Module 9   Risk Management & Trading PsychologyChapter 1

Orientation note

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1.1 – A unique opportunity

I’m excited about this brand new module on Varsity, wherein we will be discussing two important and closely related market topics – ‘Risk Management and Trading Psychology’. While risk management may seem straightforward, ‘psychology’ may sound boring. Trust me; both these topics can potentially open up new realms of trading. Risk management, for instance, is not what you are thinking – it goes beyond the usual topics of position sizing, stop loss and leverage. While trading psychology is a reflection of your actions in the markets – helps you introspect and find answers to why and how you made a profit or a loss in a particular trade or investment.

Given the exhaustive nature of these topics, I tried looking for ideas on how best I can structure this module, and what chapters to include, and to my surprise, there are no contents related to these topics. Of course, you can find tonnes of content online, but they are all fragmented and lack continuity. This gives us both the opportunity and the responsibility to develop some dependable content around these topics, centered on the Indian context. We will have to work as a team here – we will take up the responsibility to post the content and you will have to take up the responsibility to enrich it by posting queries and comments.

1.2 – What to expect?

At this stage, I can give you a brief orientation on what to expect, however as we proceed, if necessary I’ll take the liberty to alter the learning methodology, although not too drastically.

So there are 2 main topics we are dealing with here –

  1. Risk Management
  2. Trading psychology

Risk management techniques vary based on how you are positioned in the market. For example, if you have a single position in the market, then your approach to risk management is very different compared to the risk management techniques of multiple positions, which is again completely different compared to the risk management techniques of a portfolio.

Given this, we will look at risk management from multiple angles –

  1. Risk Management from a single trading position
  2. Risk management from multiple trading positions
  3. Risk management for a portfolio

In my attempt to explain the above, I will cover the following topics –

  1. Risk and its many forms
  2. Position sizing – guess this one is mandatory to cover
  3. Single position risk
  4. Multiple position risk and hedging
  5. Hedging with options
  6. Portfolio attributes and risk estimation
  7. Value at Risk
  8. Asset allocation and its impact on risk (and returns)
  9. Insights from the portfolio equity curve

I’m guessing these topics will give you a completely different perspective on risk and how one can manage risk.

Further, we would be discussing trading psychology both from a trader and an investor’s perspective. The discussion would largely involve cognitive biases, mental models, common pitfalls, and the thought process which leads you these pitfalls. Here are some of the topics we would be discussing in this section –

  1. Anchoring bias
  2. Regency bias
  3. Confirmation bias
  4. Bandwagon effect
  5. Loss aversion
  6. Illusion of control
  7. Hindsight bias

Of course, we will build upon this as we proceed. This is going to be an exciting discussing these topics.

Stay tuned.

154 comments

  1. RITUKANT MAURYA says:

    Looking forward to get experience trading psychology in Indian Share Market Context. Read many books on the subject like Mark Douglas – The Disciplined Trader, Trading in the Zone etc. Very excited to get it.

  2. msdtime says:

    No pdf yet of previous module!

  3. purvank joshi says:

    I eagerly waiting for risk management management in f & o , especially in options trading… which may include in above list!?!!

  4. Ramesh says:

    Hi Karthik, can you suggest good books for risk and trading psychology apart from Marcus Douglas books which I have read already

  5. Ruchit says:

    Eagerly waiting for all the upcoming stuff from you guys!

  6. Subbu says:

    Sir,
    Pardon me I am a little bit off topic.
    With the confidence received from Zerodha’s lessons, I was able to clear nism equity and common derivatives exam with 90 and 75 % marks respectively.I want to accelerate my career in the brokerage industry. I am currently planning to pursue CFA charter course. However before that, I seek your opinion on which course would be most relevant to the capital markets analysis and strategies. I am also considering cdms( certificate in derivative market strategies) offered jointly by nism and Moody’s. Thus I am full time confused. Can you please throw some light on this?

    • Karthik Rangappa says:

      Subbu, happy to know you could clear the NISM certifications. If you are serious about a carrier in the investment or trading industry, then I’d advise you to explore CFA.

  7. Gagandeep says:

    The content is written really well. I give blessings to the person who write this 🙂 . I am eagerly waiting for the 10th module. May i know when it is scheduled or is it scheduled?

    • Karthik Rangappa says:

      Thank you 🙂 I’ll take your blessings on behalf of my entire team at Zerodha.

      It should be done in 2nd half of this year.

  8. Ashutosh says:

    Excellently articulated.. Eagerly waiting for this.. Everyone knows how to play cricket, hit the ball, bowl etc.. but the ones who are able to manage the softer nuances of the personality are the ones that go on to make it big… and i believe that this module would be facilitating the right temperament and thought processes. Great Work Sir… Many thanks for taking up this pain….

  9. Jitendra Nikam says:

    Dear Karthik,

    First of all thank you very much for your write-ups they are very useful and simple to understand.
    Coming back to Psychology I would like to share my experience (this might be useful while you cover Psychology topic).
    1) As a trader: I started with trading (with leverage money) and incurred a loss. As in few stocks I didn’t book profit and in few loss. In few stocks i booked profit very early and hold loss making stocks for long term. Everyone says let your profit run and book a loss. BUT, i find it difficult me implement. YOUR GUIDANCE WILL HELP ON THIS.
    2) As investor: So, i changed my style and become investor. But, the main problem is I am not able to hold any stocks for more than a year. Reason being if a stock goes from 100 to 200, i continue to hold it and if it starts southward journey i book the profit at 130. And it again start going up. And problem starts when I use same thinking for other stocks and book profit at 130 and it goes till 250. And this thing continues. People says we should review our investment and book accordingly and I get many messages for stocks like unitech (1L invested become 10K)etc.
    3) Options (no future): here again I keep on holding loss making trade and profit making one sell early. And this experience affects next trade.
    4) Don’t want to keep idle money in trading account, jumping the gun investing in hurry at high price.

    Once again thank you very much for reading such a long mail. Eagerly waiting for you article.

    Thank you.

  10. Ramesh says:

    Hi Karthik,

    Did you get a chance to look at what are the books recommend for risk and trading psychology.

    Regards,
    Ramesh

  11. bbhalaji says:

    Hi Karthik, thanks for starting such a wonderful topic. Some days back I realized that a risk management/money management is mroe important that your strategy. But I also have this question in my mind – to make big money, you have to take big risk. Is this not contrary ? Please comment on this. Also, can you please add a module on effect of different factors such as interest rate hike, pharma policies, USD/INR , Fed hike etc on the market /sectors from your experience. This will be helpful for people like me who have no background/idea of economics. Thanks.

  12. Amol Sawool says:

    Hi Dear Karthik & Zerodha team…..hearty greetings !!! I hv been associated with Zerodha since more than 1.5 years & honestly, as far as educational material is concerned, I have not found any other material (even some of the good books written by greats) as engrossing as Varsity. I wish you keep up the good work, may be you can try & accelerate pending modules with their PDFs especially. Learning has seldom been this delightful……

  13. anup says:

    is it possible to perform backtesting with pi?

  14. Rakesh says:

    Hi kiran
    Please send pdf to email [email protected]

  15. prakash gadhavi says:

    traning cors hindi and gujarati nahi he

  16. sripathy chandrasekar says:

    Hi kiran
    Please send pdf to email [email protected]

  17. Arjun says:

    I am reading the book by rolf dobelli , the art of thinking clearly. Every trader must read this book. Nice work by zerodha versity, keep it up??????

  18. Biplob Dutta says:

    in PDF when ?

  19. sankar says:

    Dear Sir,

    Beautiful guidance and hats off.I could not see download for chap 5 and chap 9 in PDF. Please provide

    Thanks

  20. Gopalakrishnan B Chettiar says:

    Dear Mr. Kiran,
    I am newbie to stock market dealing; which I had started doing a year before after my retirement, for living, but in vain to make attractive gain even to meet my daily living. FYI, I am presently doing investing (not trading) to very very limitedly from my saving – I had invested about Rs. 300,000 in one year. I do book profit sometime to meet my expenditures.
    I do want to become full time trader / investor after acquiring deep knowledge.
    Therefore, kindly send relevant books to my Email ID – [email protected]
    Thank you beforehand.

    • Karthik Rangappa says:

      You need to ensure that you do not risk much of your capital, especially since you mentioned that you’ve just retired. I do not have any books in PDF form.

  21. Hardik Upadhyay says:

    Please provide download pdf option for this module also.

  22. Hardik Upadhyay says:

    Please provide ‘Download PDF’ option for Module 9 also.

  23. Ilango says:

    Hi Karthik, when is the pdf for 9th module expected

  24. raghuram says:

    Dear karthik,
    Is it a good idea to go long or short for gap up or gap down openings at 9:15 itself without going much into all the technical analysis ? For example, if a stock’s previous close was 100 and it opened today at 105. I can buy at 106 and put stoploss at 105 and target as per my risk. Same strategy for gap down openings. Will not it work?

  25. pradeep says:

    please update pfd for 9th module.. love to learn trading from u guys

  26. Ron Kalra says:

    Hi Karthik,
    Do you have any plans to have a module or course on day trading. would love to have you do this for all of us.
    many thanks in advance

  27. Ron Kalra says:

    also i know this has nothing to do with you but can i request you to have Ichimoku cloud indicator on you pi software. i have emailed before requesting this in your support email address but didn’t received any response.

  28. Shrikant says:

    Sir, please put “chapter 9” in pdf. Thanks

  29. Naman says:

    Does liquidity decrease during the bear market ? Please share your experience about market behavior during the recession (Year 2008). How much different is bear market from bull market ?

    • Karthik Rangappa says:

      If market volumes are any reflection of liquidity, then I remember the 2007/08 as years flushed with high volumes. 2008 was crazy – it had become a routine to see 1-1.5% drop on the index. I regret not picking up my long term stocks then 🙂

  30. Anjali Murkute says:

    THANKS A LOT KARTHIK SIR, YOUR WEBINARS AND VARASITY MODULES ARE REALLY HELPFUL, I HOPE YOU WILL CONTINUE EDUCATING US.
    CAN I REQUEST YOU TO ADD ‘OPEN HIGH LOW CLOSE’ ON CANDLE STICK IN THE CHARTS.

  31. Anjali Murkute says:

    IM SORRY, I GUESS ITS THERE, THANKS ANYWAY

  32. prashant says:

    awaiting PDF download feature here.

  33. Sanjay says:

    I say..wow..

    Such a lucid language..very nice

  34. Tanveer Hussain says:

    Hi Sir
    Please write the module on “Value Investing…..also…

  35. Rajendra Kumar says:

    Hi Sir,
    If it would be good in Pdf format better to read.

  36. Anoop says:

    The pirate image is really amazing. 🙂
    Kudos to the drawer.

  37. shafik s says:

    Dear Nitin and karthik sir,

    why don’t you open a university courses where people can get to do certificate courses based on content like in varsity.
    This varsity content is in real sense revolutionary in financial thinking of society.
    By certificate courses people can verify and confirm their own level of understanding of the subject.

    Thank you very much.
    shafik s.

  38. CHETHAN S says:

    how to download pdf files of all the modules

  39. RAJU SHINDE says:

    Sir,
    Is there any trading concept of Supply and Demand zone? Please guide

  40. RAJU SHINDE says:

    Sir,
    Is there any trading concept of Supply and Demand zone? Please guide

  41. Harpreet says:

    hello sir.
    can you provide some intraday stock selection techniques

  42. Sagar walunj says:

    Friends how to download this

  43. Bandi Sivasankar Reddy says:

    ?????????? THANK YOU KARTHIK ??????????

  44. Sunil says:

    I am unable to download module no 9 & 10. Can you help us…?

  45. pramod says:

    Sir please write one module about excel analysis for stock , F&O ASAP….!!!!

    And thank you for the varsity modules. I read 7 of them.
    Honestly the best material ever on market…
    thank you,….

  46. Chanu says:

    Hi Karthik , In this Risk Mgt Module their are so many chapter to read. Pls can you tell importance one for day trader & knowledge purpose. Thanks

  47. VISHANT says:

    Sir please also make module on ”HOW TO MAKE CARRER ON STOCK MARKET” Means in broking industrial,matual funds industria.

  48. Prem ,Dehradun says:

    l am a senior citizen of 67 years old.Reading had been my pleasure since my adolescence but I do not know computer’s basics and had been suffering. some time back I got interested in share market and started looking forward through you tube etc. As luck would have been in my favour,I came across with ZERODHA VARSITY and your DEDICATED DEVOTED HARD WORK, PERFECT in all spheres to my knowledge and best expectations. Congratulations to entire zerodha team and my regards. Keep it up. Have you all a nice life.

    • Karthik Rangappa says:

      Thank you so much for the kind words! I’m glad you liked Varsity and will continue to enjoy reading here 🙂

  49. Sachin says:

    Sir yah content agar Hindi mein mil jaaye to aap ki aseem kripa hogi

  50. sachin says:

    Risk Management & Trading Psychology…. this chapter convert in hindi….plz

  51. ranjeet Maurya says:

    hello respected sir
    all lessons are very good but please I request you to if possible please make a video lecture which is very useful for the Zerodha customer to learn exactly all the technical things and keyword which is used in the theory part.

    thanking you
    Ranjeet Maurya

  52. Nirav babariya says:

    Please update in hindi version also

  53. Haakan says:

    Sir is series ko b hindi mai translate kr dijiye 🙏🙏🙏

  54. Abdul says:

    Thank u sir
    You are doing a grt job.
    A teacher has a big heart who engcourages students to ask questions.
    Looking forward for Risk Management & Trading Psychology
    Thank u.Regards.
    Abdul

  55. Mohammed Salman says:

    Sir Karthik sir.
    Please update the content of risk management and trading psychology for iPhone users also. It will be very much helpful.

    Thank you.

  56. Kishor S says:

    Hello Karthik,
    Firstly thanks to you for putting so much efforts in making the investing community aware of the financial concepts in such clear and crisp manner.
    I have gone thro almost every article that you have written and wanted to know something on HEDGING.
    Can you please create a chapter/chapters on HEDGING which is also used as Risk Management strategy?
    Thank you once again

  57. Akshar says:

    Thank you for such amazing content. 😄

  58. jayesh says:

    What a brilliant way idea to explain this concept! Thank you so much for sharing with us!

  59. Professional Coder says:

    Hello Karthik,

    I started learnt stock marketing 1 year ago mostly through your course, and it helped a lot and I am happy to say, I am net profitable for last 4 months.

    There is something I struggle a lot with, and I wonder if you could help me with any suggestions. It’s trading psychology and risk management. It’s a bit long post with specific situations I deal with. And for the record, I am a mix of swing trader and day trader using Futures and Options extensively. I ideally want to execute my orders once a day at market closing time, but I can’t keep myself from micro-managing my portfolio and day trading.

    Like everyone, I struggle with trading psychology and risk management. I decided to solve it by writing my notes in a text file.

    I basically wrote about different scenarios such that if X happens, I will do Y.

    But what messed up is that I still miss them on daily basis. Sometimes I forget what I note. Other times, I get greedy or panicky. I even write a trading journal and mention all my blunders there every day, but I still repeat them.

    I can give some example where I missed up.

    1. Yesterday I could have got 25% more gains if I had stuck to my strategy instead of exiting at a small sign of reversal.

    2. Today my investment went down by 7%, which is big for the Options position. All I could do was panic and think about what to do. I had a rule written saying “I exit the market for a day if I had X amount of capital loss, which I completely forgot”.

    3. There was also another mental rule which I forgot to write. I forgot to execute it too. It said, if the stock falls by x% below the previous closing price, I should exit. But all I kept thinking about was what to do, and didn’t do anything because I couldn’t remember what I wrote in my notes.

    I basically froze and panicked the whole day today losing 7% instead of exiting at 2.5% loss today. It all makes sense now to me, and now I am wondering why I didn’t do it, but earlier my brain just shut down.

    So, please tell me suggestions on how to strictly follow through with strategy and risk management without shutting off my brain with emotions. How do you do it?

    Thank you so much for reading my question.

    • Karthik Rangappa says:

      Firstly, congrats on staying profitable, thats a bright sign 🙂

      The things you’ve explained, are very common, especially in your early days. The true solution for this is to grow dispassionate towards the money at work for you. You need to develop a clinical approach, the feeling between you and your capital should be the same as that of a doctor and the patient on the operation bed. I understand this is easier said than done, but I’ve noticed this over and over again, traders who are successful and stick to strategies are the folks who are detached from the capital at work.

      This won’t happen overnight, but it will at some point.

      One thing that you can do is to try and reduce your risk size, you bet smaller amounts (deliberately) so that you can get used to developing a strong mindset to follow the strategy.

      Hope this helps.

  60. Professional Coder says:

    Hi Karthik,

    Thank you very much for your response. I was not really expecting it because of the length of my message.

    You are right. I actually did a post-mortem of my last 2 days trade. To do that, I introduced a VaR (Value at Risk) field in my MS Excel trade journal. To keep it simple, I decided VaR is the value I will lose if my trade falls by 10%. For FUT contract, it’s 10% of the contract value, for options, to keep it simple, I pegged it to 100% of contract value (since after 10% loss in stock underlying, options will barely be any worth). I am a programmer and have developed custom reports earlier. So I even implemented this field in my live P/L report tool to easily monitor it from now on.

    Here is what I found. My typical VaR is 3.5 Lakh. On Tuesday, I made 3 Lakh profit. So instead of booking any of it, I reinvested it + added 50K from my own funds, both in options trade. So, on Wednesday, my VaR was 7 Lakh was **twice** my risk appetite. So that’s where I messed up really. From now on, I am going to consult VaR before increasing/decreasing positions at the end of the day instead of doing it at a whim. Ideally, I am planning to reinvest only 25% of the gains from now on.

    I also ordered a printer last night so I can print my notes and their revisions easily whenever I need to. I think it might be easier to glance at strategy notes when they are on printed paper rather than a text file on a computer. Humans are lazy. Nobody wants to scroll through 2 pages of a text file to look for a line. Maybe the printed notes will help me follow my strategy more strictly, and help me remember it.

    I think you are right about the doctor-patient relation. It should be like that. I will try to do it more often. Every day I write a journal and mention how much more profit I would have made if I had stuck to my strategy. Looking at those number of missing gains helps a little in being strict. I also read your Trading Psychology module frequently, hoping it settles deep inside my brain.

    If I am honest, there is just one thing that prevents my very strict risk management, and that is the stock market bull run. I am always worried that once it ends, my opportunities for swing/momentum trading will diminish. So I feel I should make the most out of it while it lasts. Clearly, this emotion is not helping me though and just making me lose money.

    • Karthik Rangappa says:

      I agree VaR is a better measure of the stock’s volatility. I don’t know your capital size, but 10% of contract size is quite a hit for many traders, but I’m sure you’ve done your math.

      At some stage, you need to develop a basket of strategies that you can deploy given the situation in the market (no need to fear the end of cycles).

      Good luck.

  61. Professional Coder says:

    Hi Karthik,

    Thank you very much. I said VaR of 10% of capital size because it’s to calculate it and remember it. It’s like the worst that can happen. But, my ideal exit is at 2.5% loss of the trade.

    I also ran some test yesterday. I calculated annual gains in F&O stock during the last 10 year time. Except 2009-10 (after the financial crisis) where it was 450%, the max median annual gain in F&O stocks since is 150%, whereas the max this year is whooping 600%.

    But you are right, being greedy and risking too much is not going to help me. I need to keep developing new strategies in future.

    Thank you.

  62. Sankar C says:

    Looking Excited..!

  63. Manoj says:

    How did Satyam stock fall as much as 78% in a day? No lower circuits back then?

  64. Vivek says:

    Sir, Please Make a Chapter for Hedging with options. For Hedging Small Size Portfolios.

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