Three Elements To Stock Trading Success, One Of Which You Need To Master

A trader should ideally be doing fewer things so as to concentrate most on the difficult part of the job, writes CK Narayan.

<div class="paragraphs"><p>A trader reacts while working in a brokerage house in Mumbai. (Photographer: Prashanth Vishwanathan/Bloomberg News)</p></div>
A trader reacts while working in a brokerage house in Mumbai. (Photographer: Prashanth Vishwanathan/Bloomberg News)

This week I am penning down a couple of things that I feel are important for trading success. Some may disagree but that is fine because the market is made of people with different mindsets and approaches. This is my way of thinking as of now.

Trading has the following elements:

  1. Some good methodology to define tradable setups in the market.

  2. Handling the stress when one is in the trade. This includes mindset and money.

  3. The exit.

We have to be able to handle all three elements to trade successfully. If you look at it though, you will find that the first and the third can be outsourced. But the second element has to be managed all by you. Outsourcing methodology and exits (i.e. a and c) is a great way to go because handling stress (b) is in itself a big job. A trader should ideally be doing fewer things so as to concentrate most on the difficult part of the job. And outsourcing of advice is an easy way to reduce his or her own work load.

There are many services available in the market for advice. The main point is that people should take that advice. Many people who are active in the market have little competence in dealing with the markets but refuse to acknowledge this. Instead, they set about trying to do something (that is quite difficult) by themselves with a wrong belief that they can do it. It won’t happen. The simple fact is that a retail trader needs all the help he/she can get. The tragedy is that he/she doesn’t know it or doesn’t realise it.

Element ‘b’ needs some additional detailing. It is the critical element because it can greatly assist or completely destabilise all the help available from external sources.

The question to really ask is -- what creates stress while in a trade? Stress is not just connected with losing trades alone, it is also in winning trades as anxiety over the profits of winning trades can also cause stress.

If you really examine, trading stress boils down to two main aspects – the size of your position and the capital that you allocate to trading. This will impact how you feel, the amount of discipline you can bring, and consequently, your returns.

Trading Too Small, Too Big, And Just Right

Let’s start with position-sizing first. Now positions taken can be too small, too large, or just right. People who are inherently structured to avoid risks in all situations will do so in the market as well. Hence they are (mostly) the people who take very small positions – buy shares in very small lots (seldom exceed 100) and never engage in short-selling (most don’t even know about it) and avoid F&O as though it was the plague. Those who risk too low will also have very low performance. In the market, you reap what you sow. If you buy 10 shares and the stock doubles, you have made 100% no doubt but the absolute quantum of money you make is very low. When measured against the funds available, the returns may be minuscule.

It is not just trading returns that get hit with low allocation. When you trade really small, you stop paying attention to the position because you know it cannot damage you in any way. This leads to carelessness and could lull you into letting your position run against you further than usual. It can also make you complacent and bored. This impacts decision making and the trading process is not well executed.

On the other extreme is when too much risk is taken with a much larger position than what you can handle. Things are great when you win but when matters go against you then threat responses start getting activated in your mind. Emotions begin to run high and stress picks up swiftly. Worry and then fear show up. When these are running speedily within your mind, decision-making and trading processes once again go for a toss. Execution suffers.

So where is the sweet spot? Right in the middle somewhere of course. This is where profit maximisation and strategy execution are in balance. How do we find this? Only two ways, trial and error for some and for others, research and modeling.

A simple rule of thumb is to do a deep dive into how you feel about the positions that you have.

  • If they are creating anxiety then you are trading too big.

  • If you are comfortable then you may be at a sweet spot.

  • If you are not really bothered, then it is possible that you are trading small.

You are the best judge of the size of your positions. Bigger positions (than what is reasonable as per your capital) will affect your trade management. In profit, you will not hold the trade to the target because the swings in the P&L are too enticing for you to ignore. In loss, you may not apply the stop at the price you should because you don’t want to book that large a loss.

A sweet spot is dependent on many factors, like:

  1. Market liquidity and volatility

  2. Risk tolerance

  3. Strategy

  4. Current P&L

  5. Experience and skill level of the individual

  6. Level of market risk or event risk.

  7. How many positions you hold, etc.

As traders you do need to find it because that is the place of least stress. Each of them is a subtopic for discussion by themselves.

Getting The Capital Math Right

The other stress-inducing factor is capital. No one is quite sure how much capital is needed to engage in the business of trading. Most people, I believe, lose because they allocate inadequate capital. It is not that many of them don’t have capital, it is just that they don’t want to allocate it to the business. That is also owing to not seeing trading as a business. In today’s markets, if a reasonably active trader in futures (3-4 positions open on average), the margin requirement itself is about Rs 15-20 lakh for this. Then add at least a couple of lakhs for paying mark-to-market. How many people are ready to earmark this kind of money? There is some silly belief that they can manage with a smaller capital of a few lakh. It doesn’t work.

Improper capital allocation is the biggest risk to trading well and hence the other biggest reason for stress.

People then try to confine trades to intraday. Now, trades need not work in the time frame that you want them to work. But lack of capital will then force you into actions that are not dictated by the system or methodology. It forces profits to be cut and losses to be taken when not necessitated. Profits left on the table cause stress. Losses that can be avoided cause stress.

So the two biggest factors for reducing trading stress are to allocate the right capital and take the correct position size. If one pays attention to these two aspects and takes the appropriate steps, handling stress will not become a big issue. Once you have taken care of stress in trading and have also outsourced the methodology for identifying trade setups, entry, risk control, and exit to agencies, then you have pretty much taken care of the important elements to trade successfully.

CK Narayan is an expert in technical analysis; founder of Growth Avenues, Chartadvise, and NeoTrader; and chief investment officer of Plus Delta Portfolios.

The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its editorial team.