CHAPTER 6 : MIND OVER MARKETS

MIND OVER MARKETS:

This chapter would tell you that trading is a game of mental toughness. There are certain mistakes which need to be avoided & there are certain principles which need to be followed in order to become a successful trader. Every trader more or less is aware of these mistakes & principles, but the biggest challenge is the execution. In order to make you a more disciplined, assertive, active & passionate trader, we have designed few trading concepts. Three major concepts are discussed in this chapter:-

  1.  Trading Trap
  2. Trading Table
  3. Trading Equation

In one way all these concepts are similar to each other but on the other way these are pretty different from each other. Let’s don’t get into confusion. Read these concepts very carefully, as this book is specially written for this chapter.

Trading Trap

There is no one who can say that I am successful in trading without getting stuck into trading trap. Trading trap is a concept, which exists; but can’t be seen by anyone. Once you are stuck in this only then you realize you are getting trapped by something i.e. ‘Trading Trap’.

Stock market is just like a magnet. If anyone is making money, he can’t leave it as he is making money; if anyone is losing money, he can’t leave it as he want to recover whatever is lost. In short, once you have become a trader in the equity markets you just can’t leave it whether you are making money or you are losing money. The concept of ‘Trading Trap’ can be better explained through a story. Come with me and experience something which is part of life of every trader.

Fear Factor: This is the first concept of trading trap. Mr. Jerry wants to enter in the stock markets but, he is new to the stock markets so he is fearful. He is not aware of the stock market concepts and mechanism of the stock markets. One day he decided that he would start his investments with a small amount. He decided and started searching for the best of the stocks available in the markets. He made all his efforts to find out the most lucrative and blue-chip companies. He consulted his friends who are already in the markets; he took advice from the experts and then he himself did find out lots of information about the companies he selected for the investments. Mr. Jerry after making himself satisfied; invested a small amount in the companies he shortlisted.

There can be two types of ‘Fear’:-

  1. The New Entrant Fear: When a new investor enter in the markets he is fearful as he is not aware of the short term ups and downs of the stock markets. He makes all his efforts in finding out the best stocks. Even he may take advice from the people who don’t know anything about the markets. He will ask his friends, colleagues or family members or even he may hire the services of a professional consultant. This is called the new entrant fear which is obvious for everyone.

 

  1. The Market Crash Fear: When market starts falling investors would lose their confidence they would start taking their money out of the markets. The more the markets will fall, the less will be the confidence of the investors. At the bottom of the markets volumes become very low. Every investor seeks confirmation of the uptrend before entering in the markets. This is called market crash fear which keeps the investors out of the markets for a particular time frame.

Now, again we will come back to the story of Mr. Jerry. Because of the new entrant fear, he got his positions exit with a very small profit. After the completion of the trade, he was happy that first time he invested in stock markets & got some profit.

Now, markets started falling. It came down heavily form the top it has touched. Everyone was selling in the market. Infact, most of the experts advised to stay out of the markets for the time being. But always remember if it has made a top, it would definitely make a bottom also. At the bottom of the markets most of the investors are fearful; they want some kind of confirmation before they enter in the markets.

I remember during the fall of 2008, most of the investors and traders were fearful. They were afraid to buy when the sensex was trading below 10,000 and nifty below 3000. The same investors were comfortable buying when sensex crossed 14,000 and nifty crossed 4000 mark. This is nothing but the first factor of ‘Trading Trap’ i.e. ‘Fear Factor’. The same thing happened during 1992 (Harshad Mehta Scam) and 1999-2000 (Ketan Parekh Scam). Mr. Jerry is perfect example of fear factor so; he missed out on opportunities to make some handsome profits.

How to overcome this ‘Fear Factor’? Keep on reading you will get your answer…

Greed Factor: Take a look at the statement mentioned below.

“Every recession is followed by a boom and every boom is followed by a recession.”

The same thing happened in the markets and markets started recovering. When markets came up substantially from the lows now everyone starts thinking, this is the right time to enter the markets. Mr. Jerry did the same thing and again entered in the markets at a level which is much above the lows of the markets.

Now, all investors and traders are in comfortable zone and think that our economy is doing well; companies are expanding their businesses along-with their top-line and bottom-line. Most of the investors and traders including Mr. Jerry are sitting at a profit which is a notional profit.

To get the confirmation of the market trend Mr. Jerry went back to his friends and expert consultants & asked about the market situation. He got his answer that, when everyone is buying why you want to sell and left out of the next market rally.

During this period we usually get the following opinions and news:-

  • Markets are doing well and will continue to do well.
  • Our economy is doing well and will outperform other markets in the world.
  • Companies and corporates are doing well and will show better growth in the future.
  • GDP rate, Employment opportunities, per capita income etc. are increasing.
  • Market is consolidating and ready for the next big run.

‘In short, everything is fine and you can wait for the bigger profits.’

Here the next factor of ‘Trading Trap’ comes into picture i.e. ‘Greed Factor’. Greed forces you to hold the positions & wait for the bigger profits. But, eventually in most of the cases these profits get converted into losses. For example, Mr. Jerry is sitting at a profit; but he is waiting for the bigger profits.

Now, markets are consolidating in a small range. During consolidation it took a small dip. As per suggestions given by the friends and experts Mr. Jerry bought some more stocks at the same level. After some time markets started falling and it came down to the lower levels where Mr. Jerry is in a position of ‘No Profit No Loss’. He took out all his savings from banks etc. and bought some more shares of the companies he was already holding. This process of buying in a falling market is known as ‘Averaging Down’.

Averaging down emerges out of the three factors of ‘Trading Trap’ i.e. “Fear, Greed & Hope” which eventually will become the reason for disaster. Once you have put all your savings in the stock markets then you will realize that you have committed a mistake and your losses are increasing at a faster pace. Your losses will force you to hope to get the markets recover. You will start praying to God to get your losses recovered. You will not be able to sleep properly; you would be thinking about your stocks all day and night; you will keep a constant and continuous check on the stock price. Certainly you will start spending more time in markets than your real profession. It will affect your earnings from the current job or business or profession.

How to get rid of ‘Greed Factor’? Keep on reading you will get the answer…

Hope Factor: Markets keep falling but investors and traders continue buying at every level without waiting for the markets to settle down. When they are fully invested in the markets then they realize if the markets will fall further they will have to suffer the huge losses. In this situation, investors and traders start abusing the markets and give the following statements:-

  • No one can earn money in this market.
  • Markets are very bad.
  • Oh God; please get my losses recovered I will take my money out and will not come back to this market again.
  • I don’t know what happened to my stocks, markets are not falling still my stocks are falling continuously.
  • That’s my biggest mistake to invest in this market.

All this give rise to third and last factor of trading trap i.e. ‘Hope Factor’. Hope is something which keeps the investors invested in the markets for a very long period of time. There are some stocks which fall during the market crash and never recover back to their previous levels. Infact, during the bull phase even the sick and bad companies have very high valuations; and during the bear phase even blue-chip and best companies falls below their intrinsic value.

Just look at the statement given below:

“People mis-understand equity markets, they feel that the market can understand their sentiments; but they forget that the market is the output of sentiments of millions of people around the world.”

Whether you are making profits or losses, market is not concerned about that. Markets can’t understand an individual’s sentiments but investor / trader have to understand the market movement and be with the market swings.

‘Hope Factor’ will have the following effects on the traders / investors:-

  • ‘Hope’ will force the investors/traders to hold on to the worst of the companies.
  • ‘Hope’ will force the investors/traders to average down the stocks you are already holding.
  • ‘Hope’ don’t allow investors/traders to cut their losses and re-enter at a better level.
  • ‘Hope’ don’t allow investors/traders to churn out their portfolio from bad stocks to good stocks.

Given above are the only three reasons (Fear, Greed & Hope); why an investor/trader loses money in equity markets. If one can manage these factors effectively there is no reason to lose money. The cycle of Fear, Greed and Hope grab every trader in its vicious circle. How to get rid of three factors of ‘Trading Trap’? This is a big question. But don’t worry we will give you the permanent and effective solution for the same.

As shown in the picture given above there are some principles which can be followed to get out of the trading trap. Now, I would explain the same in detail:

Stop Loss: To overcome fear factor, stop loss is the best thing. It’s not possible to make profit on every trade but yes we can minimize our losses by keeping a stop loss which at the end of the day would help you to maximize your profits. When you create a position you need to decide your stop loss at the same time. This will help you calculate the risk-reward and reap the maximum benefit out of the available money.

Stop loss means knowing your risk. Every person has limited risk taking ability. Before entering in the markets every trader need to decide their risk appetite. Many times investors/traders ask; what is the right time to invest in the stock markets? The answer is with you and with everyone i.e. every time or any time is the right time to enter the stock markets if you keep a strict stop loss with it. Many times best of the opportunities can be converted into losses if you don’t keep a proper stop loss.

Let’s assume an example here if you look at the chart given below its very difficult for any trader to decide whether he should buy in this market or keep a short position when the market was trading near 4985. But if a trader just decides any of the following he would be able to get good risk reward ratio:-

  • Buy @ 4985 with a SL of 4970.
  • Short @ 4985 with a SL of 5000.

In both of the positions traders can make good amount of profit with a small SL; but if you will wait for the confirmations etc., you will miss out on several opportunities to make profits. I am not saying here that you can establish position at any level. But, if you can see any opportunity and you feel like creating a position then you don’t have to wait for any kind of confirmation, you don’t have to hesitate, listen to your instinct decide your SL and create the position.

As you can see in the chart buy position can create profits for you to the tune of 40 to 50 points. It’s always good creating a position where you can earn Rs. 3 against a risk of Re. 1. You don’t have to be afraid of loss. ‘You can’t drive a vehicle with fear of accident in mind. But you have to be confident and be careful.’ In the same way in stock markets it’s not possible that you can make profits without considering losses. SL helps you to decide the limit of your losses and protect your money to recover the lost money.

“Money preservation is just equally important as money appreciation.”

We would be discussing about Stop Loss in more details in further concepts.

Target: A trade without target means visiting a road which is completely dark and expecting to reach an unknown destination. Every trader needs to decide the exit on both the sides’ downside and upside i.e. Stop loss and Target. For example as shown in the diagram below; you made a decision to buy Nifty @ 4990 and keep a SL near 4970 (low of day) with a target of 5030 (high of day). This will help you to book profits and capitalize on other opportunities to make money. You can also adopt extensive strategy of trailing Stop loss where you can trail your stop loss once target-1 is achieved and wait for the target-2 to achieve bigger profits. As in the above example once target-1 i.e. 5030 is achieved; you can trail your SL to 5015 and keep target-2 at 5050. If you are right you will get bigger profits and if you are wrong still you will not lose all of your profits and exit your position with a decent profit.

“A good trader never allows their large profits to turn into losses.”

We would be discussing in detail about target in the further concepts.

Be Fast: As rightly said above, ‘Trading is the only place where fast and wrong is right whereas slow and right may be wrong.’ A trader can’t afford to be slow. Once you have made a decision to enter a position you need hit it immediately; you just can’t wait to get a confirmation. But always remember few things:

  • You should have a valid reason to enter the position.
  • You should decide your exit immediately.
  • & Exercise Discipline.

A trader has to be fast on the keyboard & should practice orders. There should not be any scope for keystroke error. He should be able to execute his plans & get the best prices to enter & exit. For example, Mr. Jerry is watching a stock & expecting the stock to rise. He should buy the stock at the current price & keep the stop loss very near to the buying price. In this case if Mr. Jerry is right he will make good amount of money & if he is wrong he may lose couple of bucks. On the other hand, if he is slow to enter the trade he may not get the best price & at the time of exit he may not be able to execute decided exits. A trader must have two qualities; one he should be quick decision maker & two he should execute his decisions immediately.

This is my promise to you; if you can execute mantras of Stop Loss, Target & Be Fast; you can stay out of trading trap of Fear, Greed & Hope. I hope you are enjoying this journey, keep on reading there are lot more interested & exciting concepts of trading.

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