Speculation to Technical Analysis- Mundane to Exciting

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If you are acquainted with valuepickr forum you would have been seen this thread and many other threads under two identification i.e. 1. The Confused Consultant 2. Suvendurath. I am the same person, my idea is here not repeating the same story everywhere but disseminating information to more people, help and learn from them.

Anatomy of a Stock Wizard- Know Yourself First

We touched this subject in one of previous post . Story remains same for a Trader but we have to blend certain philosophies specific to understand crowd behaviour. Being a traditional accountant who attempted investing methods based on pure fundamentals, it was not easy or simple for me to adopt the nuggets of wisdom offered by wizards.

Aspiring to be contend within

First few months of understanding speculation was mostly around technical analysis. Bullish pattern, candlesticks, Fibonacci, Head and Shoulders and a long list of names which I never understood by heart and soul. Somehow, I couldn’t convince myself that these are best when it comes to understand crowd behaviour, perhaps these successful indicators were built with a rationale. Knowing those rationales should be important, are there not any other way. Now the good point I can share with you is 1. I have not abandoned the analysis of balance sheet nor will in future. In fact, creative accounting practices will be significant challenge going forward. 2. I rarely used any of popular technical indicators available with charting tools. 3. Large part of success comes from managing risk and position size, I will write in due course.

Then obviously how does an ingrained fundamental investor learn the nuts and bolts of crowd behaviour or speculation? I never refrained from approaching those who are approachable. I chased a stock market wizard and US investing champion, some useful guidance shared by him. My request to 20 plus guys would be, do not hesitate; chase your man BUT give him/her a hope that he can see some of you within him. This means in simple language is demonstrate some hard work and objectivity before expecting nuggets from wizards.

Finally, I have my mentor, if you don’t have one go for it. They are fun and interesting, knowledgeable and helpful, guide and examiner and more importantly you chase them initially; after some time, they chase you to finishing line.

Now credits:

  1. Market Wizard series
  2. Michael Covel interviews and books
  3. Mark Minervini books ( to me these books are too good)
  4. Another bunch of books and articles
  5. Lessons learnt at few seminars on behavioural finance, crowd behaviour.

First thing I was told and learnt is ‘ you may follow different investing method but you can not avoid certain common traits (like capital protection, you call stop loss or something else is not relevant).’ Second you can build any emotional discipline (rather we call philosophy) and customise. For example these days I pick up stocks from momentum screener, come back to check acceleration growth, again goes back to see crowd behaviour before checking competitive advantage of company and so on. Third as my mentor says ‘ a desire to succeed’.

My mentor says every successful results as a precedence requires opportunities and greed in first place. And stock market provides plenty of them for you to find out and execute. Do not let anyone who influence you that you can’t do it. It’s mostly told by people either they haven’t done it or I can not be Warren Buffett or George Soros. We don’t want to belong a category WHO CAN’T DO IT, rather we try and fail. On second aspect we have spoken before, are there only two people (namely Buffett and Soros) in stock market who buy and sell? Who wants to be them? Irony is they want to see different styles of Buffett and Soros within us. My experience says there are thousands neither do not grab attention on television or newspaper, even not billionaires but richer in many aspects than they could have. Mumbai guys, search your neighbourhood Spiderman :blush:, you guys are lucky. But we are promising we will catch up with you soon, of course nothing takes away gigantic spirit of Mumbai.

Unlearning: upside down

How much I can lose not gain is key question behind every speculation. Risk first approach is cornerstone behind success and trust me this is the most difficult to practice as we set foot in stock market either to make a lot of money or become famous having lot of bhakts.

Never give up- starting from March 16 I couldn’t make headway much in world of trading. A number of times I was about to quit the game. This time my excuses were different obviously. A. why do I have to disturb well-oiled machine which so far delivered my living expenses in first place and allowed me to practise a profession of choice B. Am I not digressing from objective and becoming a speculator. By end of Sep 16 things were bit clear but not to my satisfaction. By March 17 I could have changed my approach several times which of course is a symbol of confusion. But as on day it’s stabilised, multiple failures and frustration just eats up your head. There are times when you sit up on bed midnight to think should you go back to nine to six jobs. Hundreds of occasions wife and child will ask you should we spend this and that? You know why because they can see the uncomfort in your eyes and words. Hanging on to your nerves pays of well and that is the difference between interest and commitment. Even if I do not become wealthy and rich still I am happy what I am doing is passionate about and enjoy.

Every time speculation comes up as subject name of Jesse Livermore pops up first. People are obsessed with him, either good or bad. Some think champion speculator is a big failure in life, for others he is still the original inventor of speculation tools. To me these types of personalities told WHAT NOT TO DO. The biggest of learnings from the greatest trader of world:

Do not increase yours spend because income is going up.
One doesn’t need to be fully invested to make money or survive.
Even a wizard is bound to fail with unethical practices and manipulation.
Relative comparison is recipe for disaster, be happy with what you are.
Finally the greatest challenge is not market or investment but US i.e. you and me.

Full time or part time, you have to do it yourself- I realised if I am not prepared before a trade I am just throwing stones at a target. As I am expected to throw few millions times in my life I can’t be lucky all the time. No one will ever care about me , after all it’s my money and career. I have to own up the failures, no one can make me rich. Simple and easy to remember.

Money or ego- one of the most beautiful wisdom speculators tells us. Remember riding on your immaculate skills of creative accounting practices? Or even a business model drawn up in one page? State of the art valuation technique? Time to re-think, differentiate between academics and practice. Ego is dangerous for stock market, at some point of time we have seen the problems. All of us. Now when one says how can you be money minded in stock market? Love your job not money, isn’t it? Well no one is asking to be greedy and criminal. Money is unit of account for your portfolio, the indicators of your performance. That’s it, measure it to know where you are. Nothing plus or minus.

Practice won’t make you genius- if we think lot of practice makes us a master investor again re-think. Practice is art of habit; wrong practice can take you to disaster. It’s only by honing good habits you can develop superior practice.

The thin line- does your investment philosophy address confusion and regret. Both relates to buy, sell and hold. If you have a method which define to take decision for execution and at the same time do not create regret you are done.

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Money and Risk Management- Don’t hang your lever by a thread

The Power of Mathematics

Going back to memory lane, I happen to talk to a mathematician more a professor who happens to be an investor. Like many (including me) he had numerous questions, market is unpredictable- don’t know when to buy, when to exit, how much to buy, how much to exit. Then of course am I doing all right? The business is so confusing, people say it’s a great quality company but I lost my shirt. The whole theory as he explained first time was I guess market remained a black hole to him. And finally, he blamed if you are not a person from finance background it’s just happened to be luck which can work for you.

I could understand the story, it was year 2008 2nd quarter. Massive drubbing of stock market, the falling levels of portfolio, vanishing fortune tellers, a gloom and doom media adding to the rancor mindset. We see exactly the opposite now. I said have you explored usage of mathematics in stock market? He said how, what mathematics has to do with stock market?

Edward Thorp is a mathematician on a mission to prove the world he can conquer entire financial world through mathematical understanding and application. He smashed people in card game, busted casinos with tonnes of money, decimated the stock market. He hardly understood business behind a company, but he was holding a concept water tight to his chest and that is probability. You can read this fantastic book ‘A Man for All markets’. Is anyone saying one should completely become like Ed Thorp and leave everything else. No, but it gave confirmation to another perspective, ‘in a place of uncertainty one cannot ignore the game of probability and statistics.’

Edward Thorp is a mathematician on a mission to prove the world he can conquer entire financial world through mathematical understanding and application. He smashed people in card game, busted casinos with tonnes of money, decimated the stock market. He hardly understood business behind a company, but he was holding a concept water tight to his chest and that is probability. You can read this fantastic book ‘A Man for All markets’. Is anyone saying one should completely become like Ed Thorp and leave everything else. No, but it gave confirmation to another perspective, ‘in a place of uncertainty one cannot ignore the game of probability of statistics.’

A Man for All Markets: From Las Vegas to Wall Street, How I Beat the Dealer and the Market

The incredible true story of the card-counting mathematics professor who taught the world how to beat the dealer and, as the first of the great quantitative investors, ushered in a revolution on Wall …

Update: the professor mentioned here now give me tuition every quarter on position sizing. Needless to say, he has become a far better investor, thanks to his competence and love of mathematics.

Biting more than you can chew

I was wiped out nearly twice at early stage and when I look back one of the significant reason was not able to control the loss. Root cause- 1. Unaware of mathematical tools 2. Poor behavioural finance with stuffed egos on both sides of brain 3. Poor record and metrics maintenance.

Initially I was searching the answer through Buffet’s letter, Bill O Neil’s CANSLIM, Porter’s competitive strategy. After second failure and largely due to Professor it was awakening for me to use the concepts which are evergreen always.

That brings us to a question- what did Edward Thorp did which made him to win everything he played with? What made Jesse Livermore become bankrupt 4 times from huge fortune? How did Ed Seykota turned the table with data and statistics? Why can’t it be applied to long term investing? The quest led me to as usual a bunch of books, article and then of course a customised set of rules with ongoing review by the Professor.

Risk Management- like it or hate it, can’t ignore it

Risk is part of life, let us not be hysterical any further. There are four ways a risk can be treated.

Treat- by taking appropriate action to reduce the risk.

Terminate- by stop doing to avoid the risk completely.

Transfer- give it to somebody who can manage

Tolerate- accept as fact of life, can’t do much.

If you look at stock market we can’t use terminate. It’s simple if you have to invest you can’t stop buying and selling. Transfer again not for Do It Yourself type of guys. That leaves with two choices Treat and Tolerate. I was more of tolerate follower who moved to treat. If you are still part of tolerate (I can’t manage risk, market is monster, I am long term, I am short term, good business is good money), these are all ego statements. Take a print out and paste on your desk (I do it every year), after few years you will feel incredibly stupid as you move to better understanding blocks.

Treating the Risk- but before we should know what is risk

Risk in stock market is only one thing, risk of losing capital. Capital is inventory, capital is fuel, you lose it completely you are out of the game. So, despite beaten down twice on my knees why I was a ostrich buried in sands?

Salary was coming every month, I thought bankruptcy requires perseverance; eventually I will overcome. As long as I am working I will continue to have capital.
You know a great deal of money was profits reinvested. So, profit money encashed will not have Bapu’s face on notes.

Lambi race ka ghoda (I am a long-term investor), how much lamba I didn’t know.
Mr Market is inefficient, irrational and hopeless. I don’t care what Mr Market thinks, eventually fundamental will catch up with price.

The last point, please note. It was 90% responsible for my disaster, the bruises are still there.

Loss means more nightmares, more hard work

Inverse relationship, opposite cause and effect as Professor says is cornerstone of mathematics. Incidentally my father happens to be a celebrated mathematician also, I cross checked with him. Indeed, it’s true. What it is then?

Every time you lose a percentage of money you need better tricks, better courage to fight back. Look at table:

Loss Recovery required for breakeven
10% 11%
50% 100%
90% 900%
97% 3233%
99% 9700%

If you have to recover 9700% then better you go for pilgrimage and take help of saints to expand your life by 500 years. Never going to happen in your life time. Imagine I was trying to fightback 900%, why ego, ego! Let’s talk more in behavioural finance thread.

NEVER, EVER, EVER AND EVER PERMIT A LOSS WHICH CAN JEOPARDIZE YOUR ACCOUNT FOREVER. How much and all we will talk more with examples.

Consistency over heroics

Market is not gimmickry, you can’t come at 10 O’ clock and make 10 Crores by 4 O clock. If we have to stay long and survive that would emphasize we have to be consistent. What does this mean? I make 70% in year 1, 70% in year 2 and lose 70% in year 3. Do you know what would be my return? MINUS 4.5% APPROXIMATELY! Now if I win 20% in year 1, 20% in year 2 and lose only 10% in year 3, my return would be 12% per annum. This is not me mathematics says!

One small exercise I did after I was told by Professor. I replaced my big losses with smaller losses, compounding return just fly off like Jet! That itself was an eye opener for me how important to maintain losses as low as possible. Can we make it zero, no. What is optimum loss for investing and trading, we will come back later.

Disposition effect

The Guru’s of market studied millions of transactions for multi decades and surprised to found what made these accounts went busted.

https://faculty.haas.berkeley.edu/odean/papers/disposition/disposit.pdf3

Investors allow bigger losses than bigger gains (RGR-Proportions of gains realised to PLR- Proportion of Losses Realised)
Buy more shares when they are in loss rather than in gain
Happy with small gain than small loss
See the conclusion statement of study:

This paper finds that individual investors demonstrate a significant preference for selling winners and holding losers, except December when tax motivated selling prevails. This investor behaviour does not appear to be motivated by a desire to rebalance portfolios or by a reluctance to incur the higher trading costs of low priced stocks. Nor is it justified by subsequent portfolio performance. It leads, in fact, to lower returns, particularly so for taxable accounts.

This is a 1998 study, you know what I did after reading? I said I am a value investor, I buy a business and I don’t care. This paranoid attitude las led many to doom.

Loads to talk about this subject, before I sign off I want to highlight certain things which Lee Freeman Shore highlighted, you can read in this book.

The Art of Execution: How the world’s best investors get it wrong and still make millions

Over seven years, 45 of the world’s top investors were given between $25m and $150m to invest by fund manager Lee Freeman-Shor. His instructions were simple. There was only one rule. They could only i …

‘Personally I was shocked to discover only 49% investment ideas made money.’
This begged question- how they are making money if their ideas are wrong most of the times?

‘I am afraid that misanthropic investors can not rejoice at this point, it is perfectly possible for the opposite of love to be an issue.’

Stubbornness resulted a never change in mind which ultimately led to their fall.’

‘Large losses are impossible to accept.’

‘Selling a stock is hurting your sentiments, feelings of pleasure, pain and fear go a long way to explain omissions and errors.’

‘the fact is greatest minds of the planet can be wrong.’

Do the read book, I don’t want to disclose a point which will short change Author’s effort.

We will continue with plenty of examples, pages of experience I have to share. I found it extremely difficult to change some of my beliefs, this is for those who wants to adopt certain beliefs stated here ;please feel free to raise questions, write mails or whatever way you want to connect.

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This is the last post there under this thread, next I write will use both forum. Also I feel Guru Mantra series focus on value investing, it may help us a good discussion. It’s almost 30/40 posts under that thread, pasting all of them at one go will result obsessive content. Let me think how to do that.

Money and Risk Management- Honey, it’s all about money

Stock market is just a business

Whether you hold the stock as an asset or inventory it does not allow us to afford one carelessness and that is handle with care just like a business. This is another thing I learnt a great deal from speculators, once they buy a stock they become more vigilant, more watchful not lax.

Loss is A function of gain

Whether asset or inventory loss cannot be avoided by any businessman. As I had very little losses faced in life, perhaps one of most difficult beliefs to ingrain within me. We never saw salary going down, you can get lower marks but fail is almost a taboo for majority of guys. Unless there is a loss there will not be gain, it depends how we manage it.

When a vegetable vendor closes her day out, she throws away those unsold items which cannot be further sold say like smashed potatoes, rotten tomatoes etc. She does not fret, oh my god I should have checked everything in morning, how can it be rotten? Over a period, she realises she is likely to lose 5% say of purchase as normal loss i.e. being thrown at end of day. The price she sells includes losses. How do we manage in investing world?

First, we need to assume we will have losses, unavoidable. In fact, we are in a more complex and uncertain business than vegetables, we will have more losses than many other businesses.

Second, if we allow losses more than profits we achieved year after year, month after month we have to close down our business. Imagine same vegetable vendor is not able to factor the normal loss in selling price, she has to take a cut overall loss only. After some point shut the business.

Third, if there are good days don’t complain and don’t be greedy. Immediately make a plan for partial profit booking or watch closely so that you don’t lose everything. And also, don’t throw up mental models in air to justify price rise with your brilliance. When it rains and there are few vegetable vendors they just sell and close the day. Our problem is market is not a onetime event, battle goes till the time we want.

Fourth, gain and loss depends on external factors as well. If there is an economic depression no matter how much heroics you have your gains are going to come down. Tighten your losses, this is you have to do; unlike gains it won’t adjust automatically.

Fifth be bold when in profit, be fearful when in loss. This has nothing to do overall market conditions. If you are sitting in loss in a huge bull market, others may be bursting crackers for you it’s about soul searching not euphoria. Similarly, when you are sitting in profits, make it work harder for something in first place which worked for you.

Please note I am not asking here you take loss frequently, small or anything that short of things. These are attributes of mathematics which will impact results. One need to customise carefully before building a plan.

Be fearful when others are greedy, be greedy when others are fearful. I agree with this statement with a caveat. I don’t have a problem with what people thinks but problem with what people acts. Because I belong to people!

Compounding- eighth wonder of world

The most celebrated scientist of our time was absolutely right. But like all wise men he didn’t tell us how to use, because he knew he would get into a meaningless discussion on a subject which can only be implemented customised. Anything customised we are talking about 5-6 billion case studies on earth, equal to number of humans!

Compounding works much faster with a variable time

Waiting for a long long period can some time works against you. The compounding short spells provide far superior returns than long period. Don’t want to believe?

Situation One

I invest in stock A at 100 Rs, stock goes up to 100% for year 1 and I exit. That means I get 200 Rupees. I invest that 200 Rupees into Stock B and get another 100% by year 2. My value will be 400. Right? Look at this now:

Situation two

I invest in stock A at 100 rs, goes up by 50% by six months. At end of six months my value will be 150 rs. I invest in Stock B for balance six months. My value becomes 225 Rs by end of year 1. I rotate 225 rs to Stock A for next six months at 50% gain. By end of 18 months my value becomes 337. Last six months I came back to Stock B for last assault. With a 50% gain I move to 505 rs as final value.

Two stocks, we compounded twice at 100% and compounded 50% four times in same time bandwidth. Difference in first case 300% absolute return, second case 400% return!

**Warning: not advising you to adapt these methods, just letting you know how beliefs needs to broke for proper usage. **

In a non-linear place with volatility acceleration compounding is a miracle if one can manage. One of major secret of John Maynard Keynes to Paul Tudor Jones.

Magic of expectancy

I owe this to Dr Van Tharp classes, of course I had to grind multiple times before it fits into my DNA. Imagine you are building an asset, and I come and tell you great young boy! We are so happy you are building a marvel but let me tell your chance of making profit is zero. You would get shattered, right? Welcome to mathematics my friend, I owe my father for his valuable coaching when he was not looking for my career.

Situation 1: you tried 10 stocks, win 5 and lose 5. Capital allocated at individual stock 1 lac for simplicity.

Situation 2: you tried 10 stocks, win 4 and lose 6. Capital allocated at individual stock 1 lac for simplicity.

Situation 3: you tried 10 stocks, win 3 and lose 7. Capital allocated at individual stock 1 lac for simplicity.

Now watch this, your average gain in situation 1 is 50000 and loss is 40000. Situation 2 we replace 40000 losses with 20000. For situation 3 we change 20000 losses to 8000.

Profit and loss now: Situation 1: INR 50000

Situation 2: INR 80000

Situation 3: INR 94000

Despite of winning 30% of stocks still you delivered almost 100% return more than situation 1 where you won 50%. Why this happen, probability is at play.

In stock market where we live with uncertainty probability becomes most important tool for us to manage. Never play a game with negative expectancy.

How to calculate expectancy?

Average Gain for Situation 1 to 3: 50%

Average loss for Situation 1: 40%, Situation 2: 20%, Situation 3: 8%

Hit rate of win: Situation 1: 50%, Situation 2: 40%, Situation 3: 30%

Expectancy is equal to (Probability of win* Average Win)- (Probability of loss* average loss)
So, expectancy for Situation 1 is (0.550000-0.540000) or 5000. Mathematical expectancy is MINUS 0.775.

Situation 2 is (0.450000-0.6 20000) or 8000. Mathematical expectancy is PLUS 0.4.

Situation 3 is (0.350000-0.78000) or 9400. Mathematical expectancy is PLUS 1.175.

See how powerful is situation 3 is. Now replace loss 40000 with 80000 in situation 1 (familiar with catastrophic losses?), expectancy becomes MINUS 15000 (0.550000- 0.580000). Your game is over, never go to a war by knowing you will lose from day 1. That’s what Gambling are, organiser always wins! Because before every hand is played expectancy is calculated, same goes for lottery.

ALWAYS ATTEMPT A PROJECT WITH POSITIVE MATHEMATICAL EXPECTANCY.

Please do read more about mathematical expectancy.

Multi bagger with multi looser is dooms day

We all love multi baggers, they are great to change balance sheet. Even one can change your aspiration, I been there one stock is responsible for today what I am doing largely. But now imagine multi baggers with multi losers, what will happen? Results may be shocking than you think!

Now let’s simulate: 10 stocks, capital invested in each stock 10000 INR. Total capital 1 lac

Situation 1: our average gain is 700%, loss is 90%. Probability of winning 10%. Net result MINUS 11000.

Situation 2: our average gain is 100%, loss is 50%. Probability of winning 30%. Net result MINUS 5000.

Situation 3: our average gain is 20%, loss is 10%. Probability of winning 40%. Net result PLUS 2000.

Even a 7 bagger when you lose 90% on 90% of stocks it cannot protect you. But a small 20% profit with small 10% loss and just with 40% winning stocks you are back in positive territory.
If I make 7 baggers in situation with 10 bagger I am back in 81000 Profit.

Don’t get carried away by theoretical numbers, maintain your own metrics to know where do you stand. But please do note:

Both short and long-term investing works as long as mathematics work for you. How did I survive? I lost 60% of stocks once with one 200 bagger which wiped out all loss. But having 200 baggers is difficult than we think.
When you allow loss to creep in your portfolio do not forget these numbers. Calculate once at least to know where do you stand.
A lot of message missing now, not able to pack them at one go. For example, like adding to profit line, in equal position size can create more havoc etc. Let’s discuss next time!

I leave with you my next unconventional thought- ‘Average price of a stock is one of biggest lie told to me’. Give me a chance to put my workings next time, of course comes with caveat!

But trust me unless you maintain record and metrics you won’t even know where you are, by just calculating net worth number one can jump like jackal that I cracked 40% CAGR, ahoy!

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Very informative article. Thanks