Monday, 16 September 2019

CHOICE PARALYSIS : TOO MANY OPTIONS MAKES YOU A LOUSY INVESTOR


Let's talk about nasi lemak today.

Similar to Subway sandwiches or the Family Mart oden, nasi lemak is defined by customisation. The final output is the product of an assembly line offering limited but sensible options.

At the nasi lemak stall, your choices are broken down similarly: the carbs (rice), protein source (eggs, chicken, beef, squid, etc), the usual peanuts and anchovies, cucumber slices, and a dollop of shrimp sambal to top it off. 

These sensible options are not meant to disrupt the natural order of things.

Now imagine a totally radical take on the nasi lemak or Subway sub. A boundary-busting culinary enfant terrible decides to offer you unlimited options on what goes on your plate. Instead of normal nasi, this Roadside Ramsay offers you 15 different grain options to choose from as a base. Put in a bit of quinoa with that, or some Japanese black rice. 

Instead of fried peanuts, you can get 10 different types of nuts, cooked ten different ways. Boiled almonds, anyone?

Because we're too hipster for just sambal, perhaps you can replace it with kimchi that has been fermented for two years. Hot sauce, sriracha, you name it. Have the nasi lemak of your dreams. 

Your only limit is your imagination. But do consider that too much imagination can also be the absolute bollocks. 

To press our point, beware : the following photo is not safe for work. It will be the worst thing you'll see today. 


"Every day man dishonours his food..."


PARALYSED BY TOO MUCH STUFF

Have you ever sat in front of your TV browsing for something on Netflix/Astro channels to watch for a solid five minutes, only to end up re-watching an old episode of Friends that you've probably seen a hundred times?
Have you ever spent about an hour packing your clothes for a holiday trip, crippled by indecision about what to wear? 

We're not suggesting you should ditch the mankini for something that leaves a bit more to the imagination - that's your choice - but our point is that indecision can be time consuming. Having too many options can slow down your actions. 

Instead of doing, your thinking is hindering your progress. Choice paralysis.

It's the equivalent of the Jam Experiment which you can read more about, but the gist is this:



Too many choices can lead to bad output. When it comes to hipster nasi lemak, all you're risking are your digestive system and the boundaries of good taste. You've already gone past the part where your family has disowned you.

But in investing, you're risking severe financial losses, and just as bad, subpar returns.

Diversification and creativity are great, but only to an extent. Know the symptoms of bad decision making and perhaps you might be able to avoid them.

KNOW YOUR STRATEGY, KNOW YOUR LIMITATIONS

Another hypothetical; consider an ice cream man and a neurosurgeon. They are good friends; the neurosurgeon and her kids get free sundaes when visiting the friend's home. The ice cream man gets his endoscopic thoracic sympathectomy done by his good friend when he really needed it.

OK, but would you trust them to switch jobs? Absolutely not, right? The ice cream man would make a mess of people's brains. The neurosurgeon, in a far worse crime, would end up concocting bland chocolate chip ice cream.

 bad mix... (Source)

So why would you chase any stock and every stock in every sector? Do you know what you're actually good at? Are you a student of value investing or a dividend hunter? Are you a balls-to-the-wall short term trader or a safety-at-all-costs buy-and-holder?

Most retail investors are human beings (we think), and we tend to overestimate our capability as investors. We feel that we are jacks-of-all-trades, but we are not.

As active investors, we have the same fallibility. We know our strategies, yet sometimes we fail to abide by our own rules. We miss the trees for the forest, and our constant need for action and gratification - short term trades, that is - eats up on our potential profits. 

Case in point : the following is actually totally true. We refer to our GREATEC trade and a series of subsequent trades that netted us almost RM20,000 in profits. Sounds good right? 

Well:


Since the listing, we have encountered many good trading ideas and twice as many bad ideas. We did fine, although some of our choices have been sloppy. We remain vulnerable to emotion-driven trading sometimes.

Regardless, it is nowhere near as good as we would have been had we just sat on GREATEC and did absolutely nothing else since the stock listed. As of 13 September 2019, the stock has returned 149%. In three months.

While this is not meant as a criticism on our trading endeavours (though you can treat it as such, if you like), the point is this: having 50 good choices (potential trades) might not be better than having one truly great choice (GREATEC).

Early stage listings is one of our core strategies; it is why we had succeeded with many similar IPO situations. Our responsibility should have been to stick to our strengths, and fine tune that skill.

Most people, including us, tend to have more money than sense. Why do you think people do overseas transfers of RM500,000 to help their struggling long distance lover in Nigeria?

Here's our own version of choice paralysis. By (falsely) believing that there so many great opportunities out there, we end up making subpar decisions, which subsequently delivers less-than-desirable returns. 

Making too many choices is a constant activation of the senses; you feel the buzz of the markets and the thrill of executing a potential winning trade. We are hard wired into preferring this route, but we tend to forget that what feels good is not necessarily the right thing to do. 

Being fully aware of this weakness, we decided to take action. Rather than being serial traders, we have now limited our activity severely. From 15 really big attempts a month, we limit it down to less than 5. We no longer trade like this every month; we look at the market constantly, but we act rarely.

These big attempts are the trades which we expect to deliver close to five figure profits or beyond; they are not easy to come by. The GREATEC listing and our PENTA trade are two such examples, but these golden opportunities only come by several times in a year. 

Stock is up 33% since we wrote this IN JULY! Read more here.

We try to commit our capital to the very best ideas only; merely good ones are not good enough. We still do small trades to hone our price-volume analytical skills, but the profits generated are usually negligible, at least in the grand scale of things.

Eliminating choices is not a natural thing to do. Not trading for the right reason is immensely harder  than trading for any or no reason.

Refusing those endorphin shots that come with active speculative trading is not easy; think of it like somebody kicking a years-long smoking habit. You know the bad side effects but you can't help it.

You're correct if you figured that the key lesson here is 'don't overtrade'. But as the manager of your own capital, you also have to stick to your strengths. Know your weaknesses, and then find a way to minimise losses, maximise profit potential, and optimise your trading strategy.

So if you have a good record with trading oil and gas counters, having fully understood the fundamentals and sector dynamics, stick with that and hone that skill. If one day you decide to buy into a speculative tech counter of which you know little about, you're the same as an ice cream man dabbling in brain surgery. It will get bloody sooner or later. 

The other key lesson here is 'do your homework', but you probably already know that.

When interacting with our readers*, our answers tend to be questions : what's your profit target? What are your strengths? If you plan to go into a trade, what's the fundamental/technical/whatever justification? We do this to understand your thinking and motivations. We hope you have the answers to those.

We have many weaknesses; the first step is to be self aware. Rectifying them takes a long time, but the process itself helps.

If you see our shortcomings as similar to your own failings, be assured : when it comes to investing, we have failed much worse than you have, probably.


*Twitter or Telegram - join the conversation and reach out anytime!











Tuesday, 10 September 2019

BURSA TRADING TACTIC : MANAGING STOP LOSS LIMITS FOR INDEX WARRANTS

Key players in the global geopolitical scene.

(Editor's Note : this is by far our most technically complicated post to date. We are writing this for our own reference as much as it can be yours. Let us know how we can improve the content of this post if you have suggestions; we made an effort to provide as much clarity as possible).

As you may have seen in recent weeks, it's the season to be jolly - over the Hang Seng Index, that is.

We are trying to build up some credibility as specialists in index warrants trading. The HSI warrants has been a battleground for punters, technical traders, fundamental analysts, and idealists alike. 

The protests in Hong Kong right now have been historic in their longevity and effectiveness. Without diving into the political-military-socieconomic aspects of the unrest, let's just say that the protests have changed everything; perception on human rights  and civil rights, HK-China relations, lame duck special administrative governments, and last but not least, the stock market outlook.

This is Hang Seng season because the fall in the index has been swift and severe. While concerns persist, it is clear that panic comes in small doses. Having followed the index movement for a few years now, we can translate that understanding into a viable, and profitable, trading angle.

We have been making significant market calls in regards to the Hang Seng lately. We have traded on optimism (call warrant), pessimism (put warrant), contrarianism (buy when the market is selling down), and momentum-ism-ish (ride the wave, baby).

But today we are going to be a bit more specific. We have set out to solve an intractable problem that has plagued many a small cap, small fry, penny stock trading uncles for many years. We will explain a valuable trading tactic that will allow you to minimise your downside risk and optimise your profit potential.

It's not easy but it can be done. You just have to adopt a different approach than most people.

LET US STOP YOU HERE...

Index warrants trading is challenging. The price movements alone can leave you with motion sickness. Seeing your position drop swiftly - thousands of ringgit in losses within minutes - can leave you hospitalised. You may even start encountering Pooh and Piglet in your dreams, asking them to consider the protesters' civil rights and human rights demands (it must have been a plot line from one of their weirder TV episodes).

We have a whole bunch of resources and knowledge database for trading index warrants. We urge you to read them before moving on. The following topic is for intermediate traders, although you may find them useful in your own activity.
STOP LOSS - FOR BEGINNERS

We usually refer to it as a 'puke point'; the forced visualisation of this makes the term easier to understand for most people.

Essentially a stop loss is where you absolutely, positively, resolutely have to exit a trade. This point is somewhere below your entry price for a stock or warrant.

It helps to fully quantify the extent of your losses and the amount of losses you're willing to absorb in any given trade. RM1,000? RM2,000? Good - now halve that amount. Always be more conservative than you give yourself credit for - self assessment is an unreliable thing. 

More importantly, the stop loss is a tool to take you out of a trade against your better (worse) judgment. When under pressure, we tend to dilly-dally. We go into self denial mode: I'm losing 10% now but surely the position will rebound! 

No bro, not like that at all. If you don't set stop losses, your 10% loss becomes 30%. And once you hit that point, you may either give up or worse, take it down further to a 50% loss.
Just remember this: when your position is down by 50%, the stock or warrant actually has to increase by 100% just to wipe out your losses. Take our word for it; don't get into this situation. Swallow the pain at lower prices. Move on.


 Anonymous giant hand is correct. Listen to anonymous giant hand. Source.

Our mantra for trading anything is bloody simple:

2:1 reward to risk ratio. 

So we are willing to lose 5% in the value of our portfolio for the plausible opportunity to make 10% profits. It can be 5%:2.5%, or 18%:9%. You get the idea.

The concept is to measure your potential returns relative to the risk you are undertaking. If you're willing to incur 10% losses just to trade a speculative uncle counter that promises 10% profits, you'd be in deep trouble. The numbers don't jive, or to put it more indelicately, you're wasting your time.

Let's say you go into a stock at 8.5 sen. Your 10% profit target per share is roughly 9.5 sen. (Editor's Note: it's actually 11.76%, but still the closest absolute amount to 10%. Use this handy calculator to determine your profit and stop loss points).

On the other hand, to stay true to the ratio, your stop loss point would be 8 sen for the 5% loss limit (Editor's Note : it's 5.8% actually, but it's the most exact it can be at these low prices). So when you have these figures, your trading strategy is pretty much there.

Entry point : 8.5 sen 

Profit target exit point : 9.5 sen

Stop loss point : 8 sen 

You are willing to lose 0.5 sen per share for the opportunity to gain 1 sen per share.

Now you might wonder : I got my stop loss, so now what? The next step is to manage it. It is always, by a million miles, more important to manage stop loss points than when your position is profitable. Unknown punter uncle is right when he said "profits take care of themselves, losses never do".

STOP LOSS MANAGEMENT

There are two ways to do this. 

One is to keep constant watch on the prices. This is doing it manually; it is time consuming and doesn't allow for distractions. Once you see prices dropping, or when you 'get a feel' that the market is heading lower, you'd sell off at 8. You might get lucky or you might not; there's a risk that by the time you want to sell at 8, the stock has gone down to 7.5. Outcome : you'd be screwed (by an 11.76% loss, no less).

The other way is to set an automatic stop loss threshold. You can input this in your trading platform on your own - if you don't know how, ask your broker. This order essentially 'takes you out' automatically at the price point of your choice.

If your trigger is at 8 sen, when a trade is done at that price, your position will be dumped immediately. The 'trigger price' set means that you can sit back and sip pina colada while your stock position works itself out.

What the automatic stop loss trigger looks like.

With some luck, your 8.5 sen per share position may never go to 8. It might serenely go to 10 or whatever.

Unfortunately, both methods can be problematic to implement. 

8.5 sen with an 8 sen stop loss limit? Urgh! Any time that point can be hit. The 0.5 sen increments are side by side, after all.

What if the stock hits 8 sen once (let's say some market fool decided to sell one measly lot of 100 shares at that price) but immediately rallies to 10 sen thereafter, you've just lost out on fat profits. Indeed, if this actually happens and you commit to sell your entire position at 8 sen, you will be taken out completely.

Granted, you may also opt to do partial stop loss orders - for example only half of your position committed to be taken out - but this can be an overcomplication of a simple concept.

Stop losses in theory should be inviolable, otherwise you will end up readjusting your reward to risk ratio in real time ("Oh, it just dropped to 7.5 sen for an 11% loss, now I must aim for 22% gain!"). Dilly dallying doesn't work, sister.

We will propose a smarter solution to this serious problem. This issue tends to manifest itself in volatile trading instruments, especially Hang Seng warrants. So we will use a real-life profitable example on how we utilised our stop loss management tactic to great effect.

THE TRADE



To solve the problem of managing stop loss limits for cheap warrants, we will use a recent trade. This is a bread-and-butter case for us. Rather than the profits - we achieved those - the more interesting part is how we managed the stop loss points.

The warrant we're buying is HSI-C7D, a cheap call warrant linked to the Hang Seng. This was a ride-the-wave trade. The backstory is simple : Ms Carrie Lam (pictured somewhere in this article), Chief Executive of Hong Kong, announced the government's proposed withdrawal of the much criticised extradition bill. It is one of the five key demands by protesters - and the only one that is feasible to address - and signifies the authorities' commitment towards resolving the unrest in Hong Kong currently.

While we can argue about the effectiveness of this move, the markets took it seriously. The announcement was made during lunchtime; as soon as the Hang Seng reopened for trading, the index was up 3.3%. That's a massive one-day move of historic proportions, if you must know.

 We are truly living in the worst alternate universe. Source.

This meant that we had to consider a trading angle. Our thesis is anchored on one set of belief above all else: "markets just went up 3%? Good chance it can hit 4%".

This wasn't a lucky guess. It's a calculated move in the context of the news (bill withdrawal) and the market reaction (huge). In other words, we didn't think the markets will immediately reverse course from 3% to 2%. The move was so historic and so outside the normal average that we decided to consider further upside. 

While we look at many HSI warrants, HSI-C7D was attractive simply due to its price point, and its capacity to deliver outsized profits within a short time frame. In other words, it has the potential to gain one sen, with the acceptable loss risk of half a sen. Classic 2:1 reward risk ratio.

So we ended up assuming a position at 8.5 sen. This was not easy as this price was the intraday high when we got into it. Indeed, call warrants gapped up by 2:30PM (the Hang Seng was merely up by 1% before markets closed for lunchtime, and before Ms Lam's announcement).

THE PROBLEM

We're now back to the original issue of managing the stop loss of our call warrant position at 8.5 sen.

We definitely did not want to automate a sell order at 8 sen. Once somebody hits that, we'd get taken out. But our stop loss point actually is 8 sen. We have to do this manually.

Call warrants on Bursa Malaysia are priced differently. Some can be 10 sen per warrant, others can be as high as RM1. They also vary in terms of liquidity and volatility; these are our primary considerations when choosing an index warrant to trade.

HSI-C7D simply lets us buy a lot for cheap. We are comfortable with the sizing. The liquidity and volatility were also acceptable.

Simply put, if the Hang Seng goes all the way to a 4% increase in one day - from 3.3%, when we decided to go in - HSI-C7D will most definitely gain one sen. That translates to an 11.76% profits for us, which is aligned to our 10% per trade profit target.

Conversely, a half sen decline (to 8 sen) translates to a loss of 5.8%. So the parameters are clearly set.

What's left is to deal with the volatility. The Hang Seng might fall back temporarily before rebounding. If this happens, HSI-C7D might go down to 8 sen. But we did not want to be forced to move out. What we needed was a more precise tool to measure the weakness or strength in the Hang Seng.

THE SOLUTION



Enter HSI-C7F. This is another call warrant, but it is much more pricey than C7D. It trades around the 40 sen range at the time of the massive market rally.

Recall that index warrants are priced differently.

As a general rule, the more expensive the warrant is, the more sensitive it is to the index movements.

What this means is that C7F is far more attuned to the little moves in the underlying index. We can use it as a benchmark. We still prefer to trade C7D, because it's cheaper.
This is the tactic : we are effectively using C7F not only as a barometer for the index, but also to set our stop loss points. Let us explain.

The chart below shows the 'redline'. That is the stop loss point for C7F; it the call warrant drops to 41 sen, we'd exit C7D (at 8 sen).

When we bought into C7D, C7F was trading at around 42.5 sen. At this point, the Hang Seng was also at its highest point of the day at that time. Because C7F is so finely attuned to the index, little movements will cause the call warrant to fluctuate in price. 

For C7F, there were three 'ticks', or half sen increments, between 41 sen and 42.5 sen. There's enough room for fluctuations without us being kicked out of of our C7D position.

At the time, C7D can only do one of two things; stay at 8.5 or drop to 8. There isn't much nuance; this is why we can't simply set automatic stop loss points for cheap warrants like this.

Aside from the redline, orange line is C7F. Blue is C7D with our entry (first circle) and exit points (second circle) clearly denoted. Below is a comparison of the percentage changes between the two call warrants.



We had only been talking about managing stop losses. The next technique is to actually use C7F's movement to our advantage. While 42.5 sen was the point where we went into C7D at 8 sen, we can also now manage our position as the market goes up.

For example, when C7F went up to 44.5, you can bet your bottom that we are sitting comfortably. But even at this point, C7D hasn't moved one iota. The Hang Seng actually needs to move in a bigger way - in other words, it needs to hit that 4% one-day increase mark for this trade to work.

Eventually, as the Hang Seng rallied further - it actually peaked at a 4.24% one day increase, or the highest one day move in 8 years - and C7F went all the way to 47.5.

C7D also took care of itself and hit a high of 10 sen. We very graciously exited at our desired 9.5 sen target. Locked in that 11.76% gain.

Below are our entry and exit points for C7D; the two circles are the same as the one in the blue line in the above chart.









Our main point is this : managing stop loss points is never just about the absolute numbers. There are tons of ways to tinker around with the methodology.

(Editor's Note : we honestly can't comprehend how you've read this post all the way to the end).





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