Beyond Research, Beyond Advice

"Science & Psychology of Money Making"

Why Do we Say Beyond research, Beyond Advice…. Don’t we believe that if we get Good Research and Good Advice, we too can make Big Money?
Don’t we also think that in order to win in the market, we should have the ability to identify the right stock or we should have the accurate trading method?
But in reality, what has been our actual experience?
In spite of getting good research or good trading method, have we really been able to make money?

No, having right trading method or ability to identify the winning stock is NO GUARANTEE to win consistently in the market. On the contrary, the biggest reason of a trader’s failure is that they focus only on having the PERFECT TRADING METHOD.

Then what is the secret?
The secret is: The totality approach, a combination of 3M:

  • Method
  • Money Management
  • Mind

The following figure will explain in detail:


Let us understand all the 3 concepts:

  • Method: Though most of us can talk at length about the method, for now we will just say instead of finding the “perfect” method, you should try to have a method that “suits you” i.e. if some is making big money through some method; it doesn’t mean that you would also be able to earn from that method. You should have a method based on your personal capital, risk appetite, time availability and your level of expertise. Also, instead of keep searching for the perfect method you must keep practicing one trading method and master it.
  • Money Management (MM): The statement that “you can have a brilliant trading method but if your money management is poor, a series of losses (consecutive losses) can destroy your capital.
  • Mind: What good will a perfect trading method will do, if you don’t have a discipline to follow it.

To understand Money Management & Mind, let us go through the following details.

Money Management (MM):

Here comes the second M of the Market Secret i.e. Money Management.
While the Method tells us what to buy and when to buy, Money Management (Risk Management) suggests us ‘how much to buy?” i.e. what should be the exact quantity to trade with?
Most of the traders don’t have this idea. They never have any logical base for deciding the risk (i.e. Quantity) for each of their trades. Hence, they take haphazard risk in each of their trades. At least the traders should start with some defined risk.
(Example of haphazard risk v/s defined risk. Variable v/s Fixed in rupee term)
Let us understand it with the help of an example:
Suppose there is a trader who bought 100 shares of company and he got the profit by the market movement of Rs 1000 so next time he again bought 100 shares of some other company and again he got the profit of Rs 1000 now this time he is extremely happy as his views were going correct. So this time he decides to increase the quantity of the shares and he increased it by 5 times. This time he bought 500 shares of a company but unfortunately market went against his view and he lost the trade and bears the loss of Rs 5000. Now he was really upset and decided not to take high risk. Thus next time he bought only 50 shares again he lost the trade but this time he lost only Rs 500 bucks because he took less quantity. So he finally decided that it is better to take less risk. Therefore next time as well he bought only 50 shares of a company but this time market performed extremely well but he wasn’t able to get the big profit from it.

Thus, it proves that having some defined risk is always better.
Also, one needs to understand that higher the risk is, higher are the threats to survival. For example, if we risk 50% of our capital, it requires only 2 consecutive losing trades to erode most of our capital. I.e. we will lose almost entire capital if we lose in 2 back-to-back trades. If we risk only 1% of our capital it requires 100 consecutive losing trades to get us out of the market. So, the lower amount of risk will ensure our survival in the market.
Thus, it is the MM that decides whether you will be out of game very soon or you will be in the game for longer time and gradually you will be a winner.
One another misunderstanding about the risk is; for most of the traders risk management is equal to ‘STOP LOSS’ only. And they use the fixed percentage of the price of scrip as stop loss.
E.g., when they trade in the scrip of Infosys Limited they may use 1% Stop-loss of the price of Infosys. Now, if the Current Market Price (CMP) of Infosys is Rs. 2000/-, the 1% SL means Rs. 20 per share.
Having per share stop-loss (of Rs. 20/-) is necessary, but it is not Risk Management. For example, with same SL of Rs. 20/- one may buy 100 quantity and incur a loss of Rs. 2000/- (Rs. 20 per share * 100 Qty) or the other may buy 1000qty and incur a loss of Rs.20,000/-. Thus, it is the quantity of your trade, that decides the amount (in Rupees) you lose. Thus, if you don’t understand what quantity to trade with, you are not controlling your risk.
Now, how can we decide whether we should risk Rs. 2000/- or Rs.20, 000/- per trade? The answer depends on the Trading Capital we have. Initially, a short term trader should not risk more than 2% of the trading capital. So, if we have Rs. 2, 00,000/- of trading capital, we should not risk more than Rs. 4,000/- (Rs. 2, 00,000 * 2% = Rs. 4,000/-) per trade. Under such situation one can buy only 200 shares.

Rs.4000/- loss allowed per trade

------------------------------------------ = 200 shares

Rs.20/- Stop-loss per one share

Now, if we have only Rs. 10,000/- of trading capital and if we trade 200 shares, it would be too Risky. We should not risk Rs.4000/- per trade. It would be 40% risk of our capital. In this case, in just 3 wrong trades we will be out of capital (Rs. 4000/- *3 Losing Trades= Rs. 12,000/-) i.e. we will lose more than our capital of Rs. 10,000/-
By now we hope you would have understand why most of the people loss their money in market because they don’t follow the correct money management system.
Therefore Money Management is all about managing your risk and risk can be defined only when You Know the quantity of the Shares one has bought based on the total Capital of the trader.
If we take too little risk, we might be too slow in growing our capital. If we take huge risk, we will not be able to survive. Hence, we need to understand the optimum level of risk so as to ensure the balance between the survival as well as the growth of capital at the same time.
At MH, we have master the art of Money Management which helps our clients to preserve their capital in bad times and to achieve multifold growth in good times.


MIND:

Mind refers to the psychological part of trading. It says, “what good a trading method is; if one cannot execute it with Discipline?”
Everyone knows and accepts the importance of discipline. But the fundamental question is,” why it is so difficult to maintain the discipline?”
It is because of influence of various psychological factors like greed, fear, ego etc., it becomes difficult to stay on the course of discipline.
Let’s understand through an example, as how do we break the discipline and fail to execute our trading plan?
When we get some lucrative trading method, we back test it. The back tested results convince us that we will be able to make a big profit. However, when we trade the same method the result might be totally different. Instead of making good profits, we end up losing big amount.
Have you ever thought why this happens and why it keeps happening again and again? The reasons why we keep losing money even after having a good trading method are:

  • 1. Our inability to handle the Stop-loss or Profit-target in the current (running) trade.
  • 2. Our inability to handle the Money Management rules before entering the new trade.

These both happen because of the psychological factors.

1. Our inability to handle the Stop-loss or Profit-target in the current trade.

Between the time we take an entry and the time we exit from the trade; market will be fluctuating. This fluctuations cause us much of the emotional roller-coasters. At times we feel happy and excited and at times we feel stressed. Our ability to remain calm and balance during these ups and downs has a major impact on our trading results. If the market is against us, we will feel the emotional pain and our brain starts working for pain relieving mechanism and tries to bring us in psychological comfort zone. This pain reliving mechanism forces us to either move the stop-loss farther away than its original stop-loss level or makes us take the quick loss before allowing the price to bounce back. If the market is in our favor, we may get tempted to book quick profit in the fear of losing that unrealized gain and we don’t wait for the full potential profit. In this case, we miss the opportunity to make real gain as per the method.

2. Our inability to handle the Money Management (Risk Management) rules before entering the new trade.

While we take new trade, we trade with different quantity (position size) to trade. The size of our position in the new trade depends upon whether we have made profit or loss in our previous trades. While profitable trades lead us to Greed & Excitements that cause the over trading, the losing trades generate stress and fear which forces us either to skip the next trade or to take the next trade with reduced quantity.
In both the above cases our psychology compels us to break the discipline and forces us to act against our trading plan. And while we break the rule of our trading plan we tend to curtail our profit and increase the size of our loss. Thus, instead of cutting the loss short and letting the profit to run we do the exactly opposite. And this loss which is a result of our indiscipline has nothing to do with accuracy of our method or with the market.
Thus, In spite of getting good research and good advice we hardly make consistent earnings in the market.
Hence, we need to focus on our own selves and not on the trading method. We need to master our habits rather than mastering the market.
Again the important question is, how can we start following the discipline?
The fact is, changing our habits and to be a disciplined is not an easy task. It requires changing our behavioral patterns and needs sufficiently long time. We need a mentor who can keep us on track and don’t allow us to break even a single rule. It is only under the guidance and supervision of a mentor we can develop the winning habits. At MH, we are having a personal mentor for each of our client and we hand-hold them to be disciplined and a successful trader.

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