Next Good Bets: stock markets

Showing posts with label stock markets. Show all posts

Saturday, June 20, 2009

Learn to Take Lessons from Your Losing Trades

take lessons from every trade for consistency

What makes the difference between an experienced trader and a novice trader? Is experience just about passing time with one stock trade after another? Or is there something smart that a trader should do before he/she can be considered an experienced trader? Well, the answer to all of these questions lies with the ability of the stock trader to take lessons from his/her losing trades.

Many stock traders trade stocks just by the urge. They are not disciplined in their trading. Their plans of trading transactions are not organized. The moment is enough to catch their instinct and execute a trade. Well, not all traders are like this. But there are certainly different levels of traders who are smart in their trading.

How to Determine if Someone is an Experienced Trader?

The different levels of trading expertise come from two different aspects. One is the amount of time a trader has spent trading in his/her life. The other is the qualitative lessons that the trader has taken from his/her losing trades. To truly call yourself an experienced trader it is not just time that is important but also the lessons that you learned from each trade and applied for future trades.

Never let your trades just go away in the sands of time. There is always a lesson to learn either new or the same old lesson but with a different perspective from every trade that you execute throughout your life as a stock trader.

The successful stock traders are made by their consistency of making right bets. And this is possible not with inherent skills or something but with the persistent will of take lessons from seemingly simple things and applying them to avoid catastrophes in the future.

You Did the Same Mistake Again, Right?

How many times can you remember doing the same mistake that you did in your first trades? For my case, I had spent my initial months of trading just without any plan or discipline. But at the same time I was looking for information from expert traders that must have left some information on the internet. Though nobody gave the exact information that I was looking for, everybody spoke about the importance of a plan for your trading. Without a plan you can be sure to leave all your money in the markets at some time.

It is not just an organized planning that makes best trades but it is the lessons learned from old trades that lets you trade right consistently. Remember consistency is the key to long term success in your trading. If you cannot even try to improve consistency then you should better close your trading accounts right now.

How to Learn Lessons from Your Stock Trading?

The best way to learn lessons from your trades is to note them down in your trading journal. Earlier I have written about this in Why You Should Keep a Trading Journal to Track Your Trades? There is enough info. to learn the importance of it. The most important and direct advantage you gain from this is the ability to learn lessons by yourself without help from anybody else. You can truly shape yourself as an expert stock trader whose bets hardly go wrong by taking note of every trade on your journey in the stock market.

When you are noting down your trades, you should make sure that it is easy to recover the information related to the reason for entry, price, profit/loss, quantity, reason for chosen quantity, exit plan, reason for exit, etc. The key is to keep it simple. The best tool to use can be a spreadsheet where you can make different columns for each of the key points related to a trade and add each stock trades chronologically with each row.

Noting it on a computer makes it easy to edit and keep clean, also able to add more columns later. But a real note book can also be helpful in a different way. Choose something comfortable to you.

Be Careful About Misleading Lessons!

You can also learn lessons from profitable trades. But the lessons you learn from these can sometimes be misleading. Even the lessons from losing trades can be misleading because for unexpected reasons you might end up in closing a trade with loss. But perhaps it could have been closed with a stoploss as it was a good bet went wrong due to trend reversal of the market. Then how do you resolve this problem?

It is simple. Remember as I mentioned earlier, the stock market is like a stochastic process. It does not vary just in samples of time but also in samples of stocks and circumstances. There is randomness to it. But you can gain powerful conclusions when you increase the sample sizes as done in statistical analyses of random variables.

Similarly to learn best lessons from your past trades, you should take lessons based on the number of such instances. If a bad trade happened only one time and not repeated as much time as other bad trades, when repeated with similar conditions, that does not have any lesson to learn other than that it is part of the random nature of reality. But if you find that some type of your behavior in executing an entry or exit a trade is consistently resulting in bad bets, then there is good lesson to learn from it. Learn not to repeat those conditions for future trades.

Mine is an Evaluated Trading Experience

Even though I have a trading experience in time of only two years, I consider that I have good experience in trading that I can help others with my principles. This is because my trading expertise does not come just by the time I had traded and the number of trades in the two years but from the evaluated experience I got from learning lessons from past trades.

I have seen many fellow traders both online and offline who just don’t get over certain mistakes. I had even advised them to start a trading journal. Even though they bite their tongue every time they repeat a mistake they never consciously tried to learn some lessons from losing trades. That is what has separated me from such traders.

There are also people who are elder than me and advised not to go for trading. They themselves don’t have much to offer in the form of lessons than telling the same old lessons like diversify, go long term etc. This is because though they have experience of years, they don’t have lessons learned from their trades. Their trading just goes much in the same way as their life just moves on.

I don’t want to offend such people, but my intention is to highlight the importance of seemingly simple thing as noting down your actions. If you are in a different profession, don’t you maintain a dairy or something similar to note down what you accomplished, planned or lessons learned from the day or week or month’s work? Same holds true for the stock trading as well.

Learn Constantly for Long Term Success

It is never too late to learn stock trading principles. Knowing the importance of right principles thoroughly from all perspectives, even if few, helps improve the consistency of your next trades. Remember the success in stock trading comes from the consistency of right bets. And that happens only by constant learning.

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Thursday, June 18, 2009

Your Loss Does Not Necessarily Mean Somebody’s Gain

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Whenever stock markets start falling like hell, people start questioning who is making gains now? I practically met lot of people who just can’t get over this myth. They always think somebody must be gaining if you are making a loss. “Oh.. So many traders are losing money.. Then someone must be making big money..”. You should note that a loss for a person does not necessarily imply a gain for a different person when it comes to trading stocks.

When you make a loss in the stock market, it is most likely that there are several other traders that are also making losses. That is the nature of the stock markets. Otherwise it would have been no different from a gambling casino.

In Gambling Your Loss is Somebody’s Gain

In gambling there is always some one that makes money when you make a loss. Or some one loses money if you were to make a gain. There is no inflow of money for the system other than from the participants. The fact of the matter is that gambling is designed to profit only the casino owners in the long run. There may be one or two gamblers that make money once in a while but most of the time most of the gamblers end up losing though a fixed amount of money. Too many losing gamblers add money to the casino which helps it take breath everyday.

The stock market is never like a gambling casino. In fact it is perfectly legal, mathematical and logical type of system. Its money does not just come from investors or stock traders. The stock traders add money and take away money. But on the overall money is pumped into the system externally by the companies listed on the exchanges. I had given elaborate explanations about these things already in the earlier article titled: Someone Loses When Someone Gains: Do You Have This Belief about Stock Markets?

Nobody Need to Gain When You Make a Loss

Let me get straight to the point of this article though it sounds similar to the other one. You should never think that when you end up in a loss there is somebody making a gain out of it. There is nothing like conservation of money or something like that for the stock markets. In Physics you must have known about the principle of conservation of energy but there is no principle of conservation of money in the discipline of stock trading.

The True Reality of Stock Markets

What really works in the stock market is this: Everyone makes profits during certain period of time and everyone makes losses during another period of time. These cycles continue one after another in the name of bull market and bear market phases. These are like the inspiration and expiration related to the lungs of human body.

But on the overall which dominates in the long run is determined by the state of the economy. Remember stock markets always reflect the economy. They run parallel with it. So if there is a net development in the economy which may be backed by outsourcing or industrical growth or agricultural growth. Whatever may be the reason, the stock market certainly reflects that as average net gains. That is what is most spoken by your brokerage agents as the long term gains of stock markets who persuade you to trade stocks.

Who Gains When Your House Burns?

Now if there were to be a catastrophe, natural calamity or any kind of man made or non man made destruction, for example, it will definitely influence the stock markets because the economy is now going to be affected. This will have a negative impact meaning there will be losses for everyone. May I now ask who is gaining here?

If you still wonder that there is always someone gaining, let me quote an example that a famous MoneyControl Boarder with name Kalidas used to quote often – “Who is gaining when your house is on fire?”. There is a destruction of your assets when your house goes under fire. You are definitely losing. But tell me who is going to gain from it?

Well, nobody. You can burn the currency notes in your pocket and who is gaining from it? There are, of course, instances when someone gains, for example, a pickpocketer taking away your money. But you should also know that there are instances when nobody gains. Fortunately there can also be instances when nobody loses while some are making gains from the stock market.

Stock Trading is Not So Simple

You can now note that the stock market is not as simple as it looks for the uninitiated. Stock trading is like any other discipline. It has its own rules and principles. You need to take a step ahead and learn them to differentiate yourself from the rest of the crowd. Don’t just go by pre-assumptions that you brought from your other professions. It really takes a smart mind to understand the game of stock trading.

If You Just Made a Loss…

So next time when you make a loss or find that the markets are frustrating you with everyday losses continuously, just remember this truth: stock markets run on a cyclical basis. There are times when everyone makes gains while no one loses. There are also times when everyone makes losses while no one gains.

What remains on the net is decided by the net developments in the economy of the location where the listed companies operate. Decide your next moves accordingly. To avoid pain from the losses, consider stock trading for long run. That expands your horizons and gives confidence about the future.

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Tuesday, June 16, 2009

Averaging the Buy Price to Minimize Risk: A Common Mistake of Stock Traders

This is something that almost every trader or investor does in his own trading at one point of time or another. I did this myself several times and had to learn the bitter lesson before stopping it. There are several bad consequences that averaging the buy price results in. Typically we tend to think that the risk in a falling stock will be minimized if we buy more quantity of the same stock at lower prices because that brings down our average buy price.

averaging the buy price to minimize risk in stocks

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My Personal Experience with Averaging Buy Price

Let me explain the situation with an example so that even if you haven’t done this before you can learn to avoid it in the future. There is a stock called CMC that I bought two years back when it was flying high. I missed its ride all of the time because I never tracked it before. It was just the time when I learned about chart patterns of stocks that make new highs and keep going higher.

The common of such stock chart patterns is the cup and handle pattern. It is nothing but the chart of the stock’s historical price movement looks like a cup (stretched U shapre) and after the top of the cup continues the same price for some more time to form the handle shape. This is found commonly in many stocks that make such exotic moves in a range trading market. The pattern lasts about 4-8 months only.

Having learned somewhere that following these patterns will help us take advantage of biggest gains the stock can in only a short period of time (about 2-3 months), I had set out to apply this in my own trading. As I started looking for such stocks studying their charts at bseindia.com, I found that this stock was just doing that. Please note that this stock was already in the list of some stocks that I used to track regularly. Otherwise I would have caught even better ones probably.

The chart of CMC has just confirmed that it fit the cup and handle pattern. But what I missed to see was that it was already in the process of making its dramatic expected move upwards. I should have found it a little earlier. Or I should have waited for more time. Thinking that these stocks repeat such movements again and again, I just entered it at 1300 when it was falling from its high of 1500.

The next day it fell down again and then it continued slide everyday. One day after touching 1150 (which I guessed rightly out of gut feeling), it made a quick bounce till only 1250. It stayed there for quite a time when I grabbed more in 2:1 ratio of existing stock to bring down the average buy price. I bought it at 1180. The average came down to 1225.

Unfortunately the stock did not make any more upmove other than going till 1265. I felt that if I close the trade at 1250 I would just close it without loss after adjusting for brokerage charges. I thought it was such a stock that I can wait even it were to fall further for some time.

Just look at this situation. My bet had gone wrong in the first place. I did a good thing to first guess the reversal or bouncing point and bought in 2:1 ratio. But I did not close the trade to avoid loss but rather desired for little more. Unfortunately I did not realize how I would feel when it slides further. It sure slid from there till 1050.

You should have guessed it right this time. I thought of averaging it further by buying more at this price. But I did not do because already it was a heavyweight in my postfolio swinging it the whole postfolio everyday. I realized that now there is no diversification. There does not seem to be hope of it coming back to atleast 1200.

Actually just at the same time, I was also trading a different stock Jet Airways that I bought based on the same chart pattern. At that time it was trying a deal to buy Air Sahara which is a competitor. Luckily I bought this one at a relatively less price (612) after it had fallen from its high of 675. It slid later all the way down to 550 but that did not shake me as much as CMC did. When I closed this it was at 735 just below the highest value it made of 745.

I couldn’t get the same thing with CMC. Because I had made a profit on a similar stock, I felt it too would show its move soon. I was missing to see why this along with others in the same industry is falling at the same time. By the time I realized this it was too late. The stock started falling further and swallowed all the profits I made earlier with the right bets. At last I made the decision to close the stock.

But I did not close it in haste. Because I had such experience before in a different stock. I learned a lesson from those earlier wrong gone bets that immediately after I sold them they made a little move up that would have offset some of the losses. So I waited as the stock bounced again.

A Bad Closing!

Unexpectedly the stock bounced all the way upto 1650 in only three days of time. I was wonderstruck and did not understand all this. I was thinking that the stock was doing another cup and handle pattern. The next day it fell down to 1450 again. Then to 1350 and so on. I just watched it thinking that I can sell it again in its next move.

As the fate would have it, it fell down below 1100. This gave me such a bad feeling because I felt like a toy in the hands of the stock that is moving on its own without any sense. I did not understand what I was missing. Eventually I closed the stock when it made its last bounce at 1125. The stock this time went all the way down to 900.

Lessons from This Mistake

The biggest lesson I had learned from this is that averaging did not bring my loss down. In percentage terms, yes it did. But as percentage of loss on my total portfolio value, it had done worse. I would have had a lot lesser loss had I instead sold at the same price I bought for averaging.

It was plainly simple. Don’t put good money in the bad stock. Let it slide. Cut your losses if possible. Or wait for a small bounce and close the trade. But don’t add to the bleeding. It results in a wound that is exaggerated by the first aid.

The other lessons too are important to consider. I was not able to stick to my plans all of the time. I was changing plans with each transaction or each time the stock made a reversal move. When it made a bounce I was thinking about selling it for a little higher price. When it was falling down further, I felt I could have closed it just a day before. Then I make plan to sell it if just goes above from there by 2%.

When it eventually made a run away completely unexpected, I was wonderstuck when I had to be quick to run away with the gold that was somehow thrown at me. I realized that apart from heavy influence the averaging effect can have on our portfolio, when combined with our discipline in trading, the matter only got worse.

Had I thought in the same way at the time I finally closed the trade, I would have seen a big hole in my portfolio. Atleast in the end I closed it in a smart way. But it left a bad feeling because I held the stock for 6 months without any returns but only considerable loss that wiped out the gains made by two other successful trades which took only 45 days. I couldn’t bet on anymore stocks during the rest of the time because I was heavily bought in the name of averaging.

Avoiding Averaging Helps Later Trades

I had learned a good lesson from this. From then on whenever my bets went wrong, I had either cut the losses short or held my breath but never added more money into it. Why put good money for the bad? This principle really helped me as I made the biggest strides by betting on the next good bets like RNRL, ELECON ENGG, GMRINFRA, and so on. At the same time I had seen some trading friends who couldn’t move fast in pace with me because they still had some bets that they made worse with averaging.

When a stock goes in unexpected direction, just hold yourself. Control the urge to turn it around by thinking about how worse it can get if the stock goes down further. The only way it can get better is if the stock makes a turn around. But then of course you will definitely feel that averaging would help you make much more.

The reality is not so simple. Most of the times a stock that goes wrong, continues to do so. Just because you saw some cases where this was not true, and also found the reason that averaging will give more advantage if the stock turned around, does not mean you should risk too much every time. This is like a double edged sword. The risk or reward increases once you increase the exposure to the same stock.

If the stock were to turn around, then you would certainly be able to find a different stock that would also make its best move. The key is to avoid regrets. If you cut the loss short it gives you a good feeling which helps you spot next best opportunity. It often happens that once you have a bad experience in a certain stock, you will continue to have more of it if you do more with the same stock. I believe that you too can find similar instances if you go and look into your trading journals!

Averaging is a Mathematical Illusion…

Note that averaging is only a mathematical illusion. You must have known the visual illusion created by certain pictures. Similarly when you do not see some details as to what will happen in the future, how it influences your portfolio etc, this illusion can continue to deteriorate your portfolio while still giving you a false feeling of security.

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Wednesday, June 10, 2009

Does History Repeat? This is About Average Stock Market Returns

If you have been hearing stock market news on radio, or TV channels like CNBC you must have heard this phrase “Is history going to repeat this time?” There are a lot of popular phrases about stock markets that these anchors use at suitable times. Today I am touching upon one of such phrases. It is a famous question “Does History Repeat This Time?”

is history going to repeat this time? stock market average returns

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There are several circumstances for which this phrase is applied. It can be about bull markets when everyone feels good. It can be about bear markets when everyone feels bad. It can be just about anything that happens in the stock market but remains in the pages of history. Overall for the current situation I am more in interested in that part of history that gave good average stock market returns. Can that history repeat in the future?

Why You Should Ask This Question to Yourself?

I have several reasons to ask this question. Many market participants still believe that history can repeat and we can continue to see good stock market returns in the coming decades. But my analysis does not indicate so. I feel that those good times are gone now. Atleast some parts of the world might face a harsh reality in the future.

Many people advice you to invest in stocks for long term just for one reason. That is based on the history so far. The stock market has consistently given pretty good returns on average per year compared with any fixed income investments. This is the reason why people tend to think that in the long run stocks will outperform all other types of investments. So it feels good to go for long term.

After studying stock market history independently and later studying in the perspective of industrial revolution of the 20th century, I had to agree with certain experts who are making calls for an alternative future. Though I don’t completely agree with them, I still feel that there is a difference in the present situation and the historical times when bull markets flowed in cycles one after another.

Warren Buffet Squeezed the Best Out of Modern Civilization!

The last half of 20th century was a great time for the average American. That was exactly the time when Warren Buffet entered the scene. He too could have lost but with the sound principles he follows, he made it big by the 21st century. Even in the group of people who follow sound principles of stock trading or investing, Buffet should be considered unique for he made such a success that is not yet matched by any other investor or trader.

Buffet squeezed the most out of the outcome of Modern Civilization indirectly. If we were to take a long term perspective of say another century, the future does not seem to be the same anymore. But don’t get disheartened. We don’t need a century of time or a life time to trade. We just need little time out of our life to make the most out of stock trading.

Does History Repeat This Time?

There are a lot of things that are happening simultaneously that pose threat for our future. Depletion of natural resources like oil and natural gas, global warming effects, deforestation effects, water scarcity and pollution, great economic disasters etc. all are happening about the same time in this century. The doubt remains, does history repeat this time?

I very much doubt about the repetition of history as it is. We may not get powerful bull markets like we got in the past century. After the great depression 1.0, there were three powerful bull markets of all time. One is during the 1955 bull markets, second during the 1967 bull markets, third was the longest (almost a quarter of a century) during 1984-2007. The last one was the longest and also most yielding bull market that ended like a bubble though not completely similar to the great crashes of 1933s.

In the immediate term there are fears about bankruptcies of largest banks in the history. This is really something that one needs to worry about because when they go down it is not just them but they are also going to pull everyone down, especially the innocent people because the governments are standing by them giving them full support.

It is like supporting a naughty child who creates lot of troubles finally ending up in trouble when the child blackmails parents by crying. Instead of punishing the stupid and criminals, for idiotic reasons the governments of today are only trying to help them – especially the United States government. By doing so they are posing great risks for their national debt and tax money.

This can eventually have disastrous consequences that I cannot dare to imagine. Many financial and political experts have already drawn out their visions about the future of US. I can’t believe completely in them but to a certain degree they are valid. They speak about how the United States will break down into small countries much like the United States of Soviet Russia did in the last century.

Not History, It is Uncertain Future…

Whether this happens or not, still there is a lot of reason to worry about the future of the stock markets. There is a great threat for the industrial civilization. As many claim this to be great depression 2.0, history may repeat but for down side. By looking at the type of actions the governments are taking to avoid another great depression or any recession, it seems the future will not be a repetition of history but it is going to be even more uncertain ride.

By making it uncertain even the people who are intelligent and well planned for the future are also going to get affected. Thanks to the lot of intelligent feeling people who are influencing the lives of every citizen.

If You Are A Stock Trader?

When it comes to a stock trader there is less to worry about. If you are a long term investor you should certainly worry about the future of the economy. This is because a long term investor only trades for one or two times but has to do that with great caution and analysis. When things do not turn out as expected, the long term investor has to shutdown or end up with wrong bets.

But if you are a stock trader, there is less to worry to about the future of the economy or the stock markets. It is because the time frame is small and a trader can switch between long term – medium term – short term to even day trading time frames. This is a unique advantage of the trader compared to a long term investor.

By reducing the time frame a trader creates more opportunities and flexibility to trade maximally best bets. But the long term investor has only one option. As the time frame can be small, even if the history repeats like it did several times in the past, it does not really matter for a trader. A stock trader, having the opportunity to do more trades in a given time period, gets to experience a variety of situations. Thus he/she learns to handle new unexpected situations as well.

Next time when you watch a TV program and the anchor asks - is history going to repeat this time? Don’t worry about what they are saying. If you are a stock trader keep in mind that you have more options to handle any kind of future. Of course except certain days like we had in the last year January or October. But they happen rarely so they will get compensated by later trades.

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Saturday, June 6, 2009

Buy at the Bottom or Buy When Everyone is Selling: A General Misconception of a Stock Trader

One of the fundamental principles that Warren Buffet had taught and had been accepted by the investors across the world about stock markets, is to buy stocks at the bottom. He does not explicitly talk about the bottom. But he says that one should buy when everyone is selling. I found many people backing up their temptation to buy stocks using this theory. Though I agree with the principle, I find that many traders and investors alike have a misconception about this theory. I will give you a paradigm shift to understand why you may misunderstand this theory.

a funny stock market index cartoon, falling 2008 index reversed

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Not on the Surface

Many investors and traders take Warren Buffet’s principles without a second thought. No matter who is sharing the stock trading principles it is highly important that you as a trader analyze from your own perspective and learn new perspectives if required. It may happen that certain principles can shift your basic paradigms that you might have had for many years.

There are some principles of Warren Buffet that cannot be applied when trading stocks. Mostly it is to do with the difference between his mindset and a trader’s mindset and fundamental beliefs. The personality traits, emotional behavior, cognitive abilities all differ from person to person. And thus always play a role in influencing a trader and an investor in different ways.

When you buy stocks for the first time you will not know whether it is bottom or top. You will not be able to tell whether it is at a high price or a low price. Because all these are only relative terms. There is a fundamental and unique aspect about stock price movements that makes it difficult to understand than any other phenomenon.

You can Not Tell Till You can Tell!

You can never tell when a stock has made a bottom until it conclusively proves by moving much further up away from a certain lowest price. There can be bottoms in intermediate time frames, short term trends, and long term trends involving 5 or more years of time period. For example, the present market (Sensex at 15K) has moved much farther away from its lowest value in the past few years of 8K. Of course all this happened in only five months of time. But nevertheless you could not tell that 8K for Sensex was the bottom conclusively till now.

This is where the stock market behavior differs from other disciplines. Stock trading involves the fundamental and fourth dimension of time. It is its time varying behavior that makes it so tough to decode its Da Vinci Code. You cannot tell so and so not only until it happens but also after enough time that the opposite happens.

When traders buy stocks as they fall they say that they are buying the stock at the bottom. They also refer the name of Warren Buffet to indicate the authenticity of their action. But they do not think once that there can be misconceptions as to any successful theory. If something is obvious in the stock market, then even before you can act there will be so many people already acting on that.

It is not something that is obvious but we need to read behind the lines. When it comes to buying a stock at its lowest price or when it had hit bottom, it is truly to buy a stock at its best possible price for a buyer. But it means the worst possible price for a seller. Then why in the hell a seller will sell the stock when so many buyers are so eager to buy it at the bottom?

Why is This Misunderstood?

The theory is not as simple as it sounds. Many traders and investors alike build misconceptions about it. The same reason holds for the seller that holds for the buyer as well. If buyer thinks it is bottom, then seller too can think so. But if seller thinks that it is not bottom then buyer too can think so. When they think opposite, that is when a transaction or a trade happens.

Now what makes two people or traders who are so similar in their professions, to differ in their thoughts, perceptions etc.? It is the need to take action and not the luxury or proactive nature. A desperate seller or a buyer makes a move for the market but not those traders who think that it is an opportunity. When those traders do act, that does not affect the market much unless the desperate actors have done with their task.

A popular reason why this is misunderstood by many involves the fact that every trader shares similar goals and thus similar thoughts. This results in the theory going into a paradox. Let us take a closer look at this principle.

“Buy when everyone is selling”

I will ask you a serious question, can you really buy when everyone is selling? Think about it. There is a paradox in it. Remember every trader is in the market for the same end goal, that is to make money by making profits, taking opportunities. If you are able to find an opportunity as to buy at bottom, unless you are a very unique individual out of tens of thousands, it is most likely that another trader too is able to find the same opportunity.

If you are willing to buy when others are selling, then there are some traders who are willing to buy similar to you. Then how it is true that you are buying when everyone is selling? The true meaning of Warren Buffet’s statement is that it is not when others are selling that you can clearly see, but it is when you yourself feel like selling even while others are selling.

Unless you too are in the mode of selling, it does not become a situation where everyone is selling. So Warrant Buffet explores a wonderful philosophy here. When you can see your reflection instead of getting trapped by the circumstance like everyone else is, that is when you can successfully control your need or urge to sell and turn around to buy the stocks at the right opportunity.

This is in fact very hard thing to do. That is the reason why Warren Buffet gives away his solid principles for free. It is not just enough to know something. When it comes to stock trading you need to live in the time when the event is happening to fully understand a theory in its true sense.

There is a Paradox in This Principle

As the stock market involves time varying behavior, your emotions, psychology, thoughts, beliefs and behavior too very with time. You feel that a theory fits well with stock market in static state when markets are closed and you are studying. But when markets start moving and the actual scene arrives you will not necessarily feel the same thing.

Now is it not hard to see why this principle is kind of a paradox. If everyone is selling how can there be any person willing to buy? Warren Buffet is referring to the kind of scene that happened in 1930s Great Depression times when everyone including rich, poor were selling stocks. It was a situation where there was no hope for the future. Even the people who normally think steadily and are safe with diverse income streams still go for selling during these times.

That is the time when you should understand that the markets have hit bottom. That is the time when you will not able to find a way to buy stocks even though everyone is selling. It happens on auto pilot. You will feel that you don’t have control over your decisions, but you have to do what everyone is also doing. Can you just imagine such a situation?

Where is the True Bottom?

where is the bottom, DJIA during september 11

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In the present market scenario, I truly believe that such a situation hasn’t yet happened. The simple fact that the markets made a sharp come back by 73% in just two months time from March to May illustrates this truth. People still have the money to buy stocks, they still have the luxury to buy stocks, even in the midst of a recession, there are so many that still have jobs to be able to think of buying stocks rather than thinking about long term future. The bottom is far from visibility.

A true bottom occurs when you, even after knowing what to do at the bottom, will not be left with any choice but to go against this principle. In such a situation to go with this principle is not a simple thing to do. It is a risk that you have to take by sacrificing some important thing from your life or possessions or relationships. But it will be worth doing and only few get the courage to apply this theory at the right time!

Thursday, June 4, 2009

Buy Low and Sell High: Why You will Not Succeed in the Long Run with This Myth?

What is the first idea everyone gets from their intelligence after looking at the stock market? Why do many traders get stuck in their first trades? Why do only few traders actually succeed in the long run in the stock trading business? At the root of all these questions lies a fundamental paradigm of stock trading. This is known as buy low and sell high. Let me assure you that if you believe in this theory, you will someday have to close your trading account!

buy low and sell high is not so simple as it seems

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This is a Truly False Theory

You may be surprised to see me call this basic belief as a myth. But it is the reality which is like a violent ocean that traders have to cross before their journey can become smooth. Very few traders cross over this myth and learn the right belief. This buy low and sell high is a concept very popular and obvious for almost every stock trader or investor on the planet. Even the people who do not trade stocks understand this theory or make it on their own.

This is also one of those false theories people make immediately from their experience. It is so obvious a theory that it does not really do what it appears to do on the outset. Let me take you on a journey to debunk this myth and explore what is the right paradigm.

A Stock Trader’s Interaction with the Stock market

Whenever you think of trading stocks in general any business involving buying goods and selling them later, you can easily understand and follow that to make profits you should buy the goods at a lower price and sell them later at a higher price. The difference in price is the profit that you get to keep for your financial growth or survival.

But when it comes to trading stocks this simple theory becomes a stupid theory. It is no longer the same case with stock markets which involve highly complicated day-to-day phenomena. The basic problem with this belief is that it makes you ignore a fundamental aspect about how a trader interacts with the stock market.

There are four things a trader does when he/she comes to stocks. They are:

Sitting on the sidelines before entering a stock
Buying the stock at entry point
Holding the stock for some time before exiting
Selling the stock at exit point

Now each of these four things is equally important. But the amount of time each one takes is quite different from the other. A trader has to most likely do each of these activities for closing every single trade in and out.

Buying and selling take just a few seconds of your time while sitting on the sidelines and holding the stock are what a trader spends most of time on. It is very tempting to buy and sell stocks than waiting without doing anything other than watching stock movements.

Buying Low and Selling High…

Many beginners get caught up buying and selling stocks at the flash of thought. They don’t have a reason to do that. They just do this repeatedly for the sake of momentary pleasure that comes immediately after action. Considering this it is actually better to think of buy low and sell high a stock. In fact these beginners slowly realize this principle on their own after several unsuccessful trades.

It also makes sense a fundamental principle in making profits in a business. By sticking to a strategy as simple as these is also a good thing for many traders. A trader should always focus on long term consequences of his/her actions than doing things out of instinct or for momentary pleasure.

But the fact is that those who begin without this theory and those who learn that this theory is a myth are better off in the long run than those smart traders who learn this theory. The beginners atleast stop trading after their first losing streak and spend their time on doing other better things. The successful traders do not believe in this theory and always are on the next good bets. So they continue for the long term success.

But the traders in between who believe this theory at heart at the people who struggle all along their trading career going up and down with the stock market. They just react to the market and not ride the stock market.

Why This is a False Belief…

Let me get to the reason why this belief is not correct. In my trading I started thinking about these just after first few trades when some of them resulted in a loss that I took or yet to take. I realized that I had to carefully buy the stock when it is low and sell it after it goes high. It looked like a very smart and fundamental strategy.

But the low and high prices of a stock are only relative. You cannot really buy a stock at its lowest price and atleast not every time. Also you cannot sell a stock at its highest price and atleast not every time.

When a stock is moving in an uptrend any price is a lower price compared to future price. If you wait for the stock to come from its current price, it may not easily come unless it changes its trend for a longer time. When it does you may be too quick to enter into it.

For example, a stock at 400 appears too high if you looked at its past prices to be less than 400. If it is in upward trend, then the next days it will go up to 420, 440 and so on. Once it goes there you will see 400 as low price. See how relative it is.

As the stock moves up and up it will may be around 500 when it takes a turn back. And you will be tempted to enter into the stock at any price below 500 because all are now relatively lower prices. If you enter at 480, it does not mean that the stock has made a low there. It can down again to 460… 440 and so on. You may even buy more stock to do averaging the stock price. When it does move up any price above your buy price seems high and you will end up selling too early after seeing a little profit.

You might have sold at 480 which will be higher than the average purchase price or 500 or 520. But when a stock can move from 400 to 500 in a single leap in the current trend, it will again make such a massive move in the next leap moving from 500 to 600 or 620. Can you recollect doing similar thing in your experience?

In reality many traders end up doing like this. They are anyway happy for taking a profit though they regret for not staying for a little more time. What they miss to see is that this profit is less than what market is giving. By undermining their profit potential they become vulnerable to risks.

The Risk Side or the Real Dark Side of it!

Let me come to the risk side of this belief. The biggest problem with this principle is that people end up being caught in the fall of a stock and just cannot get out when a major trend reversal happens.

Imagine the days of January 22 and 23 and also the months of July or August. The stocks were falling everyday. They were becoming lower and lower everyday. If you believed this theory you would have bought at any price because they are lower than their all time heights they reached just a few weeks back. But the stocks did not stop there. They continued to fall and still below their high prices. Some stocks are much farther from their highs, actually.

So when you think of buy low, you will buy the stock at low price when it starts to slide after making a high price. This is a reactive approach. Of course this is not very bad idea because sometimes it can work like safety cushion. It is always good to buy stocks at lower prices.

But what happens if the stock goes lower and lower after you buy? I used to think of another myth called averaging stock price and keep buying more on “every dip”. But how much can you buy? You will be drained of your capital in only a handful of trades.

If you think that you will use a rule to handle this situation, think again. If the stock were to go down two times, you need to buy two times. You may do a 1:1 or 1:2 division of your capital for these two buys. That means you need to buy with a lesser price first so that second one will have enough weight to average.

If the stock were to go down another time, you will have to buy with even lower price. This is not practical because the stocks do not always follow a consistent pattern. You may be good in trending markets, but when they change trend you will caught up in that. And may lose all you made or even your original capital if you had just started in a single go.

The Theory itself is Dependent upon You

The concept of buying low and selling high is not wrong by itself. It becomes inappropriate when considering the trading environment and your other beliefs or reactive behavior. No trader is ideal and no stock is ideal. Things do not need to happen as we wish them to.

Considering that this theory is also dependent on your other beliefs or paradigms, I want you to understand the long term implications of this theory. This is really a big problem if you fail to recognize a trend reversal.

Most of the people, who followed it during the downturn of the last year, are the people who are deeply in trouble today. Those who recognized the trend reversal and got out of the market have some relief despite some losses.

Go Beyond the Obvious...

Go beyond the obvious things and separate yourself from the rest of the crowd. Low and high are always relative terms in trading stocks. You should not fall for a falling stock as it becomes lower and lower. On the other side you should not sell a stock quickly because it is now higher than ever before. Most often a stock making a high price continues to make highs before it does a major trend reversal. Getting out too early is disastrous for the long term.

Even if you limit losses in failed trades, low profit trades can kill your chances of long term success. Why would you spend time trading if you were only to survive? To me that is just a waste of time.

Go beyond the obvious high and low prices. Appreciate their relative nature and accordingly look for long term high and low prices. In other words you can follow buy high and sell low for a successful long term strategy. I will explore this in the future posts.

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Sites I am Thankful to

Below are websites I am thankful to for providing a variety of market statistics:

NSE Website - provides real time quotes (only 15 seconds delay) and excellent intra day charts apart from being an official website of National Stock Exchange. This is the place for all accurate information and lot more information than other places. May not be so helpful for highly active day traders.

iCharts - amazing website that provides daily (end-of-day) charts for all stocks on NSE/BSE. There is one javascript based and another old type which is good for visual. Charts from iCharts can be used with attribution link. This site-wide link is to serve that need.
They also have paid service for intraday charts.

BSE Website - this was the site I used to check in my beginning days of stock trading in 2007. It has lot more information but not as comfortable as above sites.

Investopedia - amazing website for all basic information on stock investing and trading.

Moneycontrol - Moneycontrol is an awesome service. I track my watchlist, portfolio and also set price trigger alerts. Cool website without a natural competition. Price trigger alerts are now only for paid users. It has mostly ad heavy pages. Its competitors are coming.

Indiabulls - This has changed now. Earlier there used to be a place called Indiabulls Market Insight which was the best place to get market statistics all the time, EOD and through-Intra-D as well. Though charts were not best. Now they diversified into Indiabulls Ventures, Home Loans, etc. Now this is what has remained of their site.= to learn something from

Sharekhan - Sharekhan is an excellent broker. Their recommendations for retail investors are first-class. I haven't tried their pages much but brokerage service is nice.

Yahoo! Finance - This is another cool site like moneycontrol. It has its own unique benefits. Gives historical data of stocks all over the world. Double dhamaka on alerts (price & %) and once set they remain there forever.. so cool for learning. No need to talk about the rest of the content. It is all worth the visit to this site. Your knowledge and context just expands.

That's it for now.