Wednesday, November 14, 2012

Building Scenarios

Building Scenarios

There are always innumerable probabilities regarding the market’s direction and movement or the
lack of both these. Sometimes they can make large moves and sometimes they wouldn’t buzz for
days. Sometimes they would move in the same directions for weeks and then sometimes they would
change direction several times in a day. One of the interesting characteristics of the markets is that
they never fail to surprise us with their actions and catching us off the guard. Often these surprises
prove to be costly.

Although no one can know for sure market’s next course of action still we can prepare ourselves
to face the surprise. In the evening before the trading day we can imagine about all the possible
scenarios that can play out next day regardless of their actual probability to occur. We can, for
example, imagine the ideal conditions we would like to see before making a long entry or the worst
conditions to make a trade at all. We can imagine about our response to breakout failure or our plan
of action during a short squeeze. It won’t take much time to think of so many other possibilities and
we can do it in our free time like while exercising or during the evening walk etc. Try it if you are not
doing it already and please share your experiences regarding this whole exercise.

Again the markets have their own minds and even after this scenario building exercise they can have
something different in store for us but then if one of our imagined scenarios actually plays out, we
our ready with our plan.

[Contributed by Jitender Yadav]


Dinesh said...

Hi Jitender,

It was an excellent representation of human psychology, while trading. Thanks a lot for sharing.

Sometimes, the more I think or analyse, the more indecisive I become but sometimes it pays. Just to give you an example, I wanted to take some position before the announcement of QE3 but was not very sure. My thinking/analysis was leading me no where. I then heard someone explaining on TV that in an election year no Government in the world can afford to spoil the mood especially when the election is just round the corner. I think there is also no dispute that predicting the market right 100 % of the time is next to impossible. So, one has to do risk / reward analysis to arrive at the final call and also the size. Although the event turned out to be in my favor, I understand that there is always some degree of uncertainty in the stock market which we have to embrace. For example, RBI Governor's call to not to adjust the interest rate in the last monetary policy review. The street was expecting this especially after some positive clues from the Finance Ministry. The Finance Minister and most of the analysts were disappointed after the event.

The other example - the market had started rising a bit, just a few hours before the final declaration of the result, in the hope of Romney becoming the President. I think this was because of dilution of ‘Fiscal Cliff’ but strangely the damage that ‘Cliff’ can cause was not priced in the market. So, markets started falling after Obama’s victory was confirmed. It is very odd to imagine that ‘Cliff’ was not priced in as it appeared to be almost inevitable. It tells me that it is extremely important to understand what is priced in and what is not. Sometimes, even the obvious & almost sure bits are ignored because people are too busy enjoying the party.

So, we should do risk/reward analysis taking into account ‘what is currently priced in’ or what the street is expecting/ignoring. At the same time, I agree with you that it is like asking for a moon to expect to be right all the time. Although we should strive for it but no need to get demoralized if the market goes against us.


Ssaameer Sunil Limaye said...

This is exactly what I like to do and I always do, think on the probable scenarios the previous evening!

-Ssaameer Sunil Limaye

Ssaameer Sunil Limaye said...

Sudarshanbhai love the new looks of your blog this Diwali. Wish you and your family a very Happy and Prosperous Diwali!

Seeking your blessings,
Ssaameer Sunil Limaye

Dinesh Rishi said...


The previous look of the blog was better