Mind games in leveraged trading

In this article I will try to explain how markets play with the mind of traders and what can traders do to stay insulated from unwanted noise. The modus operandi of delivering this thought will be through a stock that I have been trading frequently in the last 6 months: HDFC Bank.


The story started in the month of September 2018. Indian markets were reacting adversely to the ILF&S fallout. I and my fellow traders in a closed group were scared to take trades. As it so happens, every trader has a tendency to become extra pessimistic when the sentiment is not good and become extra optimistic in a rosy environment. We were no exception to this vicious circle of greed and fear, however, we decided to take a contra trade in these uncertain times. After deliberating for a day or two, we decided to put our hands in HDFC Bank futures at a price of 1969 for the September futures. The spot price for HDFC Bank that day was 1956. For many days, the price did not move decisively, and we kept entering and exiting the position. These multiple entries and exits led to increased number of trades and thereby increasing the brokerage and taxes we paid, however, we could not think of any other option at that point in time. Below is the chart of HDFC Bank from September 2018 onwards



Love affair with HDFC Bank (from a trading perspective)


To sum up, the various phases in which I have been trading this scrip are as follows:

  • September 2018: The sceptical scary entry

  • October, November 2018: Zone of frustration and consolidation.

  • December 2018 - February 2019: Second level of consolidation in a narrow range

  • March 2019: The big break

  • April 2019: Test of conviction

  • May 2019: The second break

You can see how this scrip has tested my patience and conviction at various levels. To say the least, it was frustrating to have it in the portfolio. This frustration was topped by the need for money to be withdrawn for my monthly expenses. During September, October, November and December, I committed a mistake by entering multiple times, however I was fully committed in January-April and had full conviction for the trade. This conviction was periodically reinvigorated after studying the quarterly results. Below, I would like to share my P&L for this scrip. I have been trading with 2 lots (250 quantity pre lot). I have made a side-by-side comparison between 2 scenarios:

  1. The actual scene where I made multiple entries in first 4 months

  2. Retrospective analysis: if I had been patient in the first 4 months(Assuming I simply rolled over the position). In this scenario, I am assuming a rollover cost of 1 % per month (approximately Rs. 20 per month). hence, my rollover cost for 6 months will be 120 points. Price of May futures as I write this article is 2350. My initial entry was 1969. After deducting the rollover cost, the net profit per share I would have made would have been 261.


Patience & conviction vs. over-trading

You see how, the multiple entries and exits in first four months costed me in terms of number of trades, my time, brokerage and taxes. Not just that, eventually even the gross profit I made was lesser than the second scenario. Having said this, I am still happy that I decided to stick with the trade in last 4 months. It has been a wonderful experience.


Summing up my thoughts in the below points:

  1. Building conviction for a leveraged trade in Futures is extremely difficult, however, I have observed that it does come with time and experience. The most important component of building conviction is understanding the fundamentals of the company. The quality of the company and prevailing macroeconomic situation (Especially Corporate Governance) are also equally important. Conviction cannot be built just on the basis of technicals. Fundamentals and macroeconomics play a crucial role.

  2. Market volatility is an enemy, it makes you rethink your decisions several times and compels you to take a wrong decision eventually.

  3. Charts in the shorter time frames should be trusted the least. The longer the time-frame, the better is the chance of making a right decision. (Monthly > Weekly > Daily > 4 hours > 1 hour > 30 min > 15 min > 5 min). I seldom take decisions basis the monthly chart, till date most of my decisions for positional trades are restricted to weekly charts.

  4. Gap-ups form a significant proportion of breakout rallies. This is justified in the form of extra risk that positional players carry by taking positions home.

  5. The points mentioned in this article are very difficult to incorporate, however, I suggest the following tips to the readers of this article.

Practical Suggestion for becoming a positional trader

  1. Come up with a shortlist of stocks and stick with that list as far as positional trades are concerned.

  2. Study the fundamentals of these companies thoroughly and trade only those companies for which you are convinced.

  3. Track quarterly results of these companies. It is recommended not to carry home any position during results season. Irrespective of the quality of the company, results are an event of extreme volatility and carry the potential of blowing up your trading account.

  4. In case you are not sure about the quality of a company, do not carry the position for longer time unless that company has already given you sufficient profits in the past.

Conclusions

Getting into positional trading and increasing the charting timeframe is a difficult job, however in the longer term for sustainable income, this is a superior strategy. One should aim for slow transition from Intraday trading --> Swing trading --> Position trading. Holding your position through volatility is an art, and every art is sharpened with practice. This will be of great help in preventing the market from playing mind games with you.


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