Trading and Gambling or Lesson from Sholay!

Samba has his rifle cocked and pointed at Veeru’s head under instructions that he should shoot the moment Basanti stops dancing. Basanti dances until she can dance no more. Then a shot rings out. The camera zooms out and instead of a dead Veeru we see Samba slowly tumbling down from his perch. Jai has shot Samba and saved the day as he covers Veeru and Basanti while they escape Gabbars den.

We all know happens next. The ensuing chase sees the three cross a wooden bridge which is the only way to get across to the village and try and prevent the dacoits from crossing over to their side. Jai asks Veeru to take Basanti back to the village and bring back reinforcements and ammunition as he tries to single-handedly hold off the dacoits. Outgunned and out ammoed or if you prefer- outbulleted, Jai knows that his only chance to prevent the dacoits from reaching his side is to destroy the bridge.

As luck would have it, there is a stick of unexploded dynamite on the bridge. The dacoits, knowing that Jai is running out of bullets, start walking on the bridge towards Jai, all the while shooting at the rock behind which he is hiding. Seeing that he has only 3 bullets left, Jai suddenly comes out from behind the rock and walks deliberately towards the dynamite stick even as the dacoits start shooting at him. Ignoring the bullets hitting him and focusing only on the task at hand, Jai valiantly takes 3 shots at the dynamite and succeeds in blowing the bridge and most of the dacoits with the 3^rd shot. This was one of my favourite action sequences in that epic film.

In case you are wondering what this piece has to do with trading, allow me to blow your mind! Jai embodies the quintessential gambler and the dacoits the casino or the trader. Jai knows that he is outgunned and outbulleted...(I know there is no word like outbulleted...but I like it nevertheless) i.e. he does not hold the edge. He knows that when he does not have the edge then even the best risk management i.e. using the bullets sparingly will only delay the inevitable. The odds being against him, all that risk management can ensure is that he delays the end. The law of large numbers will ensure that the edge that the dacoits hold against him will prevail if the game is played long enough. The only chance he has of winning against the dacoits is to go ALL IN or take large risks and hope that lady luck favours him. That is what happened when one of the 3 bullets he had left in his gun hits the dynamite.

On the flip side the job of the trader is to be in the position of the dacoits. Like the dacoits whose edge was their larger numbers and the large supply of ammunition, the trader has to develop or discover (I prefer the word discover to copy) a system which gives him a small edge over the market. An edge that when used often enough will ensure that the trader wins. Once he has the edge, the only thing that he has to do is ensure that his capital is preserved through efficient risk management so that he can play the game over a long enough term for the law of large numbers to work its magic in his favour.

For this to happen, the trader has to be wary of not just the normal bullets coming his way but also of that lucky shot that blew the dynamite and also blew out the dacoits. His risk management in other words should ensure that there are no unexploded sticks of dynamite left lying around to take a hit from some lucky bullet. It should also be robust enough to handle not just the expected (that the dacoits will succeed in shooting Jai) but also the unexpected (that Jai will shoot not at them but at the dynamite).

So this brings me to the end of another lesson from Sholay. What a great movie! It has something in it for everybody including traders! This is also my answer to everyone who equates trading to gambling. The gambler knows or at least should know that he does not have an edge and all he can hope for is luck to favour him. A trader, on the other hand, believes he has an edge and depends on his risk management system to pull him through over the long term. Having thus paid my tribute to Sholay, I can let you know that I am currently long in the Nifty and will cut my long position and go short below 5170.