The Hindu Business Line : Trading is like driving

Click a mouse, place a few trades, and watch the money roll in. What an idyllic way to make a living through trading! Alas, the reality is different, says Brett N. Steenbarger in his foreword to ‘The Essentials of Trading’ by John Forman ( www.landmarkonthenet.com ).

“It is not easy to sustain concentration for hour after hour, removing ourselves from social interaction and the basic security that most jobs offer,” reminds Steenbarger. Also, “periods of losing money are common, even for the best and the brightest traders,” especially during market shifts.

In most activities, there are layers that separate one from the outcomes; not so in trading or individual sports, where you’d know at the end of the day how you fared. “Trading is one of the few activities in which individuals can directly compete with the world’s finest talent and take full ownership for success or failure.”

To help novices who begin with halting steps, Forman’s book has well-written chapters on trading mechanics, price action, trading plan and so on. Essential read is a chapter on risk and money management. But, first, what is risk? “The potential for something undesirable to take place in regard to some activity or lack thereof,” defines the author. “Taking positions in the financial markets, just as in driving, always implies a level of risk.”

Extending the analogy, odds of the risk happening can be higher in driving due to bad weather, poor lighting, or driver impairment. “The driver can reduce the odds of crashing by not driving under adverse conditions and by being aware, alert, and conscientiously focused when operating the vehicle.”

So too, in markets, risk can arise due to factors such as data releases, external shocks, and trade flows, Forman explains. “As in driving, the trader can reduce the odds for negative performance by being alert to the situation, applying leverage in a reasonable fashion, and diligently following the plan.”

Using stops is an oft-mentioned tip to protect oneself against big losses. There is, however, a difference between a stop intended as a money management control and one that is used in a trading system to exit a position, differentiates the author. “The former is to protect one from extreme losses due to adverse action… The latter is to exit a trade when the market indicates that it is time to do so.”

VaR or ‘value at risk’, which is a method of evaluating overall risk, indicates “the extent to which a portfolio’s value could fluctuate in a specific time period with a given level of confidence.” For example, a portfolio of Rs 1 lakh might have a 1-day VaR of Rs 5,000 at 95 per cent. “Translated, that means there is about a 95 per cent chance that the portfolio in question will change in value somewhere between +Rs 5,000 and –Rs 5,000.”

The VaR concept ties in with the concept of RoR (risk of ruin), says Forman. RoR is the chance of blowing out one’s account! A trader who considers ‘ruin’ to be losing 50 per cent of the portfolio value would have a higher RoR than one who views ruin as meaning a 75 per cent loss. “After all, it is less likely to lose 75 per cent than 50 per cent.”

Risky not to read The Essentials.

Your mind is precious

Life is short and uncertain, like a drop of water skittering around on a lotus leaf. “You never know when it will drop off the edge and disappear. So each day is far too precious to waste.”

Sombre words, these are, from Srikumar Rao in ‘Are You Ready To Succeed’ ( www.randomhouse.co.uk ), now in paperback.

The author teaches at Columbia Business School and London Business School. His course on creativity and personal mastery is ‘the only business school course that has its own alumni association,’ says the book.

Rao begins by inviting you to discover “your purpose in life, the grand design that gives meaning to all of your activities, the endeavour to which you can enthusiastically devote the rest of your life.”

There is a non-linear relationship between the ‘work’ you do and the ‘results’ you get, he explains. “Immense exertion can produce little outcome and, at other times, a little effort can yield a huge payoff. But if you have an open mind, you can learn to create serendipitous opportunities.” Not unusual in trading, you’d agree.

“Your mind is precious: protect it,” urges Rao. “You have to be mindful of what you let in.” He quotes Swami Sivananda thus: “It is better to allow yourself to be cut with a sharp knife than to let a wrong thought in your mind.”

When you are dealing with mental chatter, don’t use force, advises Rao. “The more you try to eliminate particular trains of thought, the more they will take you away on unwanted journeys. Trying to suppress them energises them.”

Instead, observe, he counsels. “The ‘witness’ is a remarkable pacifier. Being aware of what you are doing brings change of its own volition.” Awareness can also help you be a safe navigator, even as you steer through the treacherous market highway.

Energising inputs.

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D. Murali