Skill Sheet: What You Will Learn Here
- Understanding the probability of succeeding in trading
- Factors that improve the probability
As we wind up this learning journey, we hope that you found value in what we had to offer. In this concluding chapter, we want to assimilate the key learnings from Espresso Bootcamp in a way that will serve as a ready reckoner that you can revisit in the future.
In one of earliest chapters, we talked about “trading versus investing”. But as you will have known from reading it, only the title pitted trading “versus” investing as if the two were mutually exclusive. Actually, most market participants would do well to invest as well as trade. In fact, a good thumb rule could be the 25-25-25-25 rule.
Here 25% of investible money is parked in a well-diversified active or passive mutual fund, another 25% is allocated to direct stock investing. The other 25% can be used for swing or positional trading in the cash market while the remaining 25% could be used intraday and/or derivatives trading.
This way, a portion of your portfolio will get you market like returns while others try and generate alpha, or excess returns over the benchmark.
Remember that the above asset allocation is only a thumb rule and also pertains to the equity side of the portfolio. Your overall portfolio mix between equity, debt and other assets should be determined by broad asset allocation rules or agreed upon in consultation with your financial planner.
Direct Stock Investing
Speaking of direct stock investing, in Module 3, we discussed a number of ways in which you could invest: such as value and growth investing. But here’s one more perspective: are the two mutually exclusive?
Value investing traditionally means buying stocks trading at low valuation metrics like price-to-earnings or price-to-book while growth investing focused on higher-valued but fast-growing companies.
There is a middle ground here: investing in fast-growing companies trading at reasonable valuations. The market will not give you this opportunity frequently, which means you will have to invest lightly for most part while going in big during broad-based market crashes.
The Trading Journey
A SEBI report recently pointed out that nearly 90% of F&O traders lost money in 2022. Is the statistic alarming? Not so. This is a common law we see in all aspects of life. Only 10% of startups succeed. Only 10% of doctors become really famous. In fact, over the last 30 years, only 7 out of 30 companies still remain part of the Sensex.
The pattern of 90% of participants in any competition set losing plays out quicker in trading because trading is inherently more volatile. The second reason is most people confuse the ease of playing (creating a demat account; having little capital) with the ease of winning.
The solution? Start small, be methodical. Trading is more a soft skill – psychological -- game than a hard skill venture. It doesn’t matter how many technical indicators you are aware of. What will matter is whether you can identify a winning trading system, follow it consistently and hold your nerve when it is not working for you. All this will happen only when you a: implement proper risk management and b: have realistic return expectations.
The Returns from Trading
Just as people confuse ease of playing with ease of winning, most traders equally let volatility play tricks on their mind.
By now, you will know that F&O trading is an inherently volatile activity. It is not surprising to see an option double in price or fall 100% in a matter of days, or even hours.
This means that for someone who does not follow a disciplined trading style, they suffer from two problems.
One, they will have periods of outsized returns, which gives them an illusion of superiority. But it is likely that large losses will soon follow.
And two, there is the law of maths, which says that when you reduce a number by a certain percentage, it has rise much more to come back to the same level. For instance, to recover from a 10% loss, you will have to gain about 11%. To recover from a 50% loss, you will have to gain 100%. To recover from a 90% loss, you will have to gain 900%.
The above two points mean that since disciplined trading is something is learnt through a lot of hard work, mental fortitude and over time, the market is replete with stories of newcomers who were lured by hopes of easy success only to have their dreams dashed and their bank accounts emptier.
So while we explain the nitty-gritties of technical analysis, trading styles and derivatives in modules 4 to 10, the key really lies in the last two modules where we focus on execution and market psychology.
Once you realise trading does not need to be a wild roller coaster ride which will often picks you from the top and throws you out at the bottom, you will be aware of the trick played by volatility plays.
The success template for great traders is almost always this: trade less, target no more than 5-10% returns a month (to the extent where some even shut down their computers after reaching their target) and achieve this by focusing on how much you lose when you’re wrong and how much you win when you’re right.
The Opportunity Cost
Most people treat trading as a part time endeavour when it is supposed to be taken as a serious activity that requires a steep learning curve. But there’s an opposite perspective to consider.
Remember that you are not just risking capital when you trade. You are also deploying time. This means that over time, it is important to take into account the opportunity cost that you incur when you trade.
The time you spend on trading and learning about trading can equally be spent on building another skill set, perhaps one related to your career. This means that it is important to be aware of the time you are spending on this and identifying the time when you will quit if it doesn’t work for you. The ace trader Bruce Kovner said about his trading positions: “I know where I’m getting out before I get in”. Put this stop loss into effect also with your trading endeavour.
Means to an End
Since investing and trading are about making money and the activity of trying to make money in the markets is an inherently emotional exercise, it pays to realise that this is just a means to an end. And you have to find out the destination that will get you to your destination in the most stress-free way.
This means that you will have to find the trading and investing style that is best suited to your temperament. Maybe you will find more success in trading in the cash market. Maybe growth investing is not for you.
If you did nothing in the market, and just purchased an index ETF, over the long term, you will likely make returns mirroring the growth of corporate India’s earnings. Over the past 10, 20 and 30 years, this number has been about 15% compounded. This means the investor has doubled their money nearly every five years. And those are staggering returns.
How much more you want over this, you will have to identify for yourself through hard work and trial-and-error. Remember that such excess returns come at a risk: you might end up with lower returns. But just being aware of this proposition could help you be on the winning side.