests into reality. This violates the original intent of diversification in the first place. If you couldn’t plan to bet with a fixed loss limit but on a single stock, the diversification too will give a loss as much or more than the initial loss limit but with certainty. In other words you try to remove the random nature of the market to be safe. Think of a bad day like in October 2008, all bets going wrong at the same time with randomness.

But the market is no good without randomness. Unless your period of time is concentrated inside a bull market only, you cannot expect to gain anything, without randomness, better than fixed income investments. When you can alter your time period of trading, it means that there is another dimension to this randomness and diversification as well.

The Time Dimension of Diversification

It is the time dimension that also holds randomness for the stock market. That is, your bet is random not only because of the stock selected but also because of the time when the stock is selected.

Is it not very specific now as to where the uncertainty is coming from? By breaking the random nature of a bet on a stock into the selection of stock and timing, it becomes much easier to understand many implications that very few traders know about the stock market.

At any time your bet can go wrong because of the choice of the stock. If you don’t believe this then check the market statistics which list losers and gainers separately for the day, week or a particular time period. At any time there will be some stocks making a loss and some making a profit.

There will also be stocks that make profit in one period and make losses in another period of time and vice versa. This results in a bet going wrong due to the choice of timing. Note that nobody forces you to trade now. You have the choice to decide the entry time into a stock and also exit.

In other words stock trading is like a stochastic process. The random variable x is also random in time.

Diversifying in Time with the Same Stock

Thus there is another way to look at diversification, instead of in the stocks it is in the time. Whey you look at your bets, look at the time you bet. Think of the multiple bets you make one after another. Now the sample number is increased. That means the random nature gets reduced and also the risk. As per probability if you were to gain a certain number of trades and lose certain number of trades, then you know the risk, right?

This is not the risk but the loss you are certainly going to make after a certain number of bets. But this gets compensated with bets going right. So you can check your odds by changing the order in which good and bad bets happen. But remember, you always have the choice to quit the stock after two consecutive bad bets. So you have the choice to even alter this reality in time dimension!

The Power of Compounding Gets Undermined with Diversification

If you choose the right time and the right stock that means you will consistently make profits and the profits keep compounding. Otherwise there is no point in investing in the stock market. Compounding is its special feature. Those who bet for the first trade only, often miss to understand the power of compounding and even go to the extent of taking loans.

Compounding is a multiplier effect on gains. Every gain will get compounded with the consistent profits that you make provided you bet all of your capital each time. The compounding makes it faster to earn the money that will take a longer time otherwise with fixed income investments.

Even with a little change in the interest rate or profit rate per bet, your net gains after a period of time increases drastically. A 10% profit rate gives you a gain of 159% on your initial capital after 10 successful trades. After the same number of trades, a 20% profit rate gives you a gain of 519% on total capital!

The Last Problem with Stock Diversification

The right term to use for diversification in today’s reality is stock diversification. Because diversification is done only on stock domain by splitting capital into several different stocks. There is a simple problem with diversification that is on the part of the trader than the stock behavior.

When you diversify your portfolio on several stocks, there is now an increased need to focus more. If you were trading only one stock, then you would have to focus only on its behavior or background company. With too many stocks it becomes hard to focus as much as you would have done with only one stock. You may think it is not really hard. But think again and check your past behavior with diversification.

In my trading experience I had always found that I had to close my losing bets till the loss has become unbearable but still take all the loss just to stop watching the blood-shed stock in my portfolio. It also happens that a badly failed stock does not recover as fast as other stocks gain and that in turn wastes the time of investment of your capital.

The focus means to be able to do all the important activities that make the trade successful. They can be alertness during the time period into trading, right decision making with discrimination, looking at percentage numbers at the stock level and total capital level, sticking to the original reason for entry into a stock etc.

Check for yourself. If you see these problems then you should change your understanding and strategies. Don’t diversify just like that. There is a way to use diversification in its right intent that I will explore in the next post.

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Monday, May 25, 2009

Why You Should Keep a Journal to Track Your Trades?

Whether you are an employee of a corporation, self-employed, stock trader or a business owner the simple process of keeping a journal for your activities can work wonders towards your success. This is recommended by success experts and organizations as well. In my observation I hardly find any trader who keeps a daily record of their trades other than me. But several authors of best books I had read, have done this.

trading journal helps stock trading successImage Source

If you want to trade consistently and successfully, the one thing that you must compulsorily do is keeping a journal to write down all your trades. This in itself is a time consuming activity. But it pays off in the long term. Many traders like to call themselves long term investors but they miss to see things that are helpful in the long term.

It Helps You to Learn to Trade Well by Yourself

You should write a journal for all your stock trades if you want to learn by yourself in this ever changing stock market. You cannot easily find many people willing to teach stock trading courses whether it is over the internet or offline. The most important secret to success in stock trading is to learn by yourself and not just by listening to others.

When I say learn all by yourself I mean that you should be convinced about the ideas you have. You should build right beliefs for strong foundations. Even if you listen to others ideas you should be able to discriminate between what is right for you and also be able to analyze its effects from your perspective. Because at the end of the day you are the driver in your vehicle.

A trading record goes a long way to help build a successful system of trading that results in consistently right trades. Trading well consistently in the stock market is very important to progress. If your odds are always against you or even for half the time, then you cannot even expect to survive your capital. That will depreciate sooner than you thought.

The Importance of Your Trading Journal

Only by trading right consistently or in other words the right bets coming one after another, you can accumulate positive momentum for your portfolio instead of a negative momentum. If this is not the case, then the costs associated with several services will slowly accumulate and depreciate your capital soon. This is not a zero system where what one loses another gains. But quite a different one. For the context it is a negative system meaning for every move in the market a fixed amount of money is taken out from the system.

If you rely on just your brain to do the task of tracking your trades, you will not be different from the ordinary traders. You will definitely learn some mistakes but there can be hidden patterns between trades that you might not see directly. When you note down your trades in a trading journal, you will also note down the reasons for entry and exit for that trade along with other information.

This information will soon be forgotten if not written down. When you forget the reason for entry on a successful trade and a failed trade, you will continue to repeat atleast one mistake out of all that you ever did. By writing it down you will have a complete picture of the journal in your mind along with its hidden lessons. This helps you to be always conscious of a powerful system of learning and application.

Uses of Your Trading Journal

No matter what kind of profession you take, keeping record of your activities will do more help than any other kind of activity. Writing a journal lets you look at yourself in a mirror. You may be looking at your physical body regularly in a mirror. But to look at the reflection of your activities and your hidden identity behind them, a trading journal will take you a long way.

When you look at it periodically, it will reveal things that cannot be easily detected on the outset. It lets you know what are the unimportant things, where you can focus your energy more, what are the mistakes you are committing repeatedly and also if you are making enough profits out of each trade on the total capital.

Many mistakes are committed in trading stocks again and again simply because of a subconscious behavior of a trader. If you continue mistakes without control then they become your foundational skills, habits that will work automatically whenever you repeat the same action. That means you will no longer have the next good bets even if you are trading the best stocks at any time. Unless it is a blind powerful bull market of all time like the one in 2007, this applies all of the time.

Knowing the importance of a trading journal is the first step to becoming a successful stock trader. I learned the importance of it when I started trading stocks and went into a losing streak. I wanted to know what is going on and why I was doing the seemingly similar mistakes again. When I started new month and new financial year after a streak of losses, I not only started with new learnings but also started with a new journal.

I recorded all of the trades in 2007 except 2 or 3 insignificant trades of less value that happened by mistake or accident. That is what made me become a better trader with each trade. The lessons I learnt are still in my belief system but I only need to take a look at it periodically to be consciously aware of them.

There are Perils to Not Doing This..

There are negative consequences in not doing this activity. I did not record a single trade till now in all of 2008. I knew something was going wrong but I did not update my journal due to negligence on my part. I knew I could make a little time out of my busy life but I just did not.

As I look back why my trading went wrong when I started well in the beginning of the year, I see that it did not go worse overnight. It changed gradually with each trade. It was like unlearning the past lessons until I stopped trading. I stopped this vicious circle or downward spiral to calmly take a look at the whole picture before starting next time.

What Should You Note in A Trading Record?

When writing your trading journal, treat it as the most important activitiy and do not miss to fill it on any day. If you miss, make a commitment to fill it by the next day or within the same week. It is important to fill it as soon as possible because you will tend to forget certain things associated with the trade. You should not only note the obvious things like entry price, quantity, exit price, stock quote but you should also note down other details.

You should note the entry and exit dates and the difference between them showing how many days/hours you were in the trade to see the time potential of the trade.

You should also note the profit, profit after cutting trading costs, and percentage profit. This gives you an idea of the minimum limit for profits. If your profit value is negative then it is a loss. It is better to have a separate entry for that so that when you count the total profits or losses you can total them individually. That will let you know whether you are consistently right, average trader or trading on the edge being close to going broke!

You can add many other things but the most important are the reasons for your decision to enter and exit the stock. Add any new learning you made from this trade.

You can maintain a note book specifically bought for this purpose or a spreadsheet document. It is easy to keep a clean spreadsheet as you can add more columns later on and also easy to edit it in the same sheet.

In my initial search for improving my trading I found many experts suggesting the trading record as the single most important activity. It was easy to ignore at first. Many successful traders as well confirmed that they did keep a trading journal. Because it is hard to find the best lessons in stock trading it is very important to keep our own records. You can keep it as secret so that you will not hesitate to write down all you need to note.

Start Today as a New Habit!

If you are not already doing this, I highly recommend starting it from today. Every lesson in stock trading is a costlier one and the best lessons are learned from losing trades. Don’t pay again and again for the same lessons. You may go broke before you realize what you missed!

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Saturday, May 23, 2009

Can You Have The Time of Your Life for Trading Stocks?

I have never met a trader or investor who analyzed a trader’s time the same way I did. The daily stock market transactions go normally without anybody wondering about the minute details. Well, actually there are a lot of things about the stock market vs. stock trader that many people have never even thought about. Over time with my trading experience at Indiabulls – my first stock broker, I had to finally delve deep into the details of a trader’s time in the stock market.

the tunnel time of your life for trading stocksImage Source

Although I did this analysis long before by the time I had hibernated from trading stocks, I did not get the will to blog it until now. I have been following a blog of Steve Pavlina, the most successful online entrepreneur, for the last few months. There are a lot of things to learn from his blog. He had recommended listening to audio books along with reading text books so that you can utilize certain time spent on simple tasks. This is what prompted me to look for audio books on Personal Development.

In my quest for some audio books, I ended up finding many new names in the field of personal development that I had never known before. Have you ever heard about Anthony Robbins? Or better Tony Robbins? I never did. Atleast I can’t remember. I found many audio books basically created from his seminars. It is surprising to discover this new success speaker only recently while he was there active since 30 years. So I looked for what could be there over Youtube: The Time of Your Life. This title had captivated me at first. I haven’t gone through this seminar yet. But his other one on personal training was simply powerful in motivating.

The Time in a Trader’s Life

When you look deeply into the time of a trader’s life, it feels very discouraging. For the kind of returns that can be expected with successful, consistent trading, any trader trading his entire life should be expected to become richer beyond imagination. The richness is only limited by his ability to move faster with the growing number of digits along with the finite limits of everyday trading that become too tight with larger capital. If not that, atleast we can expect good times with consistent trading profession.

Well, that may be true. But if we look deeper into the realities of time distribution in a trader’s journey, things don’t look the same anymore.

Let us consider that an average person works for 40 years of his/her life from 20 years of age to 60 years before retiring. If a professional stock trader were to do the same that means he/she gets to trade for 40 years.

In any corporate environment, the standard timings for work describe 8 hours of work days with 5 work days in a week. That means we have 8*5=40 hours of work time in a week. In a year, we have 52 weeks. So we get 40*52=2080 work hours. That is of course 1/3rd of the absolute time of a year.

The average employee works for 40 years, implying 20*2080=41600 work hours in his/her entire life. Let us consider this time as work time that earns his/her mainstream income. Of course there are holidays in between. But for the most part, over work in a corporate environment, or 6 day work weeks in a factory environment more than compensate it. That is they work for more than what they get or planned to.

Now the interesting things will be uncovered when we do the same for a stock trader. The stock trader’s life is never easy. Considering my earlier analysis (What is the Time to Trade in a Typical Trading Day?), the actual trading time that a trader gets out of a typical trading day is 4 hours. This is just half the time of any other average worker’s day. If we were to consider other issues like slow moving markets, fast moving markets, etc., then this time will be much smaller.

In a week there are only 4 trading days because one of the days goes away as a holiday. A holiday in the stock market cannot be filled with another day. The only consequence is effective movement of the stock prices on the next trading day. 4 trading days = 4*4 =16 trading hours in a week.

In a year there are 52 weeks. That means 16*52 = 832 trading hours in a given year. Compare this 832 with 2080 of a corporate employee. This is hardly anything. It is only 13% of the absolute time of a year. Effectively 3 hours per day. This can be consolation to anyone who say they don’t have the time to trade. Let me tell you, nobody has the full time to trade. Even if they have their time, the market doesn’t give them as much time they want!

Did You Think 40 Years is Full?

In a trader’s life, the 40 years are not completely active years of trading. There will be cycles of bull markets and bear markets. There will be dull periods. Sometimes the markets just don’t have the minimum amount of trading activity to make it profitable.

Professional stock traders who trade on the edge may trade all years of their life. But if we consider these intermediate periods that affect the mood, discipline of the trader, we can say that some amount of time goes for no activity for prolonged periods. They can range from weeks or months to years.

That means there is not really much time in a trader’ life to trade stocks. Neither in a typical day, nor in the day-to-day week, Nor in the years and decades. An effective trader waits for all the time and makes all his/her bucks in a single powerful bull market. That is enough of trading for a life time!

Believe me the Pareto Principle doesn’t work better anywhere else. In fact I learned the importance of Pareto Principle only after I started trading stocks.

What is very surprising revelation is that the time of a trader’s life cannot be taken for granted. Its value is not the same at all the times. You can think you will trade for all of your life. But actually you won’t. At the end of the day, the actual trading time can come out to be even 1% of your life time.

You Simply Cannot Afford to Miss Your Trading Time..

In a week’s time of 84 hours, there are only 16 active hours for trading stocks. You can have the time to eat, time to shop, time to sleep, time to waste and so on through all of your life. But you will not have enough time to do the actual act of trading. You really cannot afford to miss any time.

On the other hand the markets actually don’t need all the time to make their moves. Their speed is only limited by the matching of orders. That is essentially by the emotional behavior of the trading crowds. Another limiting factor is the speed of processors that execute and match the orders. Stocks can move in an hour the same amount of change that they have done for years in the past.

You will understand what I am saying if you have watched the markets on January 22 2008. You thought it right. Similar thing happened on the Indian Stock Exchanges the day before yesterday (18 May 2009). The markets got locked at a whopping 20% circuit limit in just a few hours. The stock charts showed staircase patterns with three stairs. Several finance professionals got amazed at this phenomenon of a life time. That, my friend, still says that the longer term down trend is still intact. And this is an incredibly crazy, powerful countertrend!

You have to do all you want to do within that tiny amount of time. If you play foul and spend time correcting them with more trades, you will never get the time again easily. Note that all this time is spread out over years, decades and cycles of bull and bear markets. You will not even have the right time to regret if you miss some cycle. So let me repeat again. You simply cannot afford to miss your trading time.

Hence planning is the best thing to do for facing this reality of trading time. You cannot have the time of your life for trading. But you can have few years of time that is well planned ahead. If the right cycle comes and falls in your time, then even 5 years of it is more than enough for a LIFE TIME!

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Thursday, May 21, 2009

The White Monday, May 18 2009 in History: Bears Got Squeezed by the Bulls

What happened on the day of May 18 2009 in the Indian stock exchanges will be recorded in the pages of history as the most significant and unique day of trading. In fact very less people traded on that day. What must have caused that great event is only the short-squeezing of bears by the bulls. The great game of the stock market is nothing but the battle between bulls and bears.

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The Bull-Bear Fights

You must have heard about bears inflicting pain on the bulls. Or the bloodbath in the markets. They refer to the fact that bears are causing injuries to bulls because bears got strong and bulls became weak. The bear bites the bull with is nails and from there comes out the blood. When too many bulls get injured at the same time, there will be blood flowing all over the street. That is when you will hears the phrases – “There was blood on the Wall Street”, “There was bloodbath today on Dalal Street”.

Similarly to this bulls also sometimes inflict pain on the bears. Generally bears do not come in the way of bulls as the stock market’s general strategy is going long. What bulls do to bears is that they squeeze the bears. This is more deadlier than the bloodbath for the bulls. These two kinds of effects are opposite and happen in different types of trends.

Getting Squeezed: The Short Sellers Bloodbath

It was amazing to see that for the first time in history stock indices themselves skyrocketed on a single day to gain by 20%. In history this kind of limit is reached only on the downsides. The Great Depression 1.0 of 1930s had many such great crash days. But never was there a day when markets shot up by 20% and trading got halted at the upper limit.

The circuit limits are introduced intentionally for the downtrend as that is what causes pain for the most market participants. The upper limit is generally thought to be only for the good. But the truth of the matter is not so. Such massive moves in a short period of time do not happen because the good will of the people. Only those who run away try to do so quickly. But this time it was the turn of the short sellers who had to close their positions quickly because the reality turned around their expectations.

The election results were not only surprise to the Congress Party which has won. But also to the many market participants who went short massively after a long pause of the present bear market. The stair case price behavior of stock charts and even indices indicates massive shorters on the line. And they simply got squeezed by the over-enthusiastic bulls beyond imagination as the weekend gap played its traditional role in the opposite direction.

This is what Investopedia says about Short Squeeze:
What Does Short Squeeze Mean?
A situation in which a lack of supply and an excess demand for a traded stock forces the price upward.”

“If a stock starts to rise rapidly, the trend may continue to escalate because the short sellers will likely want out. For example, say a stock rises 15% in one day, those with short positions may be forced to liquidate and cover their position by purchasing the stock. If enough short sellers buy back the stock, the price is pushed even higher.”

If you get trapped in a short squeeze you will understand how it feels. You just can’t breathe. Even death cannot save you because the losses that come from short squeeze have no limits. And they can go beyond your initial capital you would have never thought about.

Generally short selling is considered to be the most risky kind of trading. But it is also the most profitable in a very short period of time if things go right. The perils of short trading lie with the bear squeezing. The stop losses too can’t help much. In the opposite trend, stop loss can help. But when stocks go up due to profit taking, loss booking by the short sellers or bulls squeezing bears, stocks can sky rocket in a matter of moments without notice.

But I felt happy about this though I didn’t gain anything from it due to lack of participation. A 20% gain that too on the indices which move slowly is the gain of a year. If you captured it on that day, then you can rest for the rest of the year!

It Spells Caution!

The most important thing to note from this event is that it goes to only show the powerful nature of the long term down trend we have. Even history has shown that such strong rallies happen only during longest and strongest bear markets. One example is the bear market rally of the 1933s on the Wall Street. The Dow Jones Industrial Average rose by 15.3% on March 15 1933. Nasdaq rising by 14.2% on January 3 2001. The recent one being Nekkei of Japan rising 14.1% on October 14 2008. October and September 2008 were the two months when the stock markets all over the world had their worst falls in history.

A White Monday in the History of Indian Stock Markets

Shall we call that day (May 18 2009) a “White Monday”? We should rightly call it so based on what SEBI says about the balance short selling creates during downturns.

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Monday, May 18, 2009

What is the Time to Trade in a Typical Trading Day?

A day in the life of a professional stock trader is never easy. Apart from the daily preparation that has to be done as part of the trading practice, the inefficient trading time creates lot of lost opportunities, confusion and kills the trader’s appetite to trade in the bear markets. Unlike other professionals who get a solid 8 hour work day, traders never get even half of that. The various events and broker inefficiencies only add to the woes.

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The actual market times for trading on the Bombay Stock Exchange and National Stock Exchange today are from 9:55 am to 4:00pm. This is the official timing during which the exchanges operate. It means there is a total trading time of 6 hours and 5 minutes in any given trading day. But the reality from a trader’s perspective is quite different. Though the market timing is 6 hours, there are certain classical problems that eat away part of this chunk of time.

The Intense Battle at the Market Opening

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The market opening time at 9:55am is never really for an average trader. The stocks suddenly move in a vertically steep path up or down early at the opening. This should scare the hell out of anyone wanting to trade stocks. During this time, if you check the quote, place an order and then check the quote again, you will see that the price has already changed by 5%! This happens for 15 minutes to even 30 minutes in the morning.

The first 5 minutes is actually a very intense battle between big bulls and big bears. That is between who have buy orders with huge money and those who have sell orders with huge money. I don’t know if these bigger traders actually get a special brokerage account that gives extra privileges to trade the market at the edge than an ordinary stock trader like me.

Early in the morning even before opening, there will be lot of orders from several traders who have placed orders offline the night before or just before the opening of the market. It is like opening a gate, which has on its both sides huge crowd wanting to pass to the other side through the gate. And these orders will be executed only when they match the opposite orders. It is hard to understand how this really works. But we can get a partial sense of it when we think that the more orders that match in a direction, the more quickly the stock moves in that direction.

But even after 5 minutes, the orders don’t just get finished. It is like a rush in the morning. You don’t know if you are going to get caught in a stampede. And moreover, the brokerage services for average traders are horrible during this time. If you place an order, you cannot even know if it is confirmed. I had few occasions of such experience. One time I gave another order thinking the earlier one must have met with an error. After few minutes both orders got executed. That is playing the double edged sword.

The problem here is that you cannot trade without losing the price gap advantage between buy and sell prices.

Another Intense Battle at the Market Close

The similar thing happens near the close. That is the reason why you see intense market activity just 15 minutes before the market close. Actually market suspends trading activity by 3:30pm. The rest of 30 minutes till 4pm is only for the exchanges. Before 3:30pm, the brokers play the game. From 3pm to 3:30pm, they start closing all intraday positions of their clients even without their consent. This is not really a big problem unless you want to trade the last minute fast action. But effectively this half-hour too is lost.

The Realities of the Lunch Hour

And then there is the lunch gap in between. Can you trade stocks from 10am to 4pm without feeding yourself? It is classical problem but nobody really notices it, not the retail investor for sure. I got to know this when I did my first intraday trading at home. I was trading at the edge from the morning. The mistake was that I was trading only one stock. It was my first attempt at intraday trading, so it was okay at that time.

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The stock first moved, in the morning, up and down. It had cut me first and made overall profits on the turn around. But I indulged again too soon after that. It didn’t move in my favor for a long time. Then came the lunch time. I had to be careful not to take my eye off the realtime chart of that stock. As I was at home, I made it easily within 20 minutes. But that also lead me to learn a new thing.

If you had not noticed for a long time, the markets get dull from 11am till 2pm after intense activity till 11am from opening and before intense activity from 2pm till the close. This could have been simply due to the lunch gap. Remember nobody can trade a stock without the counterparty also trading at the same time. For intense activity to take place all participants must be present at that time. There is a big chunk of traders taking break after 11am. Of course not all take the same timing. Hence the distribution is not very uniform during that time but still lesser than the early morning hours.

Any intense activity you can expect now is only on specific counters. This time is really good for the average professional stock trader. The big guys can only trade at the entry and the exit without losing money. But for an average trader all times are good except the first half and last half hours.

What Time is Left for the Trader?

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For any trader, we can take it for granted that half-an-hour goes for lunch time. Now with this we can see that three half-hours are lost in a typical trading day. That means of the 5.5 hours of active market time, there is only 4 (=5.5 – 3*1.5) hours for which a trader must work like a professional. This is way too lower than an average corporate employee’s work time.

And there are other realities that many people do not see directly. The retail investors or traders hardly close a position on the same day. So they place an order which has the chance of getting executed till the close. But a professional trader increases the chances of his/her orders getting executed in a lot lesser time, and even for more number of orders.

Some times stocks do not move at all for hours altogether. And when they do move they move pretty fast. Anyone analyzing these moves later will find it very discouraging. What if you watched the move for a long time and took a small break in between when the stock broke in either direction? There are very high chances of this happening because it is not random when we are going to choose a break.

We take a break after getting tired for a long time, and the stock breaks out after oscillating in a small price band for a long time. The chances of them coinciding are very high.

Now given that the actual movement of the stock happens within a relatively short period of time, the total 4 hours of trading time in a day are not really appropriate. It actually depends on the number of trades and the skill of the trader to find more and more trading opportunities all through the trading day.

Is There Enough Time to Trade in a Day?

is there enough time to trade in a day?Image Source

This kind of breakup of a trading day is very discouraging atleast for the novice traders and retail, small-scale investors. This takes away their confidence of their orders getting executed. You simply cannot figure out when is the right time to place an order for a particular price. Especially if you are into some kind of strategy than just gambling your way with luck, this particularly holds true as you trade with some rules. Those rules will constrain you more if you bring the time into picture. If you still didn’t get it, it is the stop loss rule.

The best way to handle these kind of problems is to avoid trading stocks! The timing is a really big problem especially during bear markets like the current powerful all-time bear market of 2008-????. In a bull market like the current one (counter trend in bear market), or in a powerful bull market of the 2004-2007s, any order placed at any time will have more chances of returning a favor without being stopped out.

Hence it is good to restrict trading against the trends and go with the trend. If that is not possible stop trading. There are still many better things to do in life. And you don’t need all the time of your life to trade to make big money. I can say that, if you are prepared and experienced, 5 years of powerful bull market is enough for a life time. We had just passed that in 2008 January!

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Tuesday, May 12, 2009

Do Stock Trading Workshops or Seminars Help?

It may sound new to many people who live their professions on different fields other than stock trading. Like any other discipline, we can have workshops on improving our skills in stock trading as well. Workshops or training seminars on stock trading are conducted by professional stock traders with decades of trading experience or by those professional traders who do extreme trading. It all boils down to one thing: Workshops are worth the money!

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Whether it is about stock trading, investing or about any other aspect of your life or career, workshops can do wonders in a very short period of time. They can bring some changes in your perceptions, improve skill in a particular activity, help you start new habits quickly, convince you with fundamentals, instill courage and confidence, give you new paradigm shifts and many other benefits.

Take any type of workshop or course. They will teach you those things that you would take considerable time to learn on your own. They will even teach skills and not just knowledge on topics. This is the reason why they work quickly, though costly and accommodate very few people at a time.

My First Contact with Stock Markets

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My first contact with the stock exchange happened when I just attended a weekend education or relief program organized by a separate team from my company. Every weekend they invite somebody to present on some thing. More than two years back it happened to be a highly inspiring presentation in investing, personal risk management and wealth building by Anand Agarwal from Hyderabad.

He presented well researched and organized information that was very new to me at that time. At the same time it was easy to understand. He also has shown examples to illustrate his points. That is when he mentioned the phenomenal growth of stocks like Infosys in a short period of only few years. That was the most captivating thing about stocks in that whole session. Later he gave lot of data and inferences that grabbed the attention of lot of audience to the new world of stock markets in a finance world.

As he never shared that presentation with anyone, I had attended another session by him after few months. This time I learned even more.

Appreciate the Importance of a Training session

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The best part of workshops or private courses is that they give you a complete coverage on specific topic they are going to cover. For example it can be on “Selling Shares at the Right Time” if it is about stock investing. Or to be more generic, it can be “Personal Effectiveness”, in the self-help series.

I had attended a two-day session on “Assertiveness Skills” three months back sponsored by my company. Although these types of courses are not new, as we had a lot of such sessions during initial training period of the job, this time I appreciated the importance of these type of trainings. Of course it was costlier. I wouldn’t have chosen it at my cost. It was a wonderful experience with so many things learned, new paradigms created and old ones shifted. The two day training was fully packed. It was worth the money. The great thing was that it came about at the same time that I felt needed it.

Same applies to workshops on stock trading as well. The money does not go waste. But we need to attend only if we are most interested in it, at this point of time. We should have already known something about that topic. We should be well prepared to actively participate and learn all that is taught.

A Training Seminar is Worth the Money

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At the end of the training they also give us various other offers like training manuals, books or any free subscription to their newsletters. They will not leave you with only a few days of lectures or practice sessions. They will look for your feedback, always be looking to help in the future and also invite or refer for further courses. They may also provide something that can work like a companion guide after the training.

Having all these things, after powerful paradigm shifts when you attend some workshops with full focus, can really change your trading for better. I personally never got a chance to attend any such workshops or courses. But I would be willing to take even at my personal cost. I think there can be many out there once we explore within the community of stock traders.

Go for It If You Want to be on The Fast Track

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The non-obvious benefit of a special course or training session is that they help you grow your knowledge and skill pretty fast in your chosen field. You can, of course, learn things on your own and practice to acquire better skills. But if somebody has already traversed that path, applied the lessons learnt and now teaching them for others, then we should go for it. If you want to be on the fast track then this must be seriously considered.

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We should always look for the quality of these trainings. Do not just go for it because it attracted you or fancied you. Do not go for it because of its cost making it feel authoritative. If you know your field, you can make out from one page of their brochure/pamphlet.

Personally I would just go for any trading course from professional stock traders like Jeff Cooper and Tony Oz. The costs can be anywhere like $500 to $1000 but it is worth the money and you will not regret!

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