The Hindu Business Line : Successful trading is based on three Ms

Would successful people who trade for a living talk about their method of making profits? The answer is `yes,' if they are talking to Dr Alexander Elder. And he comes back from his `visits to sixteen trading rooms' with enough matter to fill Entries & Exits from Wiley (www.wiley.com).

"Winners know full well that success in trading does not depend on knowing the `secret'," explains Elder. "There is no secret — only hard work, focus, attention to detail, being careful and long-term oriented with money, and having a bit of flair." Don't search, therefore, for a magic formula, which you can `buy and plug into your computer to automatically make money,' as states the intro.

"Successful trading is based on three Ms — mind, method and money," says Elder. "Mind is your trading psychology; method is how you analyse markets and make trading decisions; money is risk control." The formula is also explained as 3 Bs, viz. `balls, brain and bankroll'. These are `the legs of a three-legged stool,' because if any one is missing, you end up on the floor!

Methods that work well on paper may fail when one starts trading read money, cautions the author. "When the level of emotion goes up, the level of intelligence goes down." The best way to remain calm and preserve discipline is to keep good records, he advises wannabes. "Write down your plan for the day ahead; put it next to the keyboard, and follow it. Do not change your plan during trading hours."

Two pillars

Elder speaks of two pillars of risk control, `the 2 per cent and the 6 per cent rules.' He elaborates: "The 2 per cent rule states that you may never risk more than 2 per cent of your account equity on any single trade." For example, if you are buying a Rs 12 share with a Rs 10 stop, you risk Rs 2 per share; and if your maximum permitted risk is Rs 2,000, you may buy up to 1,000 shares.

The second pillar, that is, the 6 per cent rule states that you should never expose `over 6 per cent of your account equity to the risk of loss.' For instance, if you trade a Rs 1,00,000-account and risk Rs 1,000 on every trade, "you may not have more than six open trades at any given time." In case you lost out on two trades, you can now have not more than four open trades. "This rule allows you to have more trades when you're on a roll, but slows you down when you are starting to lose money."

The first trader you'd meet in the book is Sherri Haskell. "I troll at night, looking for consolidating stocks with unusual volume," she describes her method. "Something that hasn't moved very much but has big volume — that tells me momentum is building and it may bust out." The difficult part for her is `the discipline of not being influenced by others'. How has Sherri handled it? "I learned over time not to listen to financial programmes on TV, to reduce the number of publications I receive, and to be very careful conversing with others about the market."

Elder takes us next to Fred Schutzman's trading room. "Our percentage of winning trades is about 40 per cent, and so we shoot for at least a 2:1 return, but ideally we'd like 3:1," explains Schutzman. "We are trying to get the best risk adjusted returns — it is more game theory than technical analysis. We want to beat our competitors on a risk-adjusted basis." To succeed in the long run, take many trades, he advises. "We operate like a casino, and the law of large numbers works for us... I do the R&D, the computer pulls the trigger."

Andrea Perolo, the third trader, has a simple method: "Check the weekly, discover a trend, analyse the daily to discover a good risk/reward ratio, manage it with solid money management." And his trading room is uncluttered: "Just one computer and one monitor, with no real-time quotes." Perolo tells Elder, "Trading for me is about more than money. There is no other task that is so difficult — it is a challenge I have within myself." One useful insight he shares with the author is about fighting the feeling of arrogance. "Whenever you get a strong opinion about the market, shut down the computer and take a long walk. Your opinion is not helpful; it can influence your judgment when you look at the chart. Trade your chart, never your opinion."

Three main rules

Our next stop is at Sohail Rabbani's office. His three main rules of trading are: `use stops, use stops, and use stops'. Because, "you have to protect yourself if you want to survive in the markets," says Rabbani. Three Cs for success, according to him, are `concentration, clarity, and confidence.' That no one can know the future is one of his two maxims. The other is that most people are wrong most of the time. "To learn from the multitudes," therefore, "you have to see through their follies and position yourself on the other side of the trade."

A book worth investing in, if your goal in trading is to become `the best professional you can be'.

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