Speculation is an intellectual estimation in advance based on historical facts and figures. My mentor said which is something to similar to what Paul Tudor Jones said earlier. I did not have a choice to tap head and trying to focus on what he is saying. I asked are we saying we don’t need to understand business, or do a valuation even? Mentor cut me in middle, no I am not saying any such thing. Add speculation a layer to your investing philosophy, by the time I was shaken to the core some of books on behavioural finance. I accepted ok lets start (may be in heart I bet myself if this turns out to be gambling then no place for me!).
After six months with number of iterations we arrived at a framework which looks like this:
TEN element of speculation- reminiscence all the way
- Setting objectives
- Entry Plan
- Exit Plan
- Holding Plan
- Money Management Plan
- Trading Systems
- Testing of trading systems
- Speculation work book
- KPI Pack
- Behavioural finance tracker
Technical analysis is a small subset of speculation which increase the probability of entry plan as it is based on historical facts (hardly not even 5% of overall speculation). Element 1-9 consists roughly 25%, element ten is around 75%. What does it mean, by following 1 to 9 you can survive as speculator, but you want cut into league of ultra success or master the art of speculation you need to master element 10. I am no where close to element 10 , yet I could hole out expenses from trading in current year.
I can get into detail explanation of each of these terminologies, rather I would advise you to read and familiarise, nevertheless will cover a broad definition of each of the component. I am going to attach practical worksheet which I use to help you understand better.
A small tip which I am convinced same way it work for value investing even. If you keep on copy set up or blindly follow technical analysis only luck can make you alive.
The game of speculation is the most uniformly fascinating game in the world. But its not the game for the stupid , mentally lazy, the person of inferior balance , or get rich adventurer. They will die poor.- Jesse Lauriston Livermore
Element 1: Setting your objectives
I am not a trader, I don’t intend to be one either. This was my ego ridden reply to my mentor when we started conversation on speculation. Like a seasoned master craftsman he didn’t argue with me or pinning me down. He asked what are you looking from speculation? I learned to say now speculation rather than trading (request you to find out difference between speculation and trading- surprise is waiting for you).
I said I like the way speculator use probability to their own advantage e.g. position size, pyramid, exit strategy etc. I am sure some of them can be applied into my investing framework. Our project commenced and we have four major revisions till date. I traded more than 100 plus trades this year. Result is not of importance to you, but it is positive so far. I must confess lot of work required to become successful speculator.
Ok I said can I make 25 lacs from speculation in a year? What is the amount of capital required? My guess for year 1 was a staggering 1.5 Crore capital to generate 16% healthy return.
By the way objectives are beyond a number, if you don’t like speculation you wont be successful no matter you bring 100 Cr capital, you will blow off in the market.
Before I take you through excel spreadsheet, what are they key questions we pondered before finalising this spreadsheet.
- Target amount
- Number of stocks and trades required with appreciation there of
- Pyramid structuring to increase positions
- Permutations and combinations of winning/loosing
- Capital outlay to achieve target amount
Here is conclusion for you:
Maximum block capital (without reshuffle and reinvestment) of 88 lacs required we can generate 25 lacs speculation profit. This can be achieved through 7 winning stocks and 49 trades with a probability of winning as low as 30%. We expect the stock appreciate 48% by price.
- we are taking maximum capital outlay, in my experience this year reinvestment is well upto 50% even with strong market trend. This means you can make 25 lacs with 44 lacs capital in a strong bull or bear market.
- we assume we will exit after 48% appreciation. In fact 200 plus appreciate more than 100% last year.
- actual probability of winning over a long period extends to 40% plus.
- leverage can add a rocket to compounding both way, lets avoid for now.
In other words this figure can be conservative. Then mute question is it so easy? 80-100% return sounds like insane, isn’t it? Devil is fine details, market remains range bound 70% of time. Repeating optimistic scenarios is going to be tough, but applying proper money management techniques the return can be far higher in the year when you have a tail wind. You can enjoy your value investing during other time. Nevertheless risk appetite, position size even very much applicable to value investing.
Commentaries to excel sheet:
- Standard stop loss is used at 8% (there are multiple ways to define a stop loss, this is for illustration purpose, based on volatility in practice I use 5-12% ATR based stop loss).
- Pyramid- initial position at 3000, Trade 1 and Trade 2 at 12000, base reduced to 9000 and 6000 subsequently.
- Max position size restricted to 1.5 lacs against 12000 risk, so corresponding 3000 risk would be 37500.
- Once profit becomes 3 times of risk we are withdrawing 50% of shares from position (profit booking). The next position becomes base plate of pyramid and top becomes light.
Please let me know questions if any, even I am on learning curve and amending continuously.
Next topic ENTRY PLAN which includes:
- Market direction
- Entry set up conditions
- Rules
- Filters
- Catalysts
- Increasing position conditions
Good wishes
Trading Objective.xlsx (16.8 KB)
, you guys are lucky. But we are promising we will catch up with you soon, of course nothing takes away gigantic spirit of Mumbai.
