Friday, June 12, 2009

Risks in Trading

Brett Steenbarger, Ph.D, in his excellent blog writes:

"A while back, a trader told me he was doubling his money each year in the market and asked if I wanted to invest funds with him. I immediately declined. My rule is that, over time, a trader will always draw down at least half of his or her targeted return rate. Anyone who guns for 100% returns annually will surely, at some point, experience a 50% drawdown. That's not for me.

Risk and reward are always proportional. Those who understood that did not invest with Madoff.

I know from experience that, at some point over time, I will draw down 10 times what I'm willing to risk on a single trade. If I risk one percent of my capital in a trade, I'd better be prepared to endure a 10% drawdown in capital at some point in the future. If I risk 5% of my capital in each trade, I'll eventually lose at least half of my money. Probability and psychology guarantee slumps; wise traders plan for them.
So much of trading success is knowing how to lose."

My Notes: If you want more rewards, you have to take more risk. A desire for large returns invariables leads to big losses and destroys your trading capital (and your mental peace). But novices never believe this because they have not seen this process in action.

Traders should look at the percentage return they receive from trading. If they are getting 20%+ per annum they are doing well. Looking at percentages keeps expectations at a realistic level and avoids unneccessary risk.

I have an example from my own business: We have a service called Day Vinayak which provides day trading signals. All trades are closed at the end of the day. The big advantage is: no overnight risk. This also means that margin requirements are low, so capital requied is less. Sounds like a dream? Not really. This Monday when the Nifty fell 170 points, Day Vinayak had a dream run. Since then, in the past three days it has given back 35% of profits made on Monday. Maybe it will give back more. For traders it is disturbing to see big profits come in and then maybe 80% of it go away. But that is the way a long term approach to trading works. The fact is that the 20% that remains is also a handsome return on capital invested. Now comes the main point. Chances are that the service may earn 50% (after costs) over a one year period. But if you start with Rs 2 lakhs and want to use the profits as a source of meeting your family expenses, then the annual income will be Rs 1 lakh which is not enough. If you start with Rs 5 lakhs, and, this is your spare money meaning you do not need the money for your personal expenses, you may end up with a gain of Rs 2.5 or Rs 3 lakhs - an excellent return on capital.

I have given a lengthy example from a real life trading scenario to share with you what short term trading gives you.

15 comments:

Lakshmi Ramachandran said...

Atta Boy !

Lakshmi Ramachandran
www.vipreesaftrading.com

men said...

Dear Mr. Sudarshan,
In todays blog you have written that 20% return per year is very good, please comment on the following, I am doing Infosys since 2001 and have so far got a minimum return of 20% yoy, INCLUDING FROM 15-02-2007 TO 31-03-2008. So far my returns are 30% and still holding 50% of the shares. But I have my own unique way here, in your view should I continue doing the same, I do not look at any indicators for these trades but go purely by historical levels.
Also one could get an annualised returns of 20%+ in ITC but one has to have a lot of patience. Based on your experience can I have your view on the above. Please note the above are done ONLY IN CASH.

men said...

Mr. Sudarshan,
In addition to the above I would like to add that in every other stock that I have done I HAVE FAILED. SO this is to be considered.
Regards,

vinay v b said...

Sir, day trading evolves in huge losses. only momentum days it works.i was a subscriber for day vinayak for one month and i suffered losses. what should be the strategy to be adopted while trading with say.Rs.5 lakh capital.i would love to hear from you

dineshrishi said...

Sir I would like to Know the following :-

If I buy 500 BEEs @ 460 = 230000/-

& Sell

Jul 4600 Call @ 255/-

Case 1 if nifty closes at 4600 on Exp
Profit/Loss = ?

Case 2 if nifty closes at 4800 on Exp
Profit/Loss = ?

Case 3 if nifty closes at 4400 on Exp
Profit/Loss = ?

Of-course wot will be Break-Even-Point (BEP) (BEP) (BEP) (BEP)?

With regards

Rishi

Pi said...

@ response to vinay's comment

i guess the reason was that you did not execute all trades with discipline. in the sense that you must have missed out a few trades either because you believed the market was moving in the other direction or you were not able to take the trade.

i am not a subscriber to trade vinayak or any other such schemes but from my own observations and tests the key to success in such systems lies in taking all trades with discipline and without any personal bias. sudarshan ji too must have pointed out in the past and is true for most systems that success rates are most of the times near 50% or below that, but one makes money by making small losses and large gains.

its a typical case of cut your losses and let your profits run.

or could be a case of bad luck for you that the month you tried the system it actually made a loss. but i guess such months would be rare.

Tushar said...

Just to confirm
On weekly charts of nifty 1 month futures, I have noticed few patterns indicating revesal
(1)previous week it was an Inside bar.
(2) this week bar is an outside bar.
(3) Also this week bar is a doji.
CORRECT ME if I am wrong somewhere in analysis.
I have elobrated these terms on my blog
http://technicals4all.blogspot.com/
ok.
tushar

Tushar said...

Sorry there was no inside bar last week. Actually inside bar was on thursday in daily charts.
correct me if I am wrong.

Mind Without Fear said...

There is a saying - think of the downside as you think of the upside.

stockchart said...

hello sudarshanji...i posted my comment on the last post of yours about expanding triangle formation on intraday charts of sensex,now looking at the daily charts,i can see a rising wedge(we did see rising wedge on weekly charts ,completed in jan-08),i think we are headed for a steep correction,please comment.i ve posted charts on my blog "mastering stochcharts".bjnaik@hotmail.com

Vicky said...

Hello,
200 day Price channel may act as a resistance which stands at 4690.
Made an analysis about that in my blog.
www.powerchart.blogspot.com

Krishna said...

Quote-1
Traders should look at the percentage return they receive from trading. If they are getting 20%+ per annum they are doing well. Looking at percentages keeps expectations at a realistic level and avoids unneccessary risk.

Unquote
Dear Sir
Dont you think that with a return of mere 20% and associated risk of erosion/destruction of 100% trading capital....stk mkt trading does not form a very good business..there are many other safer heavens than betiing the whole money for such a low return..??

Quote-2
But if you start with Rs 2 lakhs and want to use the profits as a source of meeting your family expenses, then the annual income will be Rs 1 lakh which is not enough. If you start with Rs 5 lakhs, and, this is your spare money meaning you do not need the money for your personal expenses, you may end up with a gain of Rs 2.5 or Rs 3 lakhs - an excellent return on capital.

Unquote
Sir,
What do you mean by "you may end up with a gain of Rs 2.5 or Rs 3 lakhs"....Take it from me that this person who has made 2/3 lac rupee wont stop trading and at some point of time he will get trapped in consolidation phase and wud give almost all the money back to mkt ....so where is "take home money"..??

Quote-3
Chances are that the service may earn 50% (after costs) over a one year period. But if you start with Rs 2 lakhs and want to use the profits as a source of meeting your family expenses, then the annual income will be Rs 1 lakh which is not enough.

Unquote
Sir
How many traders are really able to run meet thier family expenses by doing trading in stk mkt..??
I have yet to meet such a person in real life....!!
I think more people are now turning towards para-trading activities by becoming analyst,data provider,charts provider....and this is because as they cud not run their home JUST by trading...!!

sir please correct me where required..
regards

mgv said...

Good advertisement for Day Vinayak

gurvi said...

Sudarshan ji,
I surprised by your comments on Friday.
You said to go long on this market....but from last few days you're saying to go short(every rise is an opportunity to exit).

Gaurav said...

sir can you provide me your mail id..there are few questions that I would like to ask personally. My id is gaurav.pro@gmail.com

Regards
Gaurav