Let The Market Do The Talking
Or, how to overcome a bad habit. May 21, 2015.
One of the clichés of the market, particularly relating to trading, is to be mindful of your risk. Everyone goes on and on about how we should risk 1% or 2% or some such small number of our capital on each trade. Everyone reads this and goes on to the next page without ever thinking about it! I feel one of the main reasons for not applying this otherwise wise advice is that very, very few traders in the market really have an assigned ‘trading capital’! The typical trader just, well, trades, unmindful of the quantity that he is supposed to do, unmindful of the amount of risk he is supposed to take. More, the typical trader has, often, a bunch of stocks that he has a position in. This makes it a portfolio of stocks and hence the trader may also have to think in terms of portfolio risk and portfolio beta. But none of these are ever considered because the trades themselves are seen on an individual basis! As Mark Douglas has put it, this is the reason why traders keep dying a death with every trade of theirs. Eventually, the strain becomes too much, the lack of success becomes demotivating and the ‘relative’ success of others becomes a factor to abandon what one is doing.
I was surprised to hear my old friend Ramdeo Agrawal say on TV the other day that in investing one has to address the downside mainly and leave the upside to fend for itself. He is a value investor and therefore believes that if he has found the right stock the upside will take care of itself. It will be the market’s process of discovery that will then create multi levels of returns on your investment. But the process of addressing the downside prepares the mind to deal with the non- performing times of the investment. This is very similar to what we stated earlier, about risking a certain amount of money only on your trades. In the case of the trader, the consistency of his methods will take care of the profits from the trade. He should, as Ramdeo says about the markets, allow the method to determine how much of profits can accrue in that trade! What really happens is that people will find Ramdeo’s advice rather easy to handle when it comes to investments but will completely ignore it when it comes to trading! That is silly because trading and investing are essentially the same, just with different time horizons for the life of the position! When it comes to the trade they are all over the place with its non-performance over the next N minutes! They worry so much about the profits that they overlook the fact that the concern has to be about the risks! Ultimately, they end up with small profits on successful trades and large losses on unsuccessful ones.
The chain is easy to break. The method is the door. Faith in the method is the key for the door. The method itself will tell us the risk involved. Look carefully at that and then allow the trade to run as per the dictates of the method. Value investing calls for remaining invested until price and value meet eventually. That may take months, sometimes years and sometime even decades. It is a style that is not for everyone as it needs a certain mindset. In quite the same manner, trading using a method also demands that you allow the possibilities of the method to come thru. That may take hours or days or sometimes weeks. Once we adopt the mindset of accepting the downside risk and also allowing the method to take care of the upside, you can get out of the persistent problems that most traders face.
You decide the risk. That’s all you control. The reward is decided by the market. You don’t control that, ever. But your method can help you track the market’s intent. Leave it to the method to do that work.