Find your 'edge' in investing
You’ll often hear an advice from many elderly people around you asking you to keep away from the markets. Either those folks never invested in the markets, and hence want you to maintain the legacy, or they have severely burnt their hands in the markets. I bet, if you are an active trader/ investor, you dislike all the elderly people asking you to stay away from the markets!
In this article we will try to analyse the reason why most market participants eventually lose faith in the markets and swear to keep away forever.
Most people are unable to visualize how competitive stock markets are. Everyone feels stocks markets are very easy. One of the reasons for this illusion is that we do not see our opponents in stock markets. Well, your opponents are also sitting at their computers, on a cozy chair, in a comfortable room. This comfort makes us forget that there are opponents in every battle. Such comfortable arrangement makes it impossible for anyone to believe the disliked elderly seniors asking us to stay away from markets.
Making money in the stock markets requires an ‘edge’. There are various types of it as we discuss below:
Having insider information: If you can manage to get information before others, you surely can act before everyone else does. Let’s say you know that XYZ company is going to declare good results. You buy that stock before the results are announced. And yes! You made the buck, because you had a solid edge.
Having exceptional quantitative skills: Assume that ABC stock is languishing at lower levels much below what it should be. You suddenly come across this stock and do your number crunching. Your understanding of the sector and the business makes you strongly believe that this company is undervalued. You do further due diligence and are extremely sure that what the market is thinking is not right. In short, you have a contrarian thinking backed by solid number crunching. Having such great skills and knowledge is surely an edge, as not many people in the market have this kind of wisdom.
Discipline: The entire premise of technical analysis is based on ‘rules’. When I say rules, it means that you have fixed levels at which you will enter, exit or book your loss. This works because you do not allow your position to enter into loss beyond a certain percentage. On the other hand, your rules allow you to ride the momentum till it lasts. Having such a discipline in markets is surely an edge, as most traders find it difficult to control their emotions.
The ‘eagle’ attitude: You must have seen many experienced folks not investing in large caps or bluechips. They keep focusing on the small and midcaps. Certainly, investing in smallcaps has much higher risk than investing in bluechips. What makes these folks seek the higher risk? Well, the reason is because investing in smallcaps provides them with an opportunity to find their edge. Smallcaps are generally not very well tracked or researched by a lot of analyst. This leaves possibilities of the market not knowing few good things about the company that you can find out and exploit it in your favour. Again, having this eagle attitude and finding these gems is an edge. The simple reason why this is so is because most people lack the ability and resources to analyse the quality of these risky companies and their management.
Let us now see why it is difficult to master an edge in stocks markets:
Getting insider information is difficult. Yes, it is really difficult to find people who will supply you the information for some vested interest. You may get some trustworthy information once in a while, but getting it consistently is extremely difficult. Without having the consistency in getting what you want, you can never really call it an edge.
Putting your quantitative skills and knowledge to good use has a caveat. You can put them to use only when you have enough opportunities where you can take a contrarian view from the market. Finding these opportunities is rare and hence getting them right consistently is again rare.
Discipline: Emotions keep coming into picture when you see your capital at risk. After losing an ‘x’ amount, you want to earn ‘at least’ x. This is very common human psychology. One way of bringing discipline in your trading is by thinking like a robot. In other words, you can try algorithmic execution of your trades. This again is difficult as finding the right strategy and executing it to perfection has many if’s and but’s. For this reason, most people do not get into the hassle of thinking like a robot.
The eagle attitude works very well in developing countries like India. As a country develops and matures, the number of research analyst tracking various stocks keeps rising. With the upward trajectory of analyst fraternity, it becomes increasingly difficult to find hidden gold mines.
Having discussed the various types of edge and the corresponding difficulties in mastering them, I might sound like one of the disliked elders around you asking you to keep away from markets forever. But no, there is one more edge which is often overlooked. Let’s talk about it right below.
Many of us come to the markets with the right attitude of being patient long term investors. What really goes wrong is we keep patience with the wrong companies. When we see no movement in the holdings, most of us have the tendency of saying ‘quits’!
"Investing is like watching grass grow" - Paul Samuelson
Buying the right companies and staying patient with them requires common sense and the right attitude to hold your companies for a reasonable period of time. The definition for ‘reasonable’ is subjective and varies from an investor to another. In my experience, the length of the business cycle is a reasonable period. The length of business cycle has been shrinking over the past couple of decades. What was once 10-12 years, is now down to 3-4 years. If you have the capital and the attitude to hold the right companies for multiple business cycles, you are an exceptionally lucky person. Wealth creation is certain in this case.
What makes patience an unspoken aspect is again a simple reason. It is extremely boring to just sit. Everybody in their youth likes ‘action’. When somebody asks you to ‘buy right and sit tight’, the back of your mind reminds you of the boring disliked elders who asked you to stay away from the markets!
This brings us to the conclusion. If you want to stay in the markets for a long time and make decent money for you and your family, there is no option but to master an ‘edge’. If you believe that neither of the bullet points is possible for you to do, the best option for you is buying good companies and staying invested for a ‘reasonable’ period of time.
Thank you for making it to the end. Happy investing!