June 20, 2010

A personal experiment

I was recently talking to a friend and he made an interesting comment after looking at my blog.

‘Why do you target beating the market by 2-5%, when you can make 80-90% per annum by trading? I recently started trading and have been making almost 7-8% per month. You should do that too!’

I have heard this comment from a lot of people in the past. The only common feature is that such people trade for a few months, make good returns and extrapolate it to annual returns. Ofcourse, the very same people after losing money in the market make a hasty retreat and are never heard of again.

The quants
I am currently reading a book –
The quants. It is quite an entertaining book, though I doubt there is anything to learn from it. The book is about various kinds of traders who use mathematical models and high power computers to trade in the market. It talks about a few hyper successful traders at various firms such Goldman sachs, Morgan Stanley, deutsche bank and hedge funds such as renaissance technologies and citadel investment group.

Some of these trader/ investors were pioneers in their fields, the best of the best and achieved in excess of 30% annual returns over 10 years or more. The best returns were posted by renaissance technologies, which seems to have posted annual returns of around 40% over 2 decades.

The point of the above commentary is this – If you can make 30-40% annual returns for a few years and prove it, there are people who will be ready to handover millions to you to manage. You will be rich and can retire soon. If you can make 40% or more, then you will be considered a god and there is will be books written about you – think of George soros and others.

If you think you can make 70-80% per annum for the next 10 years, then you are day dreaming. If you think you can make these kinds of returns, as my friend suggested while working in a full time job, you should meet a psychiatrist and get a mental health check done.

I think the chance of 1 crore rupees dropping on someone from the sky while walking on the road is higher than making 70-80% per annum for the next 10 years. A 75% return for ten years will give you 269 times you starting capital and 73000 times your capital in 20 years.

A personal experiment
Let me come back to title of my post. If you are new to the blog, let me say it outright – I am biased against short term trading. I do not believe it is the right approach for me. It may work for others, but not for me.

I have said this more out of a general belief and not based on any specific experience, atleast till now.

So, this time around I tried an experiment. I decided to experiment with trading in the last few months. I bought some stocks for day trading, did some momentum buys and sell and did some news based trading too.

At the end of the experiment, I tabulated my results and found that I had made around 18% on my capital in around 3 months. The maximum loss was around 6% and the highest gain on a single position was 11%. The average holding period ranged from 2-3 days to around 15 days.

A success?
If I annualize, then the returns come to around 72%. Should I declare it a success and start trading actively?

I do not term the experience as a success and do not plan to trade ever again. Let me tell you why.

I typically check my long term positions once in a month or a quarter. My broker is one unhappy guy as I have very few orders in a month and my account is generally a sleepy account.

The above experiment seems to be a success only in terms of the returns. What is not obvious is the effort and the pain behind it. I found myself scouring the internet and bse website for news and tips. In addition, I found myself checking the stock price several times in a day. There was definite change in my thought process as I found myself more anxious, stressed and reacting more and more to daily news.

I realized that my short term approach started infecting my long term though process too. I started looking at my long term holding frequently and started getting more anxious about them. One fine morning, I just plugged the plug and stopped all the trading. Life is good now and back to normal :)

A typical experience?
So does it mean long term investors should not trade? No, it only means that I should not trade because I do not have the temperament to do it.

The point of the post it this – One should invest based on one’s own temperament. Some people like fast paced action and the adrenaline rush, so trading may the right approach for them. I prefer a slower and more sedate approach where I will analyze a company for a long time and then slowly build my position. Now if that nets me lower returns, then so be it! Atleast I will sleep well at night and not check stock prices continuously during the day.

25 comments:

Anonymous said...

Rohit,
When are you going to write about Clariant Chemicals. I like the company a lot.

I don't understand why u sold Ashok Leyland even after buying at such low prices( even lower if we factor in 2.5 RS dividend for two year). This company at your cost prices would have given your decent returns for longer time periods.
Regards
Gian

Venkat Muthukrishnan said...

True, Rohit. Day trading or any form of ultra-short term trading really sucks the energy out of you. You are constantly under pressure and you are not able to concentrate on your full time job. I have had similar experience and have stopped trading completely. It begins with small gains and it is natural to get carried away and create bigger positions, particularly in the futures segment. Finally, you end up looking only at the stock ticks and everything else in life becomes waste of time. Added, you lose tons of money as well if you dont have stop losses.

Nandy said...

Hi Rohit, The reasons why one should not get into trading and why it is not as lucrative as is sounds are presented well by you. These reasons apply to most of us - whether in a full time job or a student or a housewife has its own pressures - very few would want a high adrenaline rush, high risk thing to do with their hard earned money. It, the wrong perception of high returns, and extrapolation of gains to annual returns that blinds most of them, who get into trading. Long term is sane and sensible.

Neeraj Marathe said...

Hi Rohit,
I agree with u totally..one of the 'side-effects' of trading is that it affects ur investing as well..ur whole philosophy gets jumbled-up and its a sure-shot way for taking irrational decisions..
again, if one is ONLY into trading and stuff, all this wont apply! :-)
Cheers!
Neeraj

sachin8778 said...

A very nice post. Than you for sharing.
I liked the one cr falling from sky comparision :)

Sachin

Anonymous said...

I think people have made a lot of money trading and do not get fazed by the mental pressures. There was a classic movie called trader which showed how people can enjoy trading as a game and would be bored with investing.

So the only conclusion one can draw is that your mental makeup is not that of a trader. Whether trading is better or investing is better needs a different kind of statistical analysis. There have been remarkably successful traders. George Soros being one example..

-Anon2

Anonymous said...

Hi Rohit,

Yeah, It's all about temperament.
I was tempted for this many times since I am almost full time investor.

I was also dragged towards some positional trading idea because of short term annulizing return which my friend earned. But all those trades were borrowed convictions or blind games. So it was very difficult to hang on to your loosing position.

Sachin Purohit said...

Nice post. I am currently in USA and I have friends and colleagues here, who show even worse symptoms than what you underwent for the 2-3 months of experiment. These guys stay awake all throughout the night to track the Indian markets and appear like zombies when they show up at work during daytime.

Probably, if they are as lucky as the guy who said he earns 70-80% per annum on trading, then too they may lose the equivalent amount of money on healthcare.

income.portfolio said...

The observation I have is, the people who use their own money to trade will, typically, lose in long term w.r.t. real wealth creation. It is the professional traders, who use other people's money, are the winners. Because of pooling effect and high risk taking. It is a different mental make up when you don't use your own money.

You can make tons of returns in simulated trading (for traders/hedge fund managers this is what it is).

But when it comes to own money, its the different mental makeup.

How many professional traders use their own money?

paul said...

hi rohit,
i think the indian gelatin industry is looking cheap compared to its fundamentals-nitta gelatin,india gelatin and natural capsules, even for yield hoggers!wud luv to hear ur thoughts
p,s pls take a look at a T group stock teesta agro it has cash and cash equivalents of 20 crores and a mkt cap of 5 crores!

Aniruddha said...

Hey Rohit

In last 4-5 years i have done so many experiments that one day i thought i should do leveraging. Before that I asked for your inputs but you gave me cold shoulders. So i never written about it here. But I am glad to tell you that my experiment is going exceptionally well. I could manage my finances very well after i started leveraging. earlier I used to allocate all my cashflows to market. but now i can allocate my salary income to build my contingency funds, savings over the period and leveraged money went in the market. I kept it rolling over the period and gathered enough capital.
One thing is RJ told in his interview, "Trading gives you capital to invest" That is ture. to add some spice to trading i did leveraging.


Regards
Aniruddha

Rohit Chauhan said...

Hi gian
clariant chemical was an arbitrage play, but on investigation i found it to be a good company and hence created a decent size position.

ashok leyland has given me good returns, but it is losing market share. so i decided to reduce my position size, though have not exited it completely

regards
rohit

Rohit Chauhan said...

Hi venkat
true, i comes to down to mindset. I personally have realised it does not match my mindset and hence the discomfort.
in the end, better to work with your temprament than against it

rgds
rohit

Rohit Chauhan said...

Hi nandy
another reason is trading only appears easy on the surface with easy money. in reality it is tough, highly competitive and definitely not a part time activity in the long run if one wants to invest good amounts
rgds
rohit

Rohit Chauhan said...

Hi neeraj
there are some super investors like RJ who can do both, but lesser mortals like me cannot. so better not imiate someone when one is not capable of it

rgds
rohit

Rohit Chauhan said...

sachin - thanks for the comment

anon2 - true. my post is not about if trading is better or not. there are a lot of very successful traders and very rich ones too. i think it comes to one's own temprament and approach.
at the same time, i think people think it is too easy and exicting and hence get drawn to it. i think it is not as easy as it looks
rgds
rohit

Anonymous said...

Hi Rohit,

clariant chemical an arbitrage play? I did not get clearly. What type?

BR
Arun

Rohit Chauhan said...

Hi anon1
true ..i think if one has the temprament, only can then one have the conviction to hold on to losing position.
i think part time trading is a bad idea which a lot of people follow. one should be fully committed to it and learn it in and out or leave it. half knowledge in most cases, including trading is dangerous

have we heard of part time surgeons :) ?

rgds
rohit

Rohit Chauhan said...

Hi sachin
i know what you mean and know of such people.
ofcourse thats the hieght of madness ..stay up in the night and then have a day job on the side. thats a easy way of ruining your health and peace of mind

i think it is addictive too

rgds
rohit

Rohit Chauhan said...

Hi income.portfolio
yes, most traders play with others people money. much easier to do so.
i am reading a book - the quants and its amazing to see 20 something bet billions and blow it away.

the traders who use their own money are definitely more cautious and control risk more. ofcourse the numbers are much smaller

rgds
rohit

Rohit Chauhan said...

hi paul
i have seen a few of these companies - i think some of the capsule companies. most companies are very small, dont have much competitive advantage and working on slim margins. as a result i did not move forward on it

rgd
rohit

Rohit Chauhan said...

hi anirudha
i think we have exchanged quite a few emails and if the cold shoulder means i did not reply to some of the emails, then its quite possible i missed some emails.
if the cold shoulder means, i was not enthusiastic about the leverage bit, then guilty as charged.
i dont like leverage and will never go for it. if someone asks me about, i would actually discourage it.
rgds
rohit

Rohit Chauhan said...

hi arun
clariant has land in thane, which it plans to sell. with ninad, we were looking at that sale as a special event and value unlocking. however we liked the company so much that we built a position in it
rgds
rohit

shravan said...

hi rohit,
pls chek out apossible net net situation called teesta agro

Anonymous said...

Here's some more fodder for value based investing .

http://www.wallstreetoasis.com/forums/the-hedge-fund-experience-good-bad-ugly

http://www4.gsb.columbia.edu/valueinvesting/schlossarchives/class_recordings

I think value investing is hard when your idea/thesis backfire with the volatility today.