Position Sizing for active trader; If you don't bet you can't win

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11.1 – Poker face

Last month I got an opportunity to play poker with a few good friends. I was playing poker after a gap of 6 years and I was quite excited about it. The buy in for this friendly game was Rs.1000/. For those who are not familiar with poker – it’s a card game where in your skill and luck are tested in equal measure.

So, the game started, cards were dealt, and in the very first round I bet Rs.200/- and I saw it go away, just like that. In the next round, I bet another 200, and again saw it go away. At this stage I convinced myself that I could make up my losses in the 3rd round, and with this thought I increased the bet size to 600, only to watch it go away! So for all practical purposes, I lost Rs.1000/- in a matter of 10 minutes! In the trading world, this is equivalent to blowing up your entire trading account.

I didn’t give up, after all, I’m supposed to know trading and poker draws many similarities to trading. I decided to ‘recover’ my initial loss and stay in the game longer. I bought in for another 1000 and started fresh. This time, I stayed on the table a bit longer – for a total of 15 minutes!

Clearly, it was not working for me. I had a better memory of me playing poker 6 years ago. Though not the best, at least, I would stay on the table till the game lasted and even win few hands. So what was happening this time around? I was confused and I kind of didn’t believe that this was happening to me? How could I wipe my account twice in a matter of 25 minutes?

With these confusing thoughts on my past poker skills and my current game play, I decided to buy in again for another 1000 Rupees. This was my 3rd buy in. In the trading world, this is equivalent to funding your account 3rd time over after successfully blowing it up twice.

What advice would you give someone who has blown up his account twice in the markets? – ‘get out of the markets immediately’, would perhaps be the best-suited advice right? Well, I dint pay any heed to my inner voice, gambler’s fallacy had taken over my rational thinking abilities and I bought in again for 1000 Rupees more.

For those of you who don’t know gambler’s fallacy – if you are betting on an outcome and you tend to make a long streak of losses, then at the time of quitting, your mind tells you or rather tricks you to believe that your losing streak is over and your next bet will be a winner. This is when you increase your betting size and lose a bigger chunk of money. Gamblers fallacy is one of the biggest culprits in wiping out many trading accounts clean.

Anyway, back to my poker game. This was my 3rd buying, I had already lost 2K and was betting with another 1K. I was confident I’d recover plus make some money and save myself some shame, but the boys on the table had other plans for me. They knew I was the sucker on the table and it was easy to allure me to make irrational bets. So they did and wiped me out clean over the next 7 minutes.

That was it, I called it quits and I got back more after losing 3k.

After the game, I thought through on what went wrong. The answer was very clear –

1. I had forgotten to recognize the odds of winning with the cards that were dealt
2. I was not ‘position sizing’ my bets – my bets were way too irrational and random

After a couple of weeks, I had another invite to the game. I had set a bad precedence of giving away easy money. This time around I had decided to position size my bets well.

I bought in for 1000 and started the game. Each time the cards were dealt – I accessed my odds fairly well and if I thought my odds were fair, I bet accordingly. In the trading world, this was equivalent to following a ‘trading system’ backed by position sizing techniques. The result of this simple systematic approach had a great impact on my game –

1. I won few hands
2. At the peak, I must have had about 4K of winnings
3. I lasted throughout the game and had a lot of fun along the way
4. Towards the end I gave up some gains but was extremely happy with the fact that few simple techniques helped me manage my game much better

Position sizing made all the difference in this game. It always does and this is the exact reason for me to narrate this story. I do not want you to speculate in the markets without understanding your odds or without position sizing your bets. If you do, you will end up making a fool out of yourself.

Poker is played for fun but when you trade, you are essentially deploying your capital for a more serious and meaningful outcome. So please do pay attention to some of the things we will discuss over the next few chapters. I’m certain it will have a positive impact in your trading career.

At this point I have to mention this – I myself learned position sizing many years ago by reading Van Tharp’s books. Van Tharp is one of the most prominent people to bring in the concept of position sizing to traders. I’d even recommend you buy some of his books to expand your knowledge on this subject.

11.2 – Gambler’s fallacy

We briefly discussed the gambler’s fallacy early on. I guess it makes sense to discuss a little more on this at the very beginning especially in the context of markets.

Take a look at this chart –

This is the chart of Nifty – Nifty hit the magical number of 10,000 on 25th July 2017. As a trader, how would you trade this?

1. Nifty is at an all-time high – 10K
2. Many market participants may book profits at this point – considering it is a phycological level
3. All time high implies no resistance points
4. Nifty has been in a great up wards trend over the past few weeks
5. Maybe Nifty would consolidate around these levels?
6. Maybe a correction of 2-3% before the rally continues?

Let us just assume that these are some valid points for now. This means a short position is justified or for that matter buying of puts. Your analysis could be as simple as this or as sophisticated as studying the time series data and modeling the same using advanced statistical or machine learning models.

Irrespective of what you do – there is no certainty in the markets. No one technique will tell you the outcome in advance. This implies that we are dealing with fairly random draws here. Of course, based on how meaningful your analysis is, your odds of winning can improve, but at the end of the day, there is no certainty and you have to acknowledge the fact that markets are indeed random.

Now imagine this – you have done a state of the art analysis and you place your bet on Nifty only to see the stop loss trigger. You do not give up, you place another trade and to your misfortune, you are stopped out again. This cycle repeats for say the next 4 trades.

You know your analysis is bang on – but then your stop loss is continuously getting triggered. You still have money in your account to take on bets, you are still convinced that your analysis is rock solid and the markets will turn around, you still have an appetite for risk – given all these, what do you do?

1. Would you stop trading?
2. Would you risk the same amount of money again?
3. Now that you have lost 6 consecutive bets, would you consider that your odds of making money on the 7th trade is higher and therefore increase your bet size to recover your previous losses plus reap in some profits?

Which option are you likely to take? Take a minute and answer this question honestly to yourself.

Having been through this situation myself and having interacted with many traders let me tell you – most traders would take the 3rd option, the question however is – why?

Traders tend to believe that long streaks will cease when they take the ‘next’ trade. For instance, in this case, the trader has faced 6 consecutive losses, but at this point his conviction that the 7 trade will be a winner is very high. This is called ‘Gambler’s fallacy’.

In reality, when you are dealing with random draws, the odds of making a loss on the 7th trade is as high (or low) as it was when you placed your first bet. Just because you have made a series of losses, the odds of making money on the next trade does not improve.

Traders fall prey to ‘Gamblers fallacy’ and often end up increasing their bet sizes without understanding how the odds stack up. In fact, gamblers fallacy ruins your position sizing philosophy and therefore is the biggest culprit in wiping out trading accounts.

This works on the other side as well. Imagine, that you are fortunate enough to witness a 6 or let us say 10 consecutive wins. Whatever you bet on, the trade works out in your favor. You are on your 11th trade now, which of the following are you likely to do?

1. Considering that you made enough money, would you stop trading?
2. Would you risk the same amount again?
3. Would you increase your bet size?
4. Will you take a conservative approach, maybe protect you profits, and therefore reduce your bet size?

Chances are that you will take the 4th option. You clearly want to protect your profits and do not want to give back whatever you have earned in the markets and at the same time you would want to take a trade considering you have had a great winning streak.

This is again ‘gamblers fallacy’ at play. Being completely influenced by the outcome of the previous 10 trades, you are essentially reducing your position size for the 11th trade. In reality, this new trade has a same odds of winning or losing as the previous 10 bets.

Perhaps, this explains why some of the traders, even though get into profitable trading cycle end up making very little money.

The antidote for ‘Gambler’s Fallacy’, is position sizing.

11.3 – Recovery trauma

In the trading world, the capital we bring on the table is the raw material. If you do not have enough money to trade with, then how will you make a profit? Hence we need to not just protect the profits that we make, but also protect the capital.

Extending this thought – if you risk too much capital on any one trade, then you stand a chance to risk your capital to an extent that you may burn your capital leaving you with very little money. Now if you are trading with very little money, then every trade that you take will appear to be too risky. The climb back to where you started will (in terms of capital) will be a Herculean task.

I have prepared a table to help you understand this fact. Assume you have a trading capital of Rs.100,000/-. Let us see how the numbers stack up with –

You can download the excel sheet here.

Assume you lose 5% of your capital or Rs.5000/-. Your new starting capital is Rs.95,000/-. Now, in order to recover to Rs.5000 with a capital of 95000, you need to generate a return of 5.3%, which is 0.3% more than what you lost.

Now, instead of 5%, assume you lost 10% and your capital becomes 90000, now in order to recover 10000 or 10% of your original capital, you have to earn back 11.1%. As you can see, as the loss deepens, you will have to work really hard to bounce back to original starting capital. For example at 60% loss or original capital, you are staring at a 150% bounce back.

Unfortunately, the ‘recovery trauma’ affects traders with smaller account size. Assume you come to the market with Rs.50,000/- capital. Now you would have heard of stories on how Rakesh Jhunjhunwala, grew his money from 10,000 to 15K Crores. You would want to replicate at least a small portion of this success. Honestly speaking, if you can manage to grow Rs.50,000/- to say Rs.60,000 by the end of the year, you would have done a great job. This translates to a 20% return. But this is not exciting, right? I mean earning Rs.10,000/- over 1 year when you are actively trading somehow does not seem right.

So what do you do? You tend to take bigger risks and hope to make bigger gains, and if the trade goes against you, then you are essentially falling prey to the ‘recovery trauma’ phenomena.

This is exactly the reason why you should never risk too much on any one trade, especially if you have a small capital. Remember, your odds of making good money in the markets is high if you can manage to stay in game for long, and to stay for a longer period, you need to have enough capital, and to have enough capital, you need to risk the right amount of money on each trade. This really boils down to working towards longer term ‘consistency’ in markets,  and to be consistent you need to position size your trades really well.

I’m going to close this chapter with a quote from Larry Hite.

Over the next few chapter, we will dig deeper into position sizing techniques.

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Key takeaways from this chapter

1. Position sizing forms the corner stone of a trading system
2. Gamblers fallacy is a bias highly applicable to the trading world. It makes the trader believe that a long streak of a certain outcome can break
3. When there are infinite draws, the odds of making a profit or loss on the Nth trade is similar to the odds of making the same profit or loss on the 1st trade
4. The recovery of capital is much more difficult task than one can imagine
5. Traders with small accounts have a tendency to take larger bets, which they need to avoid

https://zerodha.com/varsity/chapter/position-sizing/

Zerodha 60 day challenge trade winners

https://zerodha.com/z-connect/category/zerodha-60-day-challenge/winners

10th Std Pass, Market Wizard from Thrissur

Summary

1. 10th class pass - more education seems to be a disadvantage with trading
Perhaps, lack of higher education is what made him a small player relative to other players like Rakesh Jhunjhunwala or Mankekar. He may not have the 'theoretical' background to succeed further.

2. Risk Management 
Also, from when I started, I have made sure that only a small portion (1 to 3%) of my net-worth is used for trading, I guess that is the money management rule that you are asking me for.


MAY 22, 2014CATEGORY: Winners - 60 day challenge

Traders,
After putting up the first five interviews of some of our top traders and winners of the Zerodha 60 day Challenge, I was asked many times if engineers have better odds to win at trading, as each one of the five featured until now came from a similar background. The search to break the pattern amongst our winners ended at Joby, a 10th standard pass-out from a small town in Kerala with no access to fancy tools or resources, who has still managed to be up over 300% from active F&O trading in the last couple of years trading at Zerodha. His winnings from the market runs into crores over the many years trading F&O actively. I had to use a translator as the only language he speaks is Malayalam.

Following is my interaction with Joby.
Name: Joby      Age: 47 Years


Running a Bakery to Trading full time. How did that happen?
I was running my own Bakery in the early 1990′s and had people visiting the shop regularly after trading at the Cochin Stock Exchange. The bug bit me and without any knowledge of capital markets, I quit my bakery business to become a full time equity trader. Until 2000, my trading was only in equities and I started trading F&O when it was introduced in 2001. I am thankful to God that the risk I took by shutting down my bakery worked out well for me.

How much money did you start off with?
It all started with just around Rs 500 back when I started and today whatever I have made is all out of that Rs 500. Over a period of 22 years, I have also taken profits out of trading and invested into other avenues, and that trade also has worked out very well.

Investment into other avenues? Why not into stocks?
I have always traded the markets, but all my investments till date have never been in stocks. I guess the reason for this is because it is very tough to trade and invest at the same time, I was never comfortable doing that.  For example, I am shorting Nifty futures because I am feeling bearish, but what do I do with the stocks that I am holding for long term–hold or sell? It is very easy to say that you will hold for long term, but such scenarios where there is indecision or time taken can be detrimental to the outcome of your trade.

What do you trade on, mostly? Are they intraday or positional?
I have mostly been trading options from when it was introduced on NSE in 2000, and almost all of it shorting/writing options. I usually hold the positions overnight and sometimes take intraday trades as well.

Why mostly option writing?
I feel options give higher flexibility and shorting options inherently improves the winning odds as long as you have a risk management policy to cover when you are wrong, as the losses writing options can be unlimited. The opportunity to profit from  trading options prior to 2010 was much higher.

What is your risk management policy/money management rule?
I haven’t ever had any big losses from the time I started trading and you will be surprised to know that I don’t really have a risk management policy as such. I don’t have fixed stop losses, I average my position when in loss, I go against the trend, break many rules that a lot of analysts keep shouting out on TV asking to follow. One of those things I do though is that when I take a wrong trade that was not intended to, I immediately book the loss if any and try to stay away from trading on that particular day.

Also, from when I started, I have made sure that only a small portion (1 to 3%) of my net-worth is used for trading, I guess that is the money management rule that you are asking me for.

So what about the trading strategy, how do you enter or exit?
It is based on support and resistance, I wait with a lot  of patience for market to show a range and when it displays the same, I start writing options which will benefit if the market stays within the range. Most of these trades typically are hedged because I would be shorting calls and puts at the same time so that I can benefit from both the calls and puts premium losing its value when in the range. From the time India VIX  was launched in 2009, I also keep a tab on it to decide how aggressive I should be writing options, the best times being when value of VIX is relatively higher.
When convinced that the range is getting broken,  I will start taking single sided trades either long or short and these could sometimes be plain long options or buying/selling futures. I also as a rule completely avoid writing naked put options.

How do you determine this support and resistance in charts?
I don’ t follow any technical analysis or look at any charts. To be very honest I don’t even know how to use computers properly. But all the years I have been trading actively, I have spent countless hours looking at the terminal on how Nifty prices move. If the market is trading, I am looking at the screen if I am in a trade or not. I have my own unique way of calculating the resistance and support just by watching and analyzing the price and volume. I don’t need to look at the chart for this, just a market depth window (Snap quote window) is enough.

Do you know that what you are saying sounds like “Tape Reading or Reading the Tape“?
As I said earlier, have studied only till 10th, don’t browse the internet, have never followed tips, don’t believe in stop losses, I am able to look at the symptoms of Nifty and predict if it will be in a range or breakout.

No stop loss? So how do you exit when in profits or losses?
It is based on how I feel about my trade with respect to how the markets are moving. I don’t really have preset exit points and there have been many times where I have averaged when the price has gone against my trade. I will book a loss or profit based on my conviction of the trade.

What do you do when not trading?
My routine is working out in the morning, playing football and going on family vacations with my wife Seena and two kids once or twice every year.

It is a special achievement to be up so much trading actively on F&O, any plans to scale up in the future?
I  love what I am doing presently which is trading but not very aggressively, and wish to continue the same. Also before we end the conversation, I want to thank Zerodha for putting up a very unique initiative like the 60 Day Challenge that gives additional motivation to profit and be amongst the winners.
____________________________________________________________
I quizzed Joby for quite a while trying to figure out on how he determines the range, support and resistance and if there was any method to it. I was also astonished that he remembered the exact expiry settlement prices for almost the last 10 years. I could only conclude that he has a special skillset and importantly also the discipline to go along with it. For all the naysayers of “Tape Reading”, Joby proves it can be done and I think a critical element to his success is also the fact that only a small portion of his networth is used for trading, that in itself is his risk/money management rule.
Wishing Joby all the best,
If you haven’t taken up the 60 day challenge yet, visit here to know more and get started.

Nithin Kamath
Founder & CEO @ Zerodha, team working towards breaking all barriers that I personally faced as a retail trader for over a decade. Love playing poker, basketball, and guitar. Getting body fat % in single digit is the next personal endeavor :) .

https://zerodha.com/z-connect/zerodha-60-day-challenge/winners/10th-std-pass-market-wizard-from-thrissur

My Interview with Morgan Housel

Oct 31, 2017 11:51 am | Vishal Khandelwal

Note: This interview was originally published in the April 2017 issue of our premium newsletter – Value Investing Almanack (VIA). To read more such interviews and other deep thoughts on value investing, business analysis and behavioral finance, click here to subscribe to VIA.

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I sincerely believe in what Charlie Munger often says about envy, that it is a really stupid sin because it’s the only one you could never possibly have any fun at. I am lucky to have stayed away from this sin as far as investing and other aspects of life are concerned.

But if there is one, and just one, person who arouses this sin in me every time I read him is…Morgan Housel. And it’s for the simplicity of his thoughts that he puts across through his powerful writings. I have tried to emulate Morgan several times in my writing endeavor, but he raises the bar each time he publishes something new, more simple yet more powerful.

Morgan’s posts at The Collaborative Fund, where he is currently a partner, have been a great source of learning for me. I have also read him for years at his earlier stints at The Motley Fool and The Wall Street Journal.

Morgan is a two-time winner of the Best in Business award from the Society of American Business Editors and Writers and a two-time finalist for the Gerald Loeb Award for Distinguished Business and Financial Journalism. He was selected by the Columbia Journalism Review for the Best Business Writing 2012 anthology. In 2013, he was a finalist for the Scripps Howard Award.

In this interview, Morgan shared with me his simple investing thought process, what gets most people into trouble in investing, and the people who have inspired him the most in his journey.

Let’s get started right here.

Safal Niveshak (SN): Tell us a little about your background, how you got interested in writing and investing, and how you have evolved in these fields over the years?

Morgan Housel (MH): I started in college in investment banking. I always loved investing and knew I wanted to do it as a career. But the culture of investment banking totally put me off. I like to have time to think things through, and any culture that emphasizes 24/7 speed and fixed process over deliberation is one where I wouldn’t do well at. So, I moved on pretty quickly from that.

I then got into private equity, which I enjoyed. But this was summer of 2007, and global credit markets started freezing up, which is devastating for private equity firms that own highly leveraged companies. So, I needed to do something else.

A friend of mine wrote for the Motley Fool and said I should give it a shot. I never thought I’d be a writer, and I majored in economics in college, which meant I didn’t write much at all. But I applied, thinking a) they wouldn’t hire me, and b) if they did I would do it for six months before I found another private equity job. I ended up staying for 9 years and fell in love with the process of writing about investing.

Two years ago, I met a guy named Craig Shapiro from Collaborative Fund, a venture capital fund. We hit it off right away. Even though we come from very different backgrounds we see the world through a similar lens. I joined Collaborative Fund nine months ago and it’s been an amazing team to work with.

How has my writing evolved? Whenever you do something for 10 years you’d think it’d get easier. But writing has become much harder for me. I’ve written 3,500 articles, which means all the low-hanging fruit is long picked. It’s much harder for me to come up with ideas than it was, say, five years ago. So, I’ve slowed down as a writer. If I used to write 10 articles a week, now I write one or two. Now the stuff I write is generally deeper and longer, but every year it gets harder to come up with new ideas and topics.

Also, I’ve just become much more sceptical over time. That’s probably the biggest change in my writing.

SN: That’s an interesting journey you have travelled, Morgan. Anyways, as much as I understand, you aren’t a full-time investor nor do you manage other people’s money. How do you manage your own money? Is it through direct stock picking, or mutual funds, or both?

MH: My entire net worth is a house, a checking account, and the Vanguard Total Stock Market Index. I don’t think investing needs to be complicated so I keep it as simple as I possibly can. The fewer knobs you have to fiddle with the fewer opportunities you have to screw up over time.

SN: Wonderful! That’s as simple as it could get. What’s your broad investment philosophy? Has your philosophy changed much through the years? If yes, how?

MH: My broad philosophy is that investors are their own worst enemies, and the real key to good investing over time has little to do with the investments you pick and lots to do with how you manage your behavior.

Financial journalists spend years quibbling over investing strategies that might improve your returns by, say, 50 basis points a year, and then a financial crisis hits, people are forced to sell stocks to pay their bills or keep their sanity, which ends up costing them 400+ basis points a year. It’s so clear which one matters more.

To me the evidence is overwhelming that if you spend 10% of your investing energy on picking a portfolio and the other 90% on focusing on keeping your emotions in check, putting market volatility into proper context and doing everything you can to take a long-term view, you’ll end up doing better than the majority of investors.

SN: It’s good you talked about emotions, and how it is a huge mistake investor make falling into emotional traps time and again. When you look back at your own investment mistakes, were there any common elements of themes?

MH: Overconfidence. That’s true for most people and I was no different. At various points in my career, I thought I was cleverer than I was or had more insight than I did. The few times it “worked” was likely due to luck. More often it just didn’t work.

Some people are very good at certain segments of active investing. But everyone, no matter how they invest, must fight overconfidence. It’s pervasive and is probably the second-largest cause of investing regret, after ignorance.

SN: When it comes to direct stock picking, the worst problems investors get them into is by falling into behavioural biases. How has been your experience on this front? What tricks do you use to minimize mistakes of behavioural biases? What are the most common behavioural mistakes you make, apart from overconfidence that you mentioned earlier?

MH: This might sound like a weird comparison, but it’s one I think about a lot. I vividly remember on September 11 2001, looking out the window and thinking about the amount of suffering that was going on at that very moment. It’s a weird feeling to know that thousands of people are suffering at a specific spot in real time, in a way that you can accurately visualize, rather than a hypothetical. It just melts your mind.

In 2008 and 2009 I remember having a similar feeling, thinking about all the people who at that very moment were taking actions that would affect them for the rest of their lives — selling when stocks were cheap in a way that would almost certainly impact their ability to ever retire.

Of course, the impact was orders of magnitude less than 9/11, but I had the same strange feeling of thinking about the number of people who, at that very moment in October 2008, were experiencing something that would hurt them the rest of their lives. It felt strange. That’s when I started getting really interested in the behavioral side of investing. I see about 80% of investing as a psychology game.

The big takeaway from 2008 and 2009 was how quickly your own actions could harm the rest of your financial life. It really came down to understanding your own risk tolerance and how that fit into your time horizon. Panic selling is the most common behavioral mistake in investing.

For me, fighting it has been a combination of holding a lot of cash and studying market history. But there’s no easy solution to behavioral biases. These things have millions of years of evolution backing them up. The best you can do is be honest with yourself about your goals and your tolerance for decline.

SN: Okay, what’s the behavioural mistake with the biggest impact that’s the least understood or noticed?

MH: How people think about fees are probably the least-noticed bias.

Most investors don’t actually write a check for their fees. They’re deducted from your fund or investment account automatically. When something is so out of sight, out of mind, you don’t pay rational attention to them in the same way you do, say, the price of a gallon of gasoline.

The result is that investment fees may be one of the largest — if not the largest — annual expenses for upper-middle-class households. A couple nearing retirement with $800,000 in mutual funds could easily pay 1% in fund fees, 1% to a financial advisor, and 0.5% in trading and other costs. So, 2.5% in fees on $800,000 is $1,666 a month — an amount that is very real but for which the customer never actually sees or pays an actual bill. For perspective, the average mortgage payment in America is about $1,300 a month.

A lot of financial advisors earn their fees, especially if they can manage a client’s emotions and endurance. But the way investment fees are structured means people end up paying way, way, way more than they would for other service-based products.

SN: How can an investor improve the quality of his/her decision making? Does maintaining a journal help? What has been your experience in improving your own decision making over the years?

MH: Most medical doctors still go to a doctor to get their own check-up. Investors should do the same. Even if you don’t have a financial advisor I think it’s important for all investors to bounce their ideas off trusted advisors — friends, mentors, family, whatever.

Robert Shiller once said, “You have to understand that your own thoughts are not really your own thoughts.” Everything you know is a product of the people you’ve met and the experiences you’ve had, most of which were out of your control. That’s always stuck with me. It’s a reminder of how hard independent thinking is, and how important it is to hear out the views and thoughts of a diverse group of outside experts.

SN: That’s a very pertinent point you made, that independent thinking is hard. Now, with so much noise all around, it’s become terribly hard. With traditional media, TV, bloggers, twitter, etc., there’s so much information flow these days. It can feel overwhelming. How do we go about curating signal from noise?

MH: I’d think about two things.

One, when someone on TV says (or a journalist writes), “You should do X with your money,” stop and think: How do you know me? How do you know my goals? How do you know my short-term spending needs? How do you know my risk tolerance? Of course, they don’t. Which means you shouldn’t pay much attention to it. Personal finance is very personal, which means broad, general, advice can be dangerous.

For media, I’m most interested in historical finance, which helps put investing into proper context, and behavioral finance, which lets you frame investing based around your own goals, flaws, and skills. But taking direct advice from someone who has never met you is asking for trouble (this includes me).

SN: How do you think about risk? How do you employ that in your investing?

MH: I have two definitions of risk –

1. Risk is the odds that you won’t be able to do something in the future that you reasonably need to do to keep yourself happy.
2. From Carl Richards: “Risk is what’s left over when you think you’ve thought of everything else.”

The first is a reminder that risk is different for everyone, and is highly dependent on your time horizon.

The second is a reminder of how hard risk is to think about. Risk is, almost by definition, the stuff we aren’t thinking about.

SN: Indeed! Anyways, if you had just two-minutes to advise someone wanting to get into investing, what would your advice be? What are the biggest pitfalls he/she must be aware of?

MH: Keep it simple. Don’t try to be a hero. Compounding takes a lot of time. Volatility is the cost of admission for high long-term returns. That’s the message I’d get across. It’s simple but encompasses the majority of what you need to know.

SN: What are the most important qualities an investor needs to survive the complexity of the financial markets?

MH: I think it’s a combination of humility and a fine-tuned bullshit detector.

You need humility to prevent yourself from overcomplicating investing more than it needs to be and taking risks greater than you’re able to handle.

And you need a fine-tuned bullshit detector to protect yourself from the swarms of sales pitches and get-rich-quick schemes that plague the industry.

There are other things — a good grasp of basic arithmetic, delayed gratification, the ability to live below your means. But those first two are most important.

SN: You wrote a wonderful note in Feb. 2017 on getting vs staying rich. You mentioned about cultivating humility as the way to stay rich. If one is not humble by nature, can humility be cultivated?

MH: Yes — through humiliation. Lack of humility always catches up to you. Look, in markets, you’ll receive some return over the next 20 years, and most people who try to front-load those returns into shorter periods of time will cough up whatever excess short-term returns they earn down the road — reversion to the mean. It’s very similar with humility. Most ego you have today will be balanced out with humiliation down the road.

SN: Which investor/investment thinker(s) do you hold in high esteem?

MH: My top five include –

• Michael Batnick
• Ben Carlson
• Jason Zweig
• Craig Shapiro
• Brent Beshore

All have an incredible mix of insight and humility that is incredibly rare. They’re also just great people.

SN: You inspired many through your writings. Which are some of the books, blogs, and other resources on investing, behaviour, and multidisciplinary thinking that have inspired you the most over the years?

MH: This might sound odd, but I think reading about World War II has had the biggest impact on my thinking. There are few events in history that were as transformative and as well documented as World War II, so it’s just an incredible period to study to learn how people dealt with adversity, uncertainty, despair, and hope. The most accessible piece of content here is Ken Burns’ documentary, The War. It teaches you more about human behavior than anything else I’ve come across.

SN: If you were to give away all your books but one, which one would it be and why?

MH: Nassim Taleb’s book Antifragile is probably the book that I go back to the most. Taleb is a prickly personality but he’s an incredible writer and can explain complicated topics in easy-to-understand ways without dumbing it down at all. It’s a very hard skill and he’s mastered it. If you look past his ego and sharp personality I think he’s one of the smartest thinkers around today. Or at least he’s a very smart thinker and an excellent communicator.

SN: Hypothetical question: Let’s say that you knew you were going to lose all your memory the next morning. Briefly, what would you write in a letter to yourself, so that you could begin relearning everything starting the next day?

MH: I love the hypothetical question, but I think it’s impossible to relearn stuff in a planned way, since so much of what you know is based on past experiences that can’t be replicated. How do you teach someone about what it felt like to lose half your money in 2008? You can’t. You must experience it. Same for bubbles. No book can recreate the emotions of 1999.

But … I’d leave a list of 10 people to talk to, and I’d ask each of them for four or five hours of time where I sit them down and say, “Tell me the basics of your field that explain the majority of the outcomes.”

SN: What would you be doing if you weren’t writing and investing?

MH: I have no idea. I think I might enjoy teaching elementary school, but I’d probably get bored of teaching the same thing repeatedly. But if you strip out the career luck I’ve had and look at my academic background, I should probably be an accountant working 90 hours a week in a dark basement somewhere.

SN: What other things do you do apart from writing and investing?

MH: Mostly reading. I try to read more books and fewer articles. I’m also a growing fan of podcasts. And I try to walk a lot. We have a young son, so we sleep when we can — which isn’t much.

SN: That was brilliant, Morgan. Thank you so much for sharing your insights with Safal Niveshak readers. I wish you all the best for your work and life.

MH: Thanks Vishal! I hope your readers find this useful in some way.

The fall of Qing dynasty - was due to the runaway devaluation of cash currency against the benchmark value of silver

After completing the monu­mental task of compiling and arranging, in chronological order, the production of each mint from 1735 to 1911, Burger did two things with the data.

First, he was able to calculate with a high degree of accuracy the total annual cash production across China, and compare it with census-based population records. The result is an index of economic activity, from 18 coins per person at the height of China’s prosperity under the Qianlong Emperor to its depths during the period when the Empress Dowager Cixi ruled and China was deep into its period of national humili­ation, the antithesis of President Xi Jinping’s Chinese dream.

By the late 19th century, production ranged between 0.5 to one cash per person annually, which, combined with the runaway devaluation of cash currency against the benchmark value of silver, meant that economic activity had slowed to a crawl.

Second, Burger analysed prevailing annual exchange rates.

The massive devaluation of Qing currency in the 19th century is typically blamed on the opium trade, which was funded in silver imported from Mexico through the Manila galleon trade from 1565. Burger’s microscopic focus on mint data, matched with the most extensive cash collection in existence, tells a different story. Forgeries, both domestic and foreign, undermined the currency as early as the Qianlong reign.

“From the Kangxi Emperor [1654-1722] to Qianlong, soldiers were paid the equivalent of two taels of silver per month in two strings of cash,” Burger says. “From Kangxi to Qianlong, no problem. The exchange rate in Qianlong was always around 925 cash to the tael, which meant that the soldiers needed only 1,800 cash to buy two taels of silver to send home to their families and could keep 200 cash in their pockets. So, with this kind of bonus, the soldiers were happy.

“When they were called upon to conquer a new province, whether Xinjiang or Tibet, they were happy to do so.”

In the last years of Qianlong’s reign, the exchange rate suddenly spiked to 1,200 cash to the silver tael as a result of forgeries by mints originally established by loyalists of the previous dynasty, the Ming (1368-1644), in Vietnam. The forged coins were traded into southern Chinese ports and mixed with legitimate cash. The 75-year-old Qianlong forced government offices throughout the country to buy up the forgeries at scrap-metal prices, and the exchange rate rose to 900 cash to the tael.

“It took two to three years, but it was a successful operation,” Burger says. “Fifteen to 20 years after the first clean-up operation, they should have done it again.”

But they didn’t, and by the end of the reign of the eighth Qing emperor, Daoguang (1820-1850), the exchange rate was over 2,000 in every part of China, reaching a peak of 2,500. And there was no credit system.

Proposals by a reform-minded official, Wang Maoyin, in 1854, to develop a paper currency that could be used as a silver equivalent were rudely dismissed, and the continuing disintegration of the monetary system was a factor contributing to China’s losses against foreign powers as well as the government’s helplessness in dealing with the Taiping rebellion (1850-1864), during which 20 million to 30 million lives were lost.

“It was the largest disaster of the Qing dynasty,” Burger says. “All because they didn’t take care of the money. The officials had only studied the Confucian classics and had no idea about money.

“If you tell that to the historian, they say, ‘No, no, no, it’s all the bad imperialistic British. They sold us opium. Before they took tea for it and not silver, but after Napoleon occupied Spain, they couldn’t get pieces of silver any more and the pieces of eight were cut off.’

“What one can learn from how the Qing dynasty ran its show is that, although they were good book keepers – much better than the British or the Germans – they did a lousy job of making a system of their economy. The Europeans very soon had Adam Smith and, by writing down the theory and challenging it, slowly they had the economy in their grip. The Chinese never did. They had no theory.”

http://www.scmp.com/magazines/post-magazine/long-reads/article/2116027/coin-stash-puts-new-spin-chinas-100-years?curator=alphaideas&utm_source=alphaideas

Many people are perplexed that there is no asset underlying Bitcoin. One answer is that there is nothing underlying fiat money either.

Many people are perplexed that there is no asset underlying Bitcoin. One answer is that there is nothing underlying fiat money either.

https://faculty.iima.ac.in/~jrvarma/blog/index.cgi/Y2017-18/bitcoin-as-short.html?curator=alphaideas&utm_source=alphaideas

Einstein on happiness - A calm and modest life brings more happiness than the pursuit of success

Einstein scribbled his theory of happiness in place of a tip. It just sold for more than $1 million.

By Rachel Siegel October 24 at 10:58 PM


He is known as one of the great minds in 20th-century science. But this week, Albert Einstein is making headlines for his advice on how to live a happy life — and a tip that paid off.

In November 1922, Einstein was traveling from Europe to Japan for a lecture series for which he was paid 2,000 pounds by his Japanese publisher and hosts, according to Walter Isaacson's biography, "Einstein: His Life and Universe." During the journey, the 43-year-old learned he'd been awarded his field's highest prize: the Nobel Prize in physics. The award recognized his contributions to theoretical physics.

News of Einstein's arrival spread quickly through Japan, and thousands of people flocked to catch a glimpse of the Nobel laureate. Impressed but also embarrassed by the publicity, Einstein tried to write down his thoughts and feelings from his secluded room at the Imperial Hotel in Tokyo.

That's when the messenger arrived with a delivery. He either "refused to accept a tip, in line with local practice, or Einstein had no small change available," according to the AFP.

Instead, Einstein wrote two short notes and handed them to the messenger. If you are lucky, the notes themselves will someday be worth more than some spare change, Einstein said, according to the seller of the letters, a resident of Hamburg, Germany who is reported to be a relative of the messenger.

Those autographed notes, in which Einstein offered his thoughts on how to live a happy and fulfilling life, sold at a Jerusalem auction house Tuesday for a combined $1.8 million.

“A calm and modest life brings more happiness than the pursuit of success combined with constant restlessness," reads one of the notes, written in German on the hotel's stationery.

It just sold for $1.56 million. The letter had originally been estimated to sell for between $5,000 and $8,000, according to the Winner's Auctions and Exhibitions website.

Gal Wiener, chief executive of the auction house, said the bidding on that note began at $2,000 and escalated for about 25 minutes, the Associated Press reported.

“When there's a will, there's a way," read the other note, written on a blank sheet of paper. That note sold at auction for $240,000 and was initially estimated to sell for a high of $6,000.

[‘Damaged for the rest of my life’: Woman says surgeons mistakenly removed her breasts and uterus]

Neither the buyer's nor the seller's identity has been made public.

Roni Grosz, the archivist overseeing the Einstein archives at the Hebrew University of Jerusalem, told the AFP that the notes help uncover the innermost thoughts of a scholar whose public profile was synonymous with scientific genius.

“What we're doing here is painting the portrait of Einstein — the man, the scientist, his effect on the world — through his writings," Grosz said. “This is a stone in the mosaic."

Einstein was among the founders of the Hebrew University of Jerusalem and gave the university's first scientific lecture in 1923. He willed his personal archives, as well as the rights to his works, to the institution.

Back in 1922, Einstein six-week tour of Japan was a huge success.

"Close to twenty-five hundred paying customers showed up for his first talk in Tokyo, which lasted four hours with translation, and more thronged the Imperial Palace to watch his arrival there to meet the emperor and empress,” Isaacson wrote.

The country also left a strong impression on him.

“Of all the people I have met, I like the Japanese the most, as they are modest, intelligent, considerate, and have a feel for the art,” he wrote his sons, Isaacson's biography recounted.

Einstein was still traveling during the Nobel award ceremony in December 1922, so he was absent when the chairman of the Nobel Committee for Physics said that “there is probably no physicist living today whose name has become so widely known as that of Albert Einstein."

Perhaps Einstein would have settled for something more “calm and modest."

https://www.washingtonpost.com/news/worldviews/wp/2017/10/24/einstein-scribbled-his-theory-of-happiness-in-place-of-a-tip-it-just-sold-for-more-than-1-million/?utm_term=.49d7bd7ef592

If I am paranoid that I cannot lose, then I will get immobilised. I cannot take any risk: Rakesh Jhunjhunwala

1. I was more interested in the stock market. I found the stock market very intriguing because prices used to fluctuate, I used to wonder why the price fluctuates. My dad then used to try and explain to me and I got very interested and I decided at that age that I am going to make life in the stock market.

2. But you know stock market is like woman, always commanding, always mysteries, always uncertain, always volatile, always exciting. So if you want to perform well in the stock market… see stock markets is as much about psychology as about reality.

So unless you… I have a temperament where you can adjust to the stock market, you cannot succeed and the only king is the market. There are no other kings in the markets. All those try to become kings of the stock market, go to Arthur Road Jail.

So market is the king and you cannot have a good relationship with the woman by probating her. The only way you can have her is by respecting her, by understanding her, by adjusting with her. That is why market is like woman. I have two interests in life -- markets and women. Both are concerned with four letter words – markets with the risk and woman with love.

3. I not only take my work home, I take it into bed also. For me, markets are passion, an obsession and sometimes when I go on holiday, I disconnect. Otherwise, if I am in Bombay, it is on my mind 24 hours. I not only invest, I trade. For trading, I have to follow day to day news. It is so interesting and the interesting part is not so much the wealth. Wealth is important I think but… see, it is an ego battle. RK Laxman said it is the difference of opinion which makes the stock market interesting. For every buyer, there is a seller. For every seller, there is a buyer. So, I would like to know is my opinion going to be right or wrong?

4. They are only 9. I and Rekha is principally do not make any effort, in fact we want to say that they should not understand that we have money or that we are known and our circle of friends are all normal people. We have no celebrity friends or no rich friends. I have an ambition. I think wealth is not the source of all happiness. It is a means to an end. If they make lots of money, I will be happy; if one fellow wants to be a painter, I will be happy; if one fellow just wants to relax, I will be happy; if one fellow wants to be a painter, I will be happy; if one fellow just wants to relax, I will be happy. I give lots of importance to individualism. I want my children to be what they want to be and maybe if they ask me, I will try to guide them. If they would not ask me, I leave it to them

5. “We make our living by what we earn. We make our life by what we give ,“ that is what Churchill said and the other thing that Churchill said is an all-time great , which is very true for life that we have to lose many a battle to win the war that means lot of times in life you face difficulties, sometimes you have to withdraw, sometimes you have to give up in order that you have the strength to win.

6. Alia Bhatt: But can I ask you something. I know it is difficult but do you like to lose? Is it something that inspires you more or do you hate it? I hate losing.

Rakesh Jhunjhunwala: It is not a question. Nobody likes to lose but the reality is that there is no victory without loss. If there was no loss then how do you know that what would victory be. I think that I am not afraid to make a mistake, but only make one which I can afford. So that I may live to make another one. And if I am paranoid that I cannot lose, then I will get immobilised. I cannot take any risk. Though I do not mind losing but I must learn from that losing. And I must understand that there are certain things in life which are linked to human psychology where predictability is very low. Like which movie will be liked, which will not be liked. You cannot predict beyond a point. You are in a profession where uncertainty is built in. One thing in life is that rather than our own liking and disliking, let us understand what reality is and let us adjust to it. So, I am not afraid to lose. 

https://economictimes.indiatimes.com/markets/expert-view/i-am-not-afraid-to-make-a-mistake-but-only-make-one-which-i-can-afford-rakesh-jhunjhunwala/articleshow/61161672.cms

Crypto-currencies - could be $200 trillion

Ask yourself, why does the world need multiple currencies? There’s actually no real reason. The only reason we have a U.S. dollar and also a Canadian dollar is that in 1770 the people in Canada decided not to join the U.S. So an artificial border created two currencies. It’s all dictated by artificial borders.

In the past, an ounce of gold would be accepted almost anywhere in the world. In that sense, unbacked modern fiat currencies are a step backwards.

But in cryptocurrency world, there are what I call “Use Borders.” Every currency is defined by its use. For instance, Ethereum is like Bitcoin but it makes “smart contracts” easier. Contract Law is a multi-trillion dollar industry so this has a huge use case. Filecoin makes storage easier. It’s a $100 billion industry. And on.


***

We are witnessing the evolution of money.

First there was barter. Then there was gold. Gold first solved many of the problems of barter (reducing thousands of exchange rates to just a few). Then there was paper money/bank money/fiat money. Paper money solved many of the problems of gold (e.g. as a store of wealth that you can travel with, or as a transaction mechanism for large transactions).

Now there are cryptocurrencies. And cryptocurrencies are solving major problems in fiat money (no centralized control, lack of human error, no forgery, privacy, etc etc).

***

Cryptocurrencies are currencies with no government in the middle. No bank in the middle. No organizations in the middle keeping track of all your payments, or taking advantage of your spending so they can invade your privacy, and on and on.

Cryptocurrencies solve trillions of dollars’ worth of problems, which is why they will be worth trillions of dollars one day.

Consider the potential:

There is currently $200 trillion in cash, money and precious metals used as currencies in the world. Meanwhile, there’s only $200 billion in cryptocurrencies. Cryptocurrencies are eventually replacing traditional currencies.

So that $200 billion will eventually rise to the level of currencies. And probably sooner than we can imagine.

***



https://dailyreckoning.com/cryptocurrencies-could-be-worth-200-trillion-one-day/?curator=alphaideas&utm_source=alphaideas

Gold price is linked to inflation

1. Gold price is linked to inflation

If inflation increases, gold prices will increase. That's what seems to have happened over the past 15 years from 2002 to 2017. Inflation was high, so gold prices have increased.

But inflation is likely to be low world over for a long time to come, especially in developed countries with little or no growth both in economy and demographics.

Another way to look it is, there is lot of money pumped into the economies of the world by world's central banks. This could lead to inflation. So, gold prices could move higher.

2. Gold prices are affected by demand and supply

The supply of gold is likely to come down drastically because discovery of new gold mines have dropped drastically over the last 10 years.

However, demand for gold could depend on the inflation.

***

Interview with Pierre Lassonde, one of the smartest guys in mining. One of the smartest guys in the world. Pierre is the billionaire founder of top mining royalty firm Franco-Nevada.

https://katusaresearch.com/man-gold-royalty-blood-receals-whats-store-1300-gold/?curator=alphaideas&utm_source=alphaideas

https://katusaresearch.com/dinner-billionaire-wine-connoisseur/

***

Gold miners are running out of gold

https://katusaresearch.com/gold-miners-running-gold-heres-thats-good/

Some Mistakes…

by Altais

So much has been written about vicarious learning i.e. learning from mistakes of others. It is humbling to admit that despite all the knowledge out there, I failed to learn vicariously. The purpose of writing this piece is to put down the learning’s (very expensive ones) over the last decade or so.  I hope to smarten up in the future though.

Before writing about what did not work, it is important to set the context. There is no best or the right way to invest – investors have successfully generated huge returns from different investing strategies – be it buying and holding quality companies, chasing growth even at high valuations, buying cheap companies betting on turnarounds etc. People have made large amount of wealth by having concentrated as well as diversified portfolio. So investors have to explore what works for them, given their financial requirements, temperament, skill and time horizon.

Two important factors to consider while looking at the mistakes (and lessons) are:

Allocation strategy: diversified or concentrated. I go with a concentrated strategy so these mistakes are more relevant in that context.
Portfolio approach: It is important to look at the portfolio return and how the portfolio is structured. This is different from trying to maximize returns from each individual stock.
The major mistakes (with very high opportunity cost) made over the past years:

1. Selling good businesses too early: I typically sold out too early without giving due importance to long term growth outlook and the potential of the business to scale vis a vis the short term expensive valuation. Sundaram Finance, CRISIL and Gruh Finance are among the mistakes in this bucket. They went on to become multibaggers in the years ahead after the sale. Also these stocks were never cheap enough to be bought again. When you are too early into a stock (which is a good thing), your mind gets anchored to historical valuation range, without adjusting for new potential of the stock – either with better performance or increased market interest.

Lesson: If you are invested in a growing business, do not sell it for temporary overvaluation – there may be some time correction which is fine, which should be managed at a portfolio level. At the same time, one needs to be careful of slowing growth or fundamental deterioration in the business e.g. Exide Industries/ Shriram Transport Finance.

2. Going down the Quality curve: This is a derivation of the above (first) mistake. Mostly when I have sold out of good companies, which were growing well, I ended up investing in cheaper but low quality/ growth companies. Over the cycle, this resulted in sub optimal returns. E.g. Sold out of Page Industries and Indusind Bank, and invested in IDFC Bank/ IDFC Ltd.

In theory, it is logical to say – ‘What’s the sense in holding an overvalued company, when you don’t see making any money in the next 12-18 months. One should just sell it and invest in something where you can make good returns over the next 1-2 years’. Now that’s all good to say but in practice the challenges are:

a. When you sell and raise cash, there is a mental pressure to invest. The pressure increases with time and level of cash allocation. The market may move against you for a long time, and even if you get a correction, it may still be at a higher level than what you sold out at.

b. Because of the pressure, you end up investing in low quality companies. (Value traps, no growth, hope value trades, relatively cheap trades etc.)

3. Waiting for a little lower price to buy: This has been a very expensive lesson – losing 10-20 baggers waiting for 20-25% lower price! I missed the boat on so many opportunities trying to just get them a bit cheaper, which never came. The buy price keeps moving up, just behind the actual market price! If you have your thesis right, you will make good money if the business does well, so it’s stupid to wait for just a little cheaper price. What I prefer to do now is:

a. Buy a base position even at 20-25% higher than the ideal price

b. Keep adding to make it a full allocation (either with time correction or price correction)

c. If the stock goes up without any correction, atleast you have a base position and have not missed out totally, though it’s not the ideal scenario

There may be times wherein you have a drawdown or a loss because of buying expensive than the ideal price, but the potential profits forgone due to waiting for a little cheaper price are far more than these losses. Some examples here are Bajaj Finance, Hatsun Agro, Avanti Feeds, Supreme Industries.

To think about it from another angle: over a 5 year period, the stocks you like on a fundamental basis can go up multiple times and the downside to them is say 20-30%. So on a portfolio of such stocks, it’s better to be long atleast with a smaller & growing allocation than not to buy them. On a portfolio level, the downside would be even much lesser and maybe it’s just the dead money or opportunity loss.

4. Failing to consider overall market change and its impact: This is one of the least talked about topics of investing. Different stocks work in different market environments. In a bear markets, companies which are consistently growing their earnings give surer returns, while in the bear to bull market transition, major money is made from valuation rerating relative to earnings growth. e.g. In the 2010-2013 bear market, growing companies like Cera, Kajaria, Astral, Indusind Bank etc gave good returns, while in the bear to bull market environment from 2014 till date, stocks like KRBL (where earnings went up 2-3x times and the stock got rerated from 4 P/E to 25-30 P/E in last 4 years), Escorts (earnings went up 3x and the P/E rerated from 11 to 40) gave far higher returns.

5. Not experimenting enough in the portfolio: In my concentrated portfolio, the minimum position used to be 10-15%, which meant that to add anything to the portfolio, it had to pass very exacting standards. Also when adding anything to the portfolio, I used to do it in one shot rather than building up a position gradually. Now this prevented me from adding stocks with smaller allocation, due to any of the following factors:

a. New company or sector which I haven’t looked at in the past so I was not comfortable investing big there, but the company looked good per. se e.g. Chemical companies.

b. It was difficult to get more information about the company and the sector e.g. Avanti Feeds, Garware Wall ropes

c. Stocks which were very expensive, even though they were a good growing company. e.g. Gruh Finance

d. No future visibility within a timeframe e.g. Hitachi Home, Cyclicals

e. Special situations – demergers etc. e.g. Gulf Oil

Buying GARP stocks in Indian stocks makes one disinterested to look for new opportunities, which might add value to the portfolio in terms of differential alpha. One needs to have many arrows in one’s quiver, which can be used depending on where one can find best and easiest opportunities. Focusing only on a single style – Moat stocks/ Special situations/ Cigarbutt stocks can make one a man with a hammer. What we learn most from Warren Buffett is sheer range of investing strategies – Cigarbutts, high quality in distress situations, pricing power high cash flow stocks, Cyclicals, Commodity, special deals, business buyouts, index derivatives, super cat insurance bets, and now technology moats! How do you become a learning machine if you don’t experiment in real time with real money?

Now, I think it makes more sense to allocate a part of portfolio (10-20% depending on each investor’s own comfort), as a hunting ground to scale up positions as one gets more comfort. Also, it allows to allocate some capital to companies which potentially can give very large returns but you cannot make them core holding at the outset due to any of the above reasons.

6. Having a very large cash allocation: In volatile or sideways markets, cash gives mental relief. While possibility of deploying cash in steep corrections is there, but it’s very difficult to get it consistently right. It is better to be more invested (based on overall allocation), even if there is short term over valuation and gradually take profits. I have been guilty of keeping large cash balance and often times one of the 2 has happened:

a. Either the stocks, which I wanted to buy, did not correct much

or

b. The price to which they came down after correction was still not much different from the original price I saw them initially at.

From a portfolio perspective, how much cash one is holding also has a major bearing on the decision to hold or sell high growth expensive stocks. With a relatively higher cash allocation (20-25%+), it is easier to hold these stocks since any market correction which will lead to drawdowns in these stocks, will also give you an opportunity to invest the cash. High market valuations should be used as an opportunity to move from low quality to high quality stocks and not vice versa. Most of the seemingly cheap or relatively cheap stuff in a rising market is junk so that has to be avoided totally.

Even in the 2008 crash, very very few people got both the legs right – they either went into cash and did not reinvest reasonably well or they went into cash the wrong time.

7. Holding on to the non-performers for too long: When these stocks don’t move for period of time, we start treating them as cash proxy, hoping for an earning rebound. Also, we start paring down good performing companies in the portfolio as their marked to market allocation keeps increasing with performance, further impacting portfolio performance and quality.

8. Thesis change, market view changes: Often the eventual reason of the success of a stock has little to do with the initial thesis. One needs to be open minded about new data points. The initial reason for bullishness on Eicher Motors was cash and CV business, with RE being a side business. Investors got into Hatsun Agro for valued added products, but it was the liquid milk business which got success. Hawkins, TTK Prestige and Gruh Finance were slow compounders, until they hit sweet spot and then the market fancy took over.

9. The need to be Contrarian: When we see markets or stocks moving up fast, the natural urge is to be contrarian and call it speculation. It sounds more intelligent to be bearish and contrarian. In our interaction with top investors, one thing came out clearly – the overall bet has to be on economy, capitalism and entrepreneurship. One can be selective as to the economic segments or timing where one wants to be bullish, but the underline trait has to be optimism and confidence. This need to be contrarian is especially true for fast growing, quality companies – earlier examples being HDFC Bank, Asian Paints. Even in down markets, they are relatively expensive. And when they get discovered, the rerating happens very fast. Though moat is a much abused word now, it is true for select companies! Being reasonably early with fast accumulation of stock and long term view is the better way.

10. Focusing on macro: Again talking about macro sounds intellectual, but for a bottoms up individual investor, it has little relevance. Spending more than couple of percentage of your time on macro tracking or discussion is normally waste of time. Economic macros can mostly be dealt at portfolio level decisions, which need not be done on a regular basis. Mostly, only sector and company specific macros are worth tracking.

A lot of these mistakes can be avoided by focusing on the portfolio return rather than each individual stock return. This makes it much easier to hold part of the portfolio which may time correct in the near future with earnings catching up with valuations. Additionally, you can selectively invest in stocks which may not give linear returns over the next 1-2 years, but hold potential to give very high returns over a longer period of time. When large part of the portfolio compounds at 25+%, the overall portfolio return can still respectable. Essentially it comes down to optimizing the portfolio return rather than trying to maximize it.