All Hail the Saviour

Hallelujah! Today is the day the evil short sellers in Asia get their arse kicked and their heads handed to them on a platter. This has already happened in Europe and the US yesterday. Oh! the pleasure, the fun in seeing them getting killed! This ritualistic cleansing of the market of this evil of short sellers is necessary to maintain the balance of the system.

Talking of balance, it is said in Hindu scriptures that God has promised    "Yada Yada hi Dharmasya, glanir Bhavati Bharata, Abhyutthanam adarmasya tadatmanam srijamyaham. Paritranaya sadhunam, vinasaya cha duskritam, Dharma samthapanarthaya, Sambhavami yuge yuge" In case you are one of those who like me do not understand its meaning, I will attempt to copy its meaning from wikipedia!

"Whenever the balance of the Universe is disturbed by the excess of evil, then I reveal myself as the cleansing force. For the protection of the good and destruction of the evil, I incarnate myself millenium after millenium."

For the markets, BIG BEN played the role of the saviour and also the slayer of evil (read short sellers) all the way from 2008 to around the time of QE2. Since then he seems to have given up on that role. This emboldened evil to raise its head once again. Just when one thought that there is no hope left and that evil can run roughshod over all of us, God proved that he has not forsaken us. He incarnated in the form of Draghi and has again played the role of slayer of evil.

The only problem in this is that the promise of God in the Hindu scripture was to incarnate only once every millenium. The way the market is currently, He is being forced to incarnate with increasing regularity! Who knows? If the good (read the govts and the people) continue in their good old ways, we might even actually be able to test the limit of His seemingly unlimited power!

Ok, just to be clear about where I stand, evil is far more interesting than the insipid good! I am short and am remaining short until 5178 is crossed on the futures! At that point I ditch evil and turn into a good boy!

Another Lesson from Mahabharata

The title is of this note makes it clear that this is another rambling story on the connection between an epic and trading. Despite that if you have opened this note and do not want to carry on reading, I will leave you by saying that I am short and will cut my short position and go long above 5331. So now without further ado, I move to tell you the story that was at heart of Mahabharata.

Devavrata was standing before Satyavati and her father, the fisherman, and asking him for permission to marry her off to his father Shantanu who was in love with her. The fisherman reiterates his worry that the sons born to her would never be given the Kingdom. Devavrata is intent on securing her hand for his father and so he vows never to be king and to forsake forever his right to the kingdom. The fisherman is not satisfied with this. He says that while Devavratha can forsake his right, Devavratha's sons might not. They would claim it. To counter this, he makes his now famous vow. He vows to remain a celibate throughout his life and never to marry another woman or know conjugal bliss. This way he would never have children who could claim the throne. Not just this, he also vows to always see his father's image in anybody who rules the throne of Hastinapur and always work for and support the kingdom. This famous vow gave him the title with which he is now better known-Bhishma.

Bhishma did what he thought was the right thing to do for the sake of the king as well as the kingdom. A king who is lost in love and depressed is hardly in a position to rule well. He took these terrible vows not only as his duty towards his father but also as his duty to the kingdom of Hastinapur. He did what he thought was the right thing but the final outcome of his decision was his blind loyalty to the throne of Hastinapur and his inability to prevent injustice to the Panadavas which finally lead to the Great War of Kurukshetra.

In various ways, the epic of Mahabharata continues to highlight this familiar theme. One can only undertake what one believes is the right course of action. The outcome of that action need not be good nor can one have control over the outcome. It is now immortalised in the famous quote in Bhagavad Gita,the holy book of the Hindus where Lord Krishna instructs Arjuna to go to war with his own cousins, elders and teachers

“Karmanye Vadhikaraste, Maa phaleshu kada chana

Maa Karma Phala Hetur Bhurmatey Sangostva Akarmani”

Loosely translated the verse means “You have a right nay a duty to perform your action but you have no right to the fruits of your action” The second line admonishes Arjuna to “Never consider yourself the cause of the consequences or results of your actions and to never be attached to NOT doing your duty"

On the face of it this might all seem totally unconnected to the process of trading but in reality this is the essence of all trading. A trader has to have the ability to know what is the right course of action and to take it regularly without worrying about the immediate outcome of it. Once the trader has fixed on a particular methodology to trade, it is his duty to repeat it regularly without worrying whether that particular trade will result in a profit. It is also incumbent on the trader to disregard all other information (actually noise, since anything that is not part of his defined methodology is noise for him).

But as in the story of Bhishma, a trader who follows this disciplined approach to trading is not guaranteed success... he only enhances his chances of success. However, whatever the outcome of the trade itself, the trader is guaranteed the solace of knowing that he did the right thing.

While doing the right thing seems like a simple injunction to follow, like most simple things, it is not an easy thing to do on a regular basis. It is really tough to stick to this. Luckily for me, being ignorant of all other methods of trading and investing has been a boon. I know of no other way and therefore, whether easy or not, am forced to stick to my method of trading.

The enemy within

I have written about the epic Mahabharata a few times in the last couple of months. In the interest of fairness and justice, I cannot leave it at just that. I have to mention the other two epics viz Ramayana and Homer's Iliad.

Iliad describes the war between Agamemnon and other Greek states including Sparta against Troy. Paris, the price of Troy, abducts Helen the queen of Sparta and destroys a well earned peace. Menelaus, the King of Sparta goes to his brother Agamemnon for help to defeat Troy and exact revenge. This is the start of the 10 year war.

The fact that the war waged for 10 years shows that the two sides were well matched. The fort of Troy was impregnable in those days of swords, spears, axes and bows and arrows. After ten years of on and off warfare, this war was beginning to tax the Greeks will to continue and they were on the verge of giving up. It was then that Odysseus builds the wooden horse which has since become famous as the Trojan horse. Thinking that the Greeks have accepted defeat and left their lands offering this horse as a gift to their Gods, the Trojans celebrate and take the large wooden horse, filled with the Greeks back into their fort. We all know what happens next. In the night, when the city is asleep after the wild celebrations, the Greeks emerge and massacre, loot and pillage Troy. What could not be done in 10 years was accomplished in hours.

Consider the other epic Ramayana where the War starts because Ravana abducts Sita, Rama's wife. Lanka was described as impregnable and it could indeed have been the case but for the fact that Vibhishana, the brother of Ravana, defects and joins forces with the armies of Rama. This inside information was invaluable in the ultimate defeat of Lanka.

In both the epics, the war wouldn't have started but for Paris and Ravana succumbing to their desire for Helen and Sita. Troy wouldn't have lost the war if they had not believed in their own greatness so much that they actually believed that the Greeks, who were fighting them so hard till then had made them an offering and left their lands. Lanka would not have fallen but for Vibhishana's help. In both cases it was the enemy within that caused the downfall of Troy and Lanka.

The moral for the trader is not that he should start looking for problems within his methodology or the enemy within his family and relatives in order to improve his results. The moral of the story is that the genesis of the trader's problems lies not outside that is with the market, his method, the world in general or his luck for that matter but most often within himself. It lies in his mental framework, his worldview or his behavioral issues. The trading results would be much better if the trader can conquer himself first.

This unfortunately, as we all know is the hardest battle to win and easier said than done.

This note is my last one in my series of notes which used stories from epics or films to highlight problems faced by investors or traders. I have to go back to discovering Laws of Trading or some such stuff in the coming days. For the moment let me say that I have cut my long positions and gone short below 5263 (I have been mentioning this for the last couple of days)

Trading and Gambling PartII

Picture this sequence from the film the Last Samurai. Ken Watanabe, Tom Cruise and their band of Samurai warriors are ranged against the vast army of the Japanese Emperor. The Samurais have their sword and bows while the Emperor’s army has rifles with bayonets, cannons and even machine guns. The armies charge against each other and the battle is joined. The Samurais battle valiantly. Their display of adrenaline driven courage is awe inspiring. They kill two- no three soldiers for every Samurai they lose. But in the end the heroic battle is in vain as they all die in that battle field, every one of them to the last man.

The Emperors army, on the other hand, has to do very little to ensure victory. The odds are heavily in their favour. Sooner or later, their victory is assured. There is no heroism in their victory. It is just another day in the office for them.

Now picture the first sequence of the film Gladiator. Russell Crowe and his army has fought many battles over ten years and conquered vast territories. The only battle left is against a band of headstrong locals of Germania. The locals are hardly an army. The vast Roman army is a well oiled machine. Still the locals fight to retain their freedom. The battle is furious but swift. The locals are crushed. At the end of the fight, all Russell Crowe can feel for his ten years of war is a sense of tiredness and a sense of boredom. Ten years of battle against ill prepared foreigners has taken its toll. He no longer wants to continue to lead the army in a fight against strange lands and cultures.

In these two sequences, who do you think had the most excitement? Who were the most alive? In the Last Samurai it was clearly Ken Watanabe and his Samurais. In the Gladiator it was clearly the locals. Who do you think had the odds against them and who held the edge? The Samurais and the locals had the odds heavily stacked against them. The Emperor’s army and the Romans of the Gladiator clearly had the edge. The losers were fighting a heroic fight against all odds. The battle against the odds was an exciting one. Each one of the losers was bursting with excitement and adrenaline as they fought furiously in a losing cause. The winners on the other hand knew that all they had to do to win was to engage the losers in battle. Their sheer numbers would ensure victory. It was only a matter of time. The longer the battle waged the more certain their victory. Theirs was a victory without glory.

This is the curse of both the trader and the gambler. The gambler fights against the odds and therefore has a lot of excitement until he keeps betting. But the longer he plays and the longer he craves this excitement the more certain his defeat. It is easy, no there is great lure, for him to continue bet until his money runs out. Every bet gives him an adrenaline surge. He is alive every moment. This excitement, this sense of living life on the edge, is the lure and also at the same time the cause of the downfall of the gambler.

On the other hand, the trader has the odds in his favour (or let us at least agree he should have the odds in his favour if he considers himself a trader). He has to mechanically continue to bet as and when his methodology requires him to. There is no excitement or a sense of individual achievement for the trader. To top it, playing this game with efficient risk management will ensure that he makes only normal returns over a long period of time. In order to be successful the trader has to be prepared to treat trading as a business and not as a source of excitement. This is the curse of the trader.

The trader has the odds in his favour but gets boredom as a consequence. The gambler gets all the excitement but gets ruined as a result. So the choice really is between winning with boredom and losing with excitement. The problem in the real world is that even when the choice is laid out in this fashion, a lot of people might prefer the later.                                                                                                 

So this concludes my lesson on Trading and Gambling! For me a great way to distinguish whether what you are doing is trading or gambling is to ask yourself how you are feeling. If you feel fear then that is fine. A little fear of losing is normal. On the other hand, if you are always on the edge and always excited while you are trading then the chances are that what you are really engaging in is an activity where you are not sure of the odds and an activity where you do not have a clearly defined method and hence your sense of personal decision making and involvement in the trade is high. Unfortunately, this kind of trading comes awfully close to being gambling with its resultant consequences! 

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.

Luck

I was of the opinion that the people who say that "Money is not everything" are generally people who think they do not have enough of it. Ditto people who say that family is more important than success in career.

I was also of the same opinion when it came to matters of Luck. I believed that Luck was a concept developed specifically by unsuccessful people to explain away their lack of success. But recently I read a study which made me rethink. In Michael J Mauboussin's book Think Twice he highlights a study conducted by the Columbia University which shows that in real life i.e. in social worlds, social influences can catapult an otherwise average performer into the top ranks. While above average skills are only sufficient to ensure that you would not be thrust into the bottom, to be thrust into the top you need average skills plus the another factor that social worlds bring into the picture. That factor can be defined as Luck.

In case you are seriously inclined to read about the study then please write to me and I will send you the details. (BTW, if I get Rs 1000 for every person who did not ask for the details of the study, I will be a rich man!)

In any case, I do believe, that as long as you are trading on your own account, luck does not have a major role to play in your success. It is only when you define success as having a large assets under management that you come under the influence of social worlds and therefore under the influence of the social factor called Luck.

As far as my trades are concerned, I am long and will remain long until 5170 is broken.

The Future Syndrome

The Traderman Diaries have been appearing on and off in my musings. While he maintains a daily diary, most often his notes are irrelevant to trading. But in recent times he seems to have changed to writing about issues that haunt a trader. This is what he wrote on Tuesday evening after the market hours and I reproduce it here.

Dear Diary, I had a great time today. I saw a colleague reading the papers intently. Then I saw it was the horoscope! What is it with people and knowing the future? I tell you I cannot understand it at all! I want to live in the NOW! Any way I am digressing. So I asked this friend, “Can your astrologer predict where the market is headed too?” I thought I had asked a rhetorical question you know. But he actually gave me details of a couple of good astrologers who are specialised in market predictions!

The poor fool, if the astrologer could predict the future, why does he not trade it? In any case dear diary, I, the Stupendous Traderman, am not here to enlighten. I am here to make money so I encouraged my friend to continue in his endeavours to predict the future of the Nifty! One competitor less to worry about I say!

Dear Diary: Then I quickly got down to my analysis of the market! I am long on the Nifty as per my trading system. I then looked elsewhere to confirm my long trade. I looked at the Baltic Dry Freight Index. I assumed that the Freight rates must be a function of volume of trade between countries which in turn must be an indicator of the strength of the economy. I am not completely certain that this logic holds all the time but a cursory google search did not reveal any obvious objections to this deduction. So I went ahead and investigated the Index. To my dismay I found that the BD Freight Index is in a downtrend and definitely does not support my long position!

Dear Diary, after this piece of bad news I doubled my efforts and searched the ratio of Copper to Gold. The logic being if this ratio outperforms then it means that the demand of industrial metals exceeds that of precious metals...... usually a sign of improving economic performance you will agree. Unfortunately, there was nothing there too to support a rally. The trend is still down for that ratio.

Dear Diary, It looks like the economy is not really picking up at all! If the two indices are predicting anything then it is that the market uptrend cannot continue for long. It looks like I am in trouble dear diary!

But what is wrong with me? I must be losing it! How come a superhero system trader like me is worried about other assets and looking for information that can predict the future of the Nifty? Have some villains managed to slip in some virtual kryptonite into my trading software?

Dear Diary, I am beginning to realise that even a great trader like me is not immune from the seductions of predictions or forecasts of the future. I see deep down a need to be able to pre-empt the moves in Nifty rather than react to the moves in the Nifty. This need for prediction afflicts everybody because it is so insidious. It manifests itself in some through a search for astrological predictions and in others in their effort to find some lead indicators which can predict trends in the assets they trade! In some others it manifests itself in reading every news paper and watching multiple Business News Channels in an effort to get every piece of information in the market!

This mental affliction, this syndrome, I will call as the Future Syndrome. A trader afflicted by this Syndrome tries to find a way to forecast the move in the asset he is trading using any and every data that is available in the market.

Dear Diary, you might be forgiven for assuming that I would be satisfied with discovering this incredible Syndrome that afflicts all traders at some time in their career. But not for nothing am I so successful! Not for nothing do they call me the Stupendous Traderman! I had to find out who are the likely candidates to be afflicted by this syndrome, what determines the intensity of this affliction and also find a remedy for this.

On deep introspection and a lot of research-which included staring out of the window for 2 minutes in deep thought- I have come to the conclusion that this syndrome usually afflicts the trader whose P/L is not healthy. And the intensity of the affliction is inversely proportional to the profits in the book. The lower the profits the higher the intensity of the affliction! This I will call the Universal Law of the Future Syndrome.

Do I stop at this and leave the poor sufferers to their lot? No. Never. A lesser person may have been tempted to do so but I am duty bound to serve my fellow trader. I am blessed with great intelligence and as my fellow superhero Spiderman once said “with great power comes great responsibility.”

So again I went into my introspection mode and divined the solution! The cure lies in just trading each asset on its individual merit without worrying about the correlation across asset classes. Just follow the rules of trading for the individual securities. A couple of weeks of this single minded effort will be very effective in ridding oneself of this syndrome.

Can you imagine!!! In one day of writing this Diary I have discovered a Syndrome, found the law that governs it and even discovered a cure. Just think what can happen if I continue to write this Diary for a year!!!.

And so ended one more day of the Diary of Traderman. He is full of himself but there is some truth in what he says. The need to predict the future can lead to some disastrous consequences for a trader. In any case, I am long and will continue to remain long until 5170 is broken on the Nifty futures.