Why only a few are successful in trading?
In India, how many very successful traders do you know of?
By successful, I mean traders who have been able to create a sizeable wealth (500 crore+) for themselves over a period of time. (10 – 20+ years)
Trying to answer this question myself – the most successful traders in India are R K Damani and Rakesh Jhunjhunwala. (There are few others but not in the same league as these). All these traders are also very good investors and a major part of their wealth has come from investing and not trading.
So while there are so many investors in India who have been able to build a sizeable fortune for themselves, but there are only a handful of traders. Trading no doubt has a far higher mortality risk than investing. In investing – big mistakes can lower down the portfolio CAGR, but in trading – big mistakes can wipe out the capital.
After investing for over a decade in the Indian markets, my aha moment to understand trading was after reading “Trading in the Zone” by Mark Douglas. The book is a gem and should be read multiple times.
I would have underlined half the book but one of the key messages I took home was:
What the market will do next or what a stock will do next (next being after you have bought it/ or in some cases sold if going short) has no bearing on being a successful trader.
Shocked?! (If I buy and stock goes down, I am into a loss and how is it that it doesn’t matter?)
Trading is essentially taking a probabilistic bet. Whatever be your basis of arriving at the probability, the probability can never be 1 or 0. It falls between this range and that is the risk a trader takes. If his view is correct, he makes money else he loses money. What a good trader doesn’t do is argue with the market – if he is proven wrong, he takes the loss.
Thinking about trading this way takes away the whole pressure to be right about the bet all the time. While taking the bet (or the trade) itself, you know that there is a probability that you could be wrong and if that happens it is not disturbing. What kills most of the traders is the expectation and pressure to be right ALL THE TIME – which leads to fatalities ranging from hoping that it works, going crazy on risk management to losing it mentally etc. (On a side note, twitter is full of people with views on stocks and markets but no skin in the game. If they were to put money behind their views, we may only have one-tenth the traffic on Fintwit.)
Just having the background that the stock or the market can do anything after you have bought – makes it much easier to not let ego or emotion get attached to the trade.
The key to successful trading is the same as that of investing – MAKING MORE MONEY WHEN YOU ARE RIGHT COMPARED TO LOSING WHEN YOU ARE WRONG.
OR said differently
LETTING YOUR WINNERS RUN AND CUTTING YOUR LOSERS
This is very difficult. Why?
Because it takes DISCIPLINE. To have discipline, you have to make and follow rules. Following those rules makes trading boring. And MOST PEOPLE DON’T WANT TRADING TO BE BORING.
Skill is highly overrated in trading and importance of cultivating the right attitude is highly underrated.
What is the right attitude needed for trading:
- Acquiring the belief that “anything can happen” in the markets
- Predefining risk – A typical trader will not predefine the risk of getting into the trade because he thinks its not necessary, he has convinced himself that he is right before he gets into the trade and the alternative (being wrong) is simply unacceptable.
- Willingness to take losses
- Being rigid in rules and flexible in your expectations. Most traders do the opposite – they are flexible with their rules and rigid with their expectations.
One of the most difficult things about trading is accepting losses. It might seem simple in theory: use a stop loss and mechanically take a loss when price hits the stop. There is a whole lot of difference between theory and practice.
Let me share a story:
There is a person in a closed room with only a glass of water. He is told that the water is poisoned. When his thirst becomes unbearable, he most likely will drink the water even after being told that it is poisoned.But if the same person knows for sure (self knowledge) that the water is poisoned, he will die of thirst but not drink the water.
In both situations, the person has knowledge that the water is poisoned but the difference is in the first situation he does not have absolute faith and belief in that knowledge and in the second situation he absolutely knows it to be true and thus acts accordingly.
The same difference is how most of us go about in trading. The smartest and the most successful traders have already laid out all the theory about what is needed to make money while trading, but even after having all that knowledge most of us fail at it.
Let me share few of my own experiences in trading over the last few months.
Note – I started trading with a small part of the total capital, which also I have mentally written off towards learning fees. Now, there are many ways to trade stocks – intraday, positional (ranging from a few days to even months and years), swing trading etc. The trading strategy I am comfortable with given my temperament is positional trading with focus on stocks with strong fundamentals, buying on strength with clear focus on position sizing and risk management.
- After reading, understanding and agreeing to all the rules about risk management and position sizing in trading – I still ended up taking much higher losses (20-25%) on some positions than my initial stop loss. This is after having all the knowledge. Why did this happen?
- Position is down with the broad market and expectation for markets to turn
- After having made money on a few trades – not wanting to lose money on the next so letting the losses run
- Changing the position from a trade to an investment (mentally)
All of the above are among the basic reasons why traders lose money. Nothing new but I still made all the basic mistakes.
- I had read that the smartest traders average up on the winning positions. So where I was in profits, I averaged up but only to lose money on the larger position size. Now to control risk, if the position size is increased, the stop loss needs to be moved accordingly which gives lesser bandwidth for the stop losses to be hit. Only after doing this a few times, did I realize that for increasing position size on winning trades, the stop losses need to be tight on the incremental quantity atleast.
For any new trader, it will be very difficult to practice taking small losses until he has taken a big loss. Only after taking a big loss, can one appreciate the need to be disciplined about taking small losses. I have yet to read about any successful trader who didn’t take a big loss initially when they started.
Similarly, only after trying very hard to make money on all trades and failing at it, can one get into the mindset of making more on the trades that work vs losing less on unsuccessful trades.
- Trading is much more difficult behaviourally than investing. That is why only a few succeed at it. Behavior accounts for maybe 80-90% to success in trading compared to knowledge (10-20%).
- Discipline is one of the key aspects need for success in trading. It can be highly rewarding but it is not easy. A trader has to fight his own psychological weaknesses. It is very difficult.
- Trading (like investment) has to be learned – It cannot be taught. It is not possible to experience the emotions (fear/greed/regret etc.) and its impact on how one behaves in phantom portfolio vs an actual portfolio.
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