For readers who haven’t been following this series of posts, it makes sense to read these posts first:
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Patience
- Many a time, we are very early in entering positions; while trading being early and being wrong are indecipherable. The adage goes something like this; the pioneers are the ones with the arrows in their backs. One needs to be patient and wait for the right setup before putting on a trade. It is better to have the wrong idea and good timing than the right idea and bad timing.
- It is what you don't do that counts - patience is the keyword. Successful trading is the art of doing nothing. It's what you don't do in between the real trade opportunities that will determine your success over the long run. You can do so much damage to your mental capital between trades that when the big trade turns up, you are not ready for it. In other words, striving for performance consistency is a flaw rather than a virtue.
- A unicorn trade is one in which everything lines up exactly the way one wants. The idea is to ensure that one only trades such trades and to avoid all others. One may expect only 10 such trades in a year, and one can't afford to pass up on any one of them. So, in such cases, the trade size has to be adjusted upwards in a commensurate manner. Big trades are pretty simple, one has to be patient and wait for them. The legendary trader Jim Rogers has said, 'I just wait until there is money lying in the corner, and all I have to do is go and over there and pick it up; I do nothing in the meantime.' To facilitate outstanding trades, you need to be doing nothing in between.
- The big trades just scream out and trading isn't that difficult. You have to learn to not be impulsive and to not do silly things in the interim periods. So, 90 per cent of the time, the market is not going to provide any opportunities, and 10 per cent of the time, you will end up making 90 per cent of the profits.
- It is also virtually impossible to succeed at trading if you are dependent on trading profits to pay your living expenses. Famed technical analyst Peter Brandt notes, “the markets are not an annuity” - you can’t reasonably expect a steady income flow from trading.
- Keeping losses as small as possible is critical to capital preservation. The most crucial thing in trading is mental capital. You need to be in the right headspace for the next trade. When we go into a deep drawdown, our mindset is severely affected. We start entering into revenge trades to make money back. Moreover, the drawdown takes a huge toll on our mental capital, and we end up getting gun shy about taking the next trade. Always remember you want to maximize the gains when you're right (which happens only 50 per cent of the time at best, since the rest of the time you're wrong). So, when you're wrong, minimise the loss.
- A lot of losing traders seem to think that they have to make money consistently - a paycheck mentality that requires making a certain amount every month. The reality is that you may go through long periods when you don’t make anything, or even have a drawdown, and then have a substantial gain. Entrepreneurs understand that. They will invest in a company for a long time, and the payoff comes in one hit after many years of hard work. If you are looking for outsize profits, you can’t approach that goal with a mindset of consistency. At best, we are right only 50% of the time, and sometimes we are right only 30% of the time. However, when I’m right only 30% of the time, I want to earn eight times as much on my winners as I am losing on my losers. Traders have to ask themselves whether they can handle being right only 30% of the time, or do they feel they have to be right day after day? It is that latter perspective that holds a lot of people back. Opportunities are dispersed. You might have an opportunity today and then have to wait three months for the next opportunity. The reality is hard to accept because you want to make a steady income from trading, but it doesn't work that way.
- When you put on a trade with the idea of making money for a specific purpose, more often than not, you are likely to get it wrong. So, if I put on a trade with the idea of recovering my interest cost (or buying an iPhone) I am making a cardinal mistake in my thinking process and the odds that I will succeed are pretty low. The reason is that I am being guided by my material desires and not by my instincts.
- One of the cardinal rules is: Do nothing, absolutely nothing unless there is something to do. Most people always have to be doing something. You have to learn to just sit there and wait for something new to happen. Or you have to sit there and wait until you find something worth doing.
- The greatest traders are the ones who are afraid of the markets. One has to wait for the trade to present itself instead of forcing the trade. The environment should tip itself off. The cheetah waits for the baby antelope, but not just any baby antelope, it waits for the one that is lame or sick. Only when it knows that there is no way it can lose its prey, does it attack. That is how one should approach position trades. In the case of a day trade, behave like a sparrow, take small bites and run and come back to scalp more. While day trading one doesn't want to pick tops and bottoms, the mid-range is good enough and that is where the momentum is the greatest. In any case both these animals wait for 'can't lose circumstances'.
- The 'impulsive trade' is the one that has the highest failure rate and has to be avoided at all costs. It doesn't matter if I miss a trade because there will always be another opportunity
- There is an analogy between the stock market and poker. And that is to wait till you get a good hand and do nothing for the rest of the time. Don't play every hand, play the good hands and drop out of the poor hands. In this way, you can increase the odds of winning significantly.
Opportunities
- One has to be able to think clearly and act in a panic market. The markets that go wild are the ones with the best opportunities. Traditionally, what happens in a market that goes berserk is that even veteran traders will tend to stand aside. That is your opportunity to make money.
- When the volatility expands dramatically, opportunities for profit arbitrage are greatly enhanced.
- While watching the market-related shows on CNBC, the most powerful word is despite. If you hear a comment like, despite the increase in oil inventories being much higher than expected, oil prices closed higher, that is the tape telling you what is going to happen.
- If the market doesn't go down on bad news, and instead the market starts to go up, that is what a market bottom is. The market doesn't bottom on good news; it bottoms on bad news.
- Trading opportunities abound if we can Identify shifts in the market narrative that are likely to result in market repricing. One has to be able to determine what the narrative is, going into any significant event. And one has to account for the fact that when a convincing narrative is contradicted by the price action, the reaction can be violent.
- If a market doesn't respond to important news in the way that it should, it is telling you something important. And secondly, when a market makes a historic high, it is telling you something. No matter how many people are telling you that the market shouldn't be trading so high, or why things are bad, the mere fact that the price is at a new high tells you something has changed
- Markets tend to overshoot on both sides of the pendulum in any market cycle. In other words, markets tend to climb higher and also swing lower than what most participants expect. Many times we infer something and assume that the market also has inferred the same. This may not always be true. In the stock market 'surprise' is endemic to the system.
- As a general observation, markets tend to over discount the uncertainty related to identified risks. Conversely, markets tend to under discount risks that have not yet been expressly identified. Whenever the market is pointing at something and saying this is a risk to be concerned about, most of the time, the risk ends up being not as bad as the market anticipated.
- Before putting on the trade, ask yourself: 'If this trade goes wrong, how do I get out?' Losses are a very important part of trading. When one is losing, the best strategy is to book the loss. By booking a loss one can adopt one's risk appetite accordingly. By definition, we must place a greater emphasis on loss avoidance, than, on scoring gains. Every time one loses money, consider it as a learning opportunity and view the loss as a tuition fee at the ‘University of Trading’. As long as you learn something from the loss, it's not a loss. Absolute loss amounts in rupee terms, have to be predetermined, and acted upon, with no excuses.
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