Trading Insights

28-Oct-2014

Some before trading facts
It is a given fact that very few traders make money, whether in the stock market or in commodities, whether in the cash market or in futures. However, those who do, make BIG money.
But, why do so many traders lose money?
What is the difference between successful traders and unsuccessful traders?
How does one help retail participants make money by trading?
Presented in this book are a few insights and rules that will help you succeed in trading.

Some caveats before starting
Trading is a high risk, high return game. Retail participants are lured by the returns; forgetting the risk.
Trading is a high involvement activity. One cannot be a passive trader. It is better to be a passive investor, not a passive trader.
Trading requires skill, discipline and one needs to follow discipline without any emotions.
Only discipline with a certain amount of skill can help you make money and not intelligence.
Trading is nothing but a game of probability.

APPROACH TO TRADING
There are some simple rules to trading. Follow these rules sincerely and diligently and chances are you will avoid some of the mistakes that traders often make.
Allocation Strategy
Clearly demarcate funds between Investment & Trading.
Allocation for trading depends on “Risk Bearing Capacity to lose money”.
Lower the risk appetite, lower the trading allocation.

Risk Bearing Capacity % Allocation to Trading
Low Up to 10%
Medium 10% – 25%
High 25%+

Investment or Trading?
At MOSL, we classify market participation into these broad categories, based on investment styles:
Investment - Investment is placing money into an asset class (in this case equities) based on research & analysis on fundamental factors like sales turnover, net profit margins etc, with the expectation of gain over a shortterm (1year) medium term (3 years) or over long term (5 years or more).
Trading - Trading is placing money in any asset class (in this case equities) for a shorter time horizon. Unlike Investing where a company’s financials are researched, Trading involves taking buy and sell decisions based on news, technicals, short term outlook etc. Trading can be further classified into the following:
·  Positional trading - Positional trading is a speculative position taken in the markets for a time period of anything between 2 days to 3 months.
·  Intraday trading - Intraday trading is a speculative position taken in the markets for a single trading session (1 day). All trades are squared off on the same day at the end of trading session

These are not watertight categories. Participants could be present in more than 1 category at any point of time.

Before entering any trade, be clear whether that trade is for Investment or Trading. If it is for Investment – then do not worry about short term fluctuations of the price. If it is for Trading, then use of Stop Loss and Trailing Stop Loss is a must.

STOP LOSS
Use Stop Loss & Trailing Stop Loss

Stop Loss: Is a pre-determined price at which one will exit if the price moves adversely. Eg. If a stock is bought at `100 then 95 can be the Stop Loss. Below `95 the trader will exit the BUY position.
Types of Stop Loss
Trailing Stop Loss:  A situation where a trader continues to increase the Stop Loss to take advantage of any profitable trade. As price increases, the trader increases the Trailing Stop Loss. Trailing Stop loss hit above his purchase price will be his profit.

Types of Stop Loss
Intraday Stop Loss: To square off position of all intraday transactions. No carry forward.
Stop Loss based on Price %: A Stop Loss (SL) which is determined as a particular percentage of price of the stock. E.g. SL of 3% of price of stock. i.e. if the price is 100 the SL would be 97.
Time based Stop Loss: A time based Stop Loss is placed with a view to achieve the result of a particular position based on the pre determined time frame. If a Stop Loss or target is not hit within the time frame, the trader exits from the position.
Stop Loss based on Technical Analysis: This type of Stop Loss is placed by combining the

Stop Loss + Risk Reward
The risk to reward ratio for any trade should be 1 (risk) : 2 (reward). The reward ratio can increase by use of Trailing Stop Loss.
As price increases the trader increases the Trailing Stop Loss. Trailing Stop loss hit above his purchase price will be his profit.
Why book a profit at `110 if the price can run up to `125 or `130 or even more?

Stop Loss + Risk Reward
Success Ratio No. of times Stop Loss is hit Total Loss @ `1 per trade No. of times Profit is earned Profit Earned @ `2 per trade Net Position (in `)
40% 6 6X1=6 4 4X2=8 +2
50% 5 5X1=5 5 5X2=10 +5
60% 4 4X1=4 6 6X2=12 +8
70% 3 3X1=3 7 7X2=14 +11

This is a hypothetical example
Witharewardrisk ratioof2:1,moneycanbemadeevenifoneis right40%ofthetime.

Some Advantages of Stop Loss
Stop Loss is an important part of trading discipline.
For a trader, putting a Stop Loss is a must.
Stop Loss costs nothing to implement.
Allows decision making to be free from any emotional influences and emotional influences are most dangerous.
It prevents a small loss from becoming a disastrously large one (when a position is going against you, it is best to cut your losses immediately).
No need to monitor position continuously after putting Stop Loss, and it prevents the trader from watching stocks for an extended period of time.

The Flip Side
Argument against - If you are unsure about the position, then why not just bite the bullet and sell instead of waiting for a decline to take you out of the trade?
At times, Stop Loss gets activated by a short-term fluctuation in a stock’s price.
The price will hit the Stop Loss and then move in the intended direction.

Why putting Stop Loss is difficult?
Simple things are most difficult to implement.
There is an emotional aspect and human psychology at work: there is more pain in losing a rupee than earning one.
Hence, losses are not booked when Stop Loss is hit and profits are taken quickly.

POSITION SIZING

Determine your position size
Amount of money at risk in a single trade sets the ‘size of position’.


Therefore, to lose the whole amount (`5 lacs), how many times do you have to go wrong continuously?
Capital Preservation : Strict Stop Loss


Traders play both sides of the market
A trader will have a long position if he feels the prices are going up (first buy and then sell ).
He will have to go short if he feels that prices will fall (first sell and then buy).
Most retail traders unfortunately do not go short or keep a Stop Loss and hence lose money when the market falls.

TECHNICAL ANAYSIS
What is it?
Technical Analysis is the study of market action primarily through the use of charts for the purpose of forecasting future trends - John J Murphy

Purpose

The purpose of Technical Analysis is not to be able to accurately identify each and every market position all the time. The real objective is to find trading opportunities that have a probability of success - Robert Miner

Basic Assumptions of Technical Analysis

The Market discounts everything.
Prices move in trends.
History tends to repeat itself.

Benefits of Technical Analysis

Helps to protect profits.
Cut losses.
Profit & Loss figures are known before entering the trade.
Can trade on both sides of Market.
Decision is out in short time.
For short term trading, fundamental analysis is irrelevant.
Known Stop Loss and Target helps to take quick corrective action.

The Flip Side & Criticism of Technical Analysis
Stop Loss may not be fixed scientifically.
Frequent Stop Loss.
Prices don’t distinguish quality.
You could be left holding third grade stocks just because it looks technically good.
You could miss the big moves.
Criticisms
Charts are great for predicting the past - Peter Lynch If past history was all that was the game, the richest people would be the librarians - Warren Buffett

If making money is so simple, why do people still make losses?

Because,
Simple things are the most difficult to implement.
There is an emotional aspect and human psychology at work; there is more pain in losing a
rupee than earning one.
Losses are not booked when Stop Loss is hit and profits are taken quickly.
Learnings
Trading is a game of defense and not aggression.
It is a game of patience and discipline.
Decide your Trading Allocation.
Decide whether order is for Investment or Trading before executing.
Use the concept of Stop Loss and Trailing Stop Loss religiously.
Have a risk to reward ratio of 1:2.
Don’t lose more than 1% of your capital in a single trade. Position Size is the key to success.
Play both sides of the market.

There are different MOSL Research products for different approaches.Take your pick.