Is process as important to trading as in investing?

Jun 25, 2015

In this issue:
» India's insurance penetration on a declining trend
» Challenges facing the solar power dreams of Modi government
» An update on markets
» ...and more!

Today's The 5 Minute Wrap Up has an element of surprise for our readers. Not often do we invite guest writers to pen this section. It is mostly confined to the research team members.

However, in one of the previous editions, Rahul Shah shared an interesting piece of his first rendezvous with Apurva Sheth, the editor of Swing Trader.

Subsequent to that they have had many more discussions on the similarities and dissimilarities in the principles of trading and investing. And in one such discussion, Apurva offered very some interesting replies to Rahul's questions. We requested him to put them across to our readers and he willingly obliged.

So, over to Apurva....

Last time you had heard about me was when your very own Rahul Shah wrote about our war of words a few months back. This was the first time that we had a discussion about our approaches to markets and investing. But it wasn't the last one either. We have had a number of discussions about our approaches since then.

Today, I want to speak about one such discussion I had with him a few weeks back. We were having this usual discussion about our approaches when Rahul shared an example of Warren Buffett who is the most successful value investor of all time. Buffett has amassed huge wealth based on his value investing philosophies. His investment philosophies are renowned all over the world. There are many investors who swear by each and every word spoken by Buffett on investment. Rahul is probably one of the biggest followers of Buffett. He has successfully applied the same principles to the Indian market and has done remarkably well over the years.

He asked me two straightforward questions.

  1. Do you know of any successful trader who is anywhere closer to Warren Buffett?
  2. Do traders have a process which ensures they will be successful?
I knew that the first question wasn't that difficult to answer but the second one was perhaps a bit tricky. I started by answering the first question first.

The barometer of success in investing is the amount of wealth one has accumulated from it. Warren Buffett has definitely beaten everyone in the field of investments by a wide margin. He is always amongst the top 3 in the Forbes list of Billionaires. However, what most people miss out is to check out names which figure little lower down the list. If one would spend some time studying this list he would find that there are many hedge fund managers figuring in the list of billionaires.

George Soros is one of the most famous hedge fund managers around. He figures at the top amongst the list of billionaire hedge fund managers. Soros is infamously dubbed as the man who broke the Bank of England. He shorted the British Pound worth 10 billion dollars in September 1992. The UK government eventually had to devalue its currency and withdraw from European Exchange Rate Mechanism.

It is estimated that this single trade added 1 billion dollar worth of net profits to Soros's fund. Soros is given all the credit for this trade however, it was Stanley Druckenmiller who worked under Soros, originally saw the weakness. Soros' contribution was to push him to take a gigantic position. Both Soros and Druckenmiller are ardent followers of Technical Analysis. Although Soros is considered to have followed more of a hybrid approach, Druckenmiller was oriented more towards technicals. Both of them have consistently figured in the Forbes list of Billionaires.

Apart from them there are many others like James Simons, Steve Cohen, Paul Tudor Jones II who figure in this list and are followers of technical analysis.

Now coming to the second question.....

To an outsider trading may seem random and a game of chance rather than driven by process. However, if one can't see a thing does not mean that it doesn't exist. Trading is also driven by process like investing. In a way it is very much similar to investing. In fact there are some age old investing principles which apply equally to trading as well.

Many traders give the credit of their success entirely to the process that they follow rather than anything else. Every successful trader's process can be divided into two parts. First is having an edge and second is sound money management rule.

Trading edge comes from three sources - informational, analytical and behavioural. To have an edge, one must have a method. The type of method is irrelevant. It can be purely fundamental or technical or even hybrid. The type of method is not important, but having a method with an edge is critical. Developing a method requires lot of time and hard work. It requires research, observation and a lot of thought. A trader goes through many dead ends and failures before finally arriving at a method which works for himself.

It is quite natural to assume that after dedicating so much of time and hard work, traders wouldn't want to reveal their secret to anyone. They would like to keep it all to themselves. This gives an impression that a process doesn't exist at all but that's not the case. Every successful trader has a sound process behind him.

Having an edge isn't enough, good money management is equally important as well. In fact most successful traders feel that money management is even more important than having an edge. Many potentially successful trading approaches have led to disaster because the trader applying the strategy lacks a method of controlling risks.

My response was acknowledged as I debunked some of the myths that commonly prevail relating to technical analysis. I hope that this has even helped uncover some of the apprehensions that you may have about short term trading.

Stay tuned... Our conversations are likely to reveal many more interesting perspectives like these on fundamental and technical analysis in the future. And as opportunity permits we shall share the same with our readers.

Do you think technical analysis should be used as a tool in conjunction with routine fundamental analysis to make buy/sell decisions? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
Insurance is a key aspect of financial planning. However, Indians seem to be ignorant when it comes to hedging themselves against mortality risk. As seen in today's chart, insurance penetration in India has been on a constant decline over the last 5 years. Insurance penetration ratio is measured as a percentage of premiums collected to a country's GDP. While this gives a reasonable indication of a country's insurance penetration rate it is slightly flawed. For instance, a rise in GDP with no corresponding rise in premiums will artificially lower the penetration rate.

For an accurate measure of the penetration rate one should effectively see the proportion of people insured as a percentage of total population of that country. Also, when aggregating total population, children and senior citizens should be excluded as in most cases they are either not eligible for or do not need insurance.

Pie of under insured people in India rises

Nonetheless, globally, insurance penetration figure stands at about 6.2%. This is considerably higher than the 3.3% figure witnessed in India during FY15 reflecting that Indians are grossly under-insured. Another interesting factor is that in India the growth in non-life premiums is higher than life premiums.

It is believed that with lesser disposable income insurance penetration has come down. Another reason for low penetration is lack of awareness and poor channel network. Bancassurance is one means through which channel network can be improved. It may also create awareness amongst people.

India has challenges galore whether it may be related to under-insured population or for that matter meeting its solar power aspirations. The Modi government has mega plans to boost solar power capacity in India. Currently, renewable energy constitutes just 13% of India's power generation. Considering that the solar route is beneficial from an ecological standpoint the vision of the new government is laudable.

Nonetheless, achieving the dreams of 1 lakh MW of capacity by 2022 is fraught with challenges and the journey will not be as smooth despite support from the government. Cost is expected to be the biggest hindrance. The cost of generating solar power is higher than thermal power. And with power prices being government controlled significant incentives need to be given to boost investments in this space. The government is already doing that by giving tax incentives. So far so good you may say.

Nonetheless, the moot question is do the State Electricity Boards (SEBs) have the financial muscle to purchase this high cost power and pay for it? Mind you these boards are already struggling to make payments for sourcing cheaper conventional power at this moment. Hence it is anybody's guess whether they would be able to meet their payment obligations for sourcing expensive solar power. Apart from SEB health, investment in transmission infrastructure is another area that needs improvement as current capacities are already clogged.

The Indian stock markets were trading in the green at the time of writing. While the BSE Sensex was up by 204 points, NSE-Nifty was up by 54 points. However, the Asian markets were trading in the red at the time of writing. European stock markets opened mixed today.

 Today's investing mantra
"In the world of securities, courage becomes the supreme virtue after adequate knowledge and a tested judgment are at hand." - Benjamin Graham

This edition of The 5 Minute WrapUp is authored by Jinesh Joshi (Research Analyst) and Apurva Sheth (Research Analyst).

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Are companies in your portfolio cooking their books?

A discussion on a tool that aims to capture earnings manipulations by companies.
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Equitymaster requests your view! Post a comment on "Is process as important to trading as in investing?". Click here!

3 Responses to "Is process as important to trading as in investing?"


Jun 25, 2015

Yes certainly. Some organisations give both Fundamental and Technical analysis in their recommendations about a stock


Rajagopalan Ramesh

Jun 25, 2015

Stock Screeners & James Montier:
C Score almost covers all the aspects of cooking of books. This method although is not flawless, but it certainly will work well for most of the cases. The Notes to Accounts will throw a lot of information in addition to the C Score parameters. Many companies play with tax liabilities and contingent liabilities in order to window dress the results. Capital Market Magazine in most of their fortnightly issues deal with one or more of such parameters and highlight the information with reference to specific companies - so that readers can take some informed decisions to suit their stakes in such companies. Thanks for a good article.


Rajagopalan Ramesh

Jun 25, 2015

In my view, most of the TA (Technical Analysis) experts are able to give a good reasoning of the post-market movements. When it comes to prediction, either the Index or individual scrip, I find many experts have different views and many such reports flood my email. I do not want to name the experts here. Money Control portfolio gives me a lot of such opportunities. Based on TA research and report, I acted on a few tips - but the outcome is not satisfactory at all.
On the other hand, my experience shows that If I pick good scrips based on fundamentals, the market automatically presents many lucrative opportunities - may be over a period of one week to one year. I am able to make some decent returns.
The study of chart patterns differs from person to person and it does not seem to be an accurate science. In my opinion, as long as an investor has some good grasp over the macro economic parameters (both international and domestic conditions) and a good sense of the market movements, Fundamental analysis comes quite handy to become successful.

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