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Small and Many or Big and Few?

May 31, 2016 | Dr C K Narayan | Technically Oriented | 7 Comments

Small and Many or Big and Few?

The unending search for profits.

The problem for a trader is always about whether he/she should go for a series of small profits or perhaps take aim and shoot for fewer but bigger ones. This unending dialogue that a trader carries on with himself somehow never seems to end. It doesn’t and wont because the problem lies not with the market but within the trader himself.

This is often the scenario that happens. You take a trade and it runs into favour. Happy with the profit, you quickly pocket it. The stock then runs some more. And some more. What you got is just a small portion of what was available. You beat yourself up, saying what a chump you are, etc.etc. The next trade is now on and it too runs into profits. You remember the last time, how you took some loose change and left the rest of the money on the table. So you decide that this time you will go for the bigger one. You hold on past your normal ranges of holding, put up the margins, study charts, make targets etc. Then you are waiting- for the stock to deliver. It goes up some more, you get excited but then it begins to stall. It reverses a bit but you tell yourself that you are in this for the big one and hence need to hang in there. So you do. Then it falls some more and now it is beneath your entry point and into some small losses. The heart rate picks up a tad but you remind yourself again that this is the Big One and that you need to stop being this small-change-stuff kind of guy and elevate yourself to the big league. So you hold on some more. And the losses increase, because the stock keeps moving against you. Now, the stop levels are gone- because you moved them or removed them (the Big One, remember?). So you are kind of in a territory where you plain don’t know what to do. Your method has gone for a toss now. And, in a loss, no one can really give you any advice that you will listen to anyway! Next day the stock drops some more and now you cant bear it. The loss is large and the pain is much. So you decide to end it. The big one turned out to be a Big Loss!

Two aftermaths can follow this. In the first, the stock continues lower. So you feel good, that you were ‘ man enough’ to take the loss and ‘smart enough’ not to take a bigger hit. The second is that the stock stops falling and then reverses back into a quick advance, soon going past your purchase price and heading for those targets that you had set. Now you feel terrible, once again brow beat yourself for not sticking with it, lacking conviction etc. etc. The worst thing that happens out of this kind of move eis that you learn the wrong lesson- that you should never book a loss!

The final aftermath is the same, however. You will go towards a thinking that it is better to be a quick in and out trader. At least some money is made there, you tell yourself. This is so until the next round of the same things happen. Then you will sing the other tune- which is, small margin trading sucks, it is the big one that really matter, so no more this in and out stuff and I am going only for the sure thing from now!

How can we differentiate the two trades? Is one better than the other? The answer is they cannot really be compared. Profit cannot be the sole yardstick by which everything is measured. For a series of small trades to occur, realize that you need to have a well-tested method that keeps throwing out trades with some degree of frequency. Now, if this method has a success ratio of 55% and its profitability is between 1.5 to 2 (i.e. you make 2 points for every point lost), then you just want to stick to the small profit method and hope that your method throws out a lot of them. If I make, say, a thousand from such a trade, then, with a 55% hit ratio, I want to make 500 such trades over the next quarter or couple of quarters. That will carry me to the finishing line!

Finding a Big One trade is more tricky. Not only does it require more analysis, it also requires a variety of things to come together as the trade may run on for much longer. The more the length of time your trade is in the market, the more risks you run. Hence realize that the big one is, by definition, a riskier trade. Can you afford this higher risk? Are you capitalised for it? These are questions that you need to ask yourself. And answer honestly. Further, these kinds of trades come along once in a while. It is not like your trading method is going to throw out these types of trades several times in a day! So you also need to develop the patience to wait for these trades to appear. And be present when they do appear. And be able to take them. You also need to wait for them to play out and that also involves dealing with higher risk.

Most traders dream of working the least and making the most and hence the attraction of the Big One. But they don’t understand or appreciate all the other things that come along with this type of play. Most of them also have a poor understanding of the small profit game. They don’t realise that they need to have a method that keeps throwing out the opportunities. If you don’t have this, you have no way of knowing whether the next trade that comes along is a big one or a small one. How can you then decide which way to play it?

Trading, like any other profession, is a hard one, needing a lot of work, a lot of thought and a lot of dedication. Anyone who thinks it is an easy way to riches will soon find himself in the poor house.

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