15.1 – Mind games
If you are a part of any WhatsApp group related to stock markets, then chances are that you may have watched this video –
If you are in no mood to watch it, then let me give you a quick summary – This is a show where people call in during the show and ask the show host questions related to stock markets. This is a video clip of one such caller asking the host of the show, the procedure to convert 20,000 shares of MRF LTD from paper to digital form. The shares were bought by his grandfather back in the 90’s and were kept in the paper form – ‘physical certificates’, as they are called.
After informing the caller the procedure to convert the shares from the physical form to DEMAT form, the show host casually informs him the value of his shares in today’s terms.
The price of MRF on a per share basis was roughly Rs.64,000/-. Considering the fact that he has 20,000 shares, the overall value works out to –
20,000 * 64,000
= 1,280,000,000
Or about Rs.128 Crores.
Can you imagine that – ONE TWENTY-EIGHT Crore!
I was flabbergasted when I first saw this video.
The first thought that occurred to my mind was – how can someone have the vision to buy MRF 25 years ago? How is he motivating himself to still stay invested? How could he resist the temptation to not sell the stock? Especially after watching the stock grow multiple times over his initial investment?
A common investor according to me would probably sell his investment if he saw his investment return say – 50%, maybe 100%…or at most 200%. But this guy has held his stock across years, watching it grow at least 20 times or 2000%.
How did this happen?
Think about this – if we can understand what exactly is happening here, maybe it will throw out a bunch of insights which will help us create similar wealth right?
When I thought through this again (and watched the video again) – I kind of figured what was going on here. Here are my observations –
- His grandfather had bought the shares of MRF back in days, has not paid much attention to it since the purchase
- One fine day he realized that he has few shares of MRF lying in the attic
- He must have mentioned this to his grandson (the caller)
- The grandson has now decided to convert them to DEMAT
- I’m assuming that he would probably sell the shares as soon as it gets them converted
I find this situation extremely interesting, there is a lot happening here and one can draw few conclusions here –
- It is likely that the grandfather has forgotten about his investment, and spent his time somewhere else
- This is a valid conclusion as otherwise, he would have taken efforts to convert shares to DEMAT long ago
- Because he had forgotten, he has not paid much attention to the price appreciation over the years
What can we infer from this?
One straightforward inference that you would agree I suppose – granddad had made a ton of money by simply forgetting the fact that he owns shares of MRF.
Now for a moment imagine – what if he had not forgotten about his investments? What if he had access to a broker or a friend who would call him every day to tell him the stock price of MRF?
Do you think he would have held on to his shares for these many years? Don’t you think there is a high probability of him selling out his investment – at say a return of 100%, 200% or even 500%?
In other words – because he forgot and did not pay attention to his investment, he held on to his investment over the years and reaped its benefit.
Now, had he deiced to track the stock price and update himself with the latest developments – what do you think would have happened? He would analyze the data – when people analyze data – they don’t just analyze the facts, they try and be smart about it by adding their own imagination. These imaginations originate from our own interpretation of an ideal world. We often refer to this as ‘biases’.
Biases, in the trading and investing world, is the only thing standing between you and a profitable P&L.
This objective of this chapter and the next is to discuss some of these common biases and help you overcome these biases.
15.2 – Illusion of Control
Let us start with one of the most common biases traders and investors tend to have. Have a look at the chart below, a typical chart you’d find on any technical analyst’s desk. There are quite a few things happening here in this chart –
- Candlestick chart for price action
- Bollinger band to track volatility
- Fibonacci retracement to identify retracements
- Pivot points for support and resistance
- Volume chart
- ATR
- Stochastic indicator
I’m certain, at least 8 out of every 10 technical traders would have a similar setup while analyzing charts. Clearly, for someone not familiar with charts or technical analysis this chart would look quite intimidating. After all, there are so many things happening here.
Each element on this chart gives out a unique insight to the trader. Along with these so-called insights, the chart does something else to the trader at the subconscious level.
Because of the complexity of the chart, and the fact that not many people can relate to it – it somehow makes the trader believe that he is dealing with a complex subject – and he is in total control over the stock by virtue of all the ‘important insights’ he seems to have derived.
This is often called the ‘illusion of control’ – one of the biggest trading biases for a technical trader. Traders who are heavily influenced by the illusion of control often make statements like ‘This stock is not going to go above 500’ or sometimes they make super confident statements like ‘Go ahead and buy puts’, you question them why, and they will be quick to say ‘Boss, I’m telling you just buy Puts’.
Why do they do this?
Well, traders have this tendency to get attracted to complex things, it just feels very nice to be looking at complex charts and making sense out of it. This is like fighting fire with fire – markets are so complex, the default notion is to fight this complex beast with complex analysis. Further, the fact that only you can make sense of it and others cannot give you that additional kick.
This physiological behavior can be attributed to the ‘Illusion of control’.
Remember, no matter how many indicators you load or how many numbers you crunch, there is no way you can control all the outcomes. End of the day, there are several different outcomes possible for every possible situation in the market. You cannot control them all.
The only way to overcome this behavior is to stay focused on results and statistics. If you are dealing with a trading strategy, then you got to know the odds of the next trade being profitable. When you start looking at market opportunities this way, you will start being truthful to yourself (and others around you) and will always remain humble. If not for anything, you not get carried away by noise.
From all my market experience I can tell you one thing with conviction – the best analysis is done when things are kept simple. Complex does not necessarily mean ‘better’. Hence, you as a trader need to be completely aware of this and work towards building a data-driven approach and not get swayed by inputs that don’t really matter.
15.3 – Recency Bias
Here is another bias that plagues traders. I find this quite interesting – no matter how many years of experience you have, at some point, you will fall prey to it. Let me illustrate with a recent example.
If you have been tracking ‘Café Coffee Day Enterprises’ (CCD), then you’d know what is really happening with the company and stock price. For the uninitiated – the company has been under the radar of ‘Income Tax Department’ for tax evasion and hoarding large amounts of income. Couple of days ago, Economic Times carried out the story in great detail, here is what the headlines said –
I’ve always maintained one stance when it comes to making long-term investments – if the company’s corporate governance is questionable, then no matter how attractive the investment appears, one has to avoid. History has taught us many times that such investments will eventually go down the drain. Given this investment stance and the recent events in CCD, I’d be hesitant in making a long-term investment in CCD.
But what if you already have an investment and this news rolls out? Well, assuming there is truth in the news, the first thing I’d do would be to get out, no matter how much money I’d be making or losing at that point.
A good family friend had made an investment in CCD, he called me a couple of days after the news rolled out asking me for my advice. Do note, the news by the time he called me was already 2-3 days old. Things had calmed down (but the fact that the income was concealed, still remains). When he asked me for my advice – I asked him to get out. He quickly pulled the chart of CCD and asked me to take a look –
As you can see, after the steep fall, the latest green candle suggests that there was some buying in the stock. Maybe, there were few traders/investors trying to bottom fish.
Now, if the idea is to get out because of corporate governance issue – you have to. There are no two ways about it. However, this friend of mine suggested, ‘Maybe I’ll hold for few days before selling, I could get a better price’.
I just left it at that and didn’t really try convincing him to get rid of the sock.
But why do you think this friend of mine wanted to hang on to the stock? Does the latest green candle override the fact that there was concealed income at CCD? Or does it give a clean chit to the company’s corporate governance?
I don’t think so.
Instead, what it does is – it induces a bias called the ‘Recency bias’.
‘Recency bias’, gets you carried away with the latest information/event by making you turn a blind eye to the past events or facts. This is exactly what is happening to my friend – the latest green candle is making him turn bullish and he is convincing himself that there is more up move left. Well, there could be an up move – but that still does not override corporate governance and turns the stock to an investable grade stock.
Recency bias distorts your sense of judgment. It makes you weigh the recent event far higher than what you probably should.
The only way to overcome recency bias is by taking cognizance of the wider picture. You should be in a position to see things from an overall perspective and not really a microscopic view.
Key takeaways from this chapter
- Markets are complex, but the means to analyze markets need not be complex
- Traders often complicate their charts, subconsciously it makes them think they are invincible, gives them a sense of control
- Illusion of control makes you spend many hours trying to derive data, which is otherwise pointless
- More data does not necessarily mean quality of information
- Recency bias makes you turn a blind eye to the past events (which could have more impact on markets)
- Having a sense of the overall picture helps you prevent yourself from falling prey to recency bias
All traders should stick `Illusion of control` infront of their desks. Good article. Thanks.
Typo @deiced.
Thanks, will fix that 🙂
This book has everything that a begginer shud knw abt market.. Thnx a lot sir .. Thnku vry much.
Cheers! Happy learning, Rahul.
when will the PDF form will be available for this module
Another chapter after which this module will end. Post that the PDF will be available! Thanks for your patience.
Waiting for the same 🙂
Cheers!
when Module 10 ?
After module 9. One more chapter to go for Module 9.
Hello sir ..I have one question which is not related to this topic but hope you will ans hear …How to become certified financial planner ..?? Which exam should I give ..?? Fees….And last which books should I refer for exam ..??
Is there good career opportunities for financial planner…??
Yes, especially in India where the income levels are expected to go higher over the coming years.
Its best if you can take this up – https://www.cfp.net/
Mr. Karthik there’s a question I’ve been meaning to ask you since someone now. Time and again I’m just astonished by the level of knowledge and understanding you have, about finance. Now, I’ve read some books on stock markets too. But no where have I come across trading techniques such as arbitrage and hedging. My question is, how do you learn these techniques? Is it the years of trading experience or is there an elite trader’s club we all don’t know about? It would be really helpful if you could answer these in detail. Thank you.
That makes me sound like a hero, but I’m not 🙂
Everyday of my life I do something related to markets and when you spend so much time, you tend to pick up stuff and learn things. Everybody does. Its just that I’ve also shared these learnings here 🙂
Btw, no elite traders club that I’m aware of!
After reading all the modules I have come to the conclusion that no matter what you do you can’t predict the future outcome. the best way to earn wealth is not short term speculation but to invest and forget approach. what you say sir?
Well, hard to answer that as I know both good traders earning great returns and long-term investors who just invest and forget.
Hello sir first of all thank you for enhancing my financial knowledge.
Suggest some good books for fundamental analysis which can be understood by a person who is not from finance or commorce background.
Read ‘Learn to Earn’ by Peter Lynch. You will thank me
Brilliant!
Thanks for your valuable advice ankur ….I m gonna order this book
Cannot really advice any one book, Samir. Topics are fragmented, I;ve suggested few books here https://zerodha.com/varsity/chapter/finale/
Yes sir I read the little book of valuation by ashwath damodaran but it is very complex & cannot be completely understandable for person who is not from commerce background.
I request you to suggest some book that can be considered as pre-read book for complete understanding of those books mentioned in varsity page.
Thanks
Have you checked out the module on Fundamental Analysis? The idea there was to simplify things like balance sheet, P&L, and cash flow. This will lay a foundation to read other books.
Happy Dipawali to u Market Guru.!
Market, is the only Guru for all 🙂
Happy Deepavalli to you as well!
sir my english is not good ,canpost or send your all post in hindi.
That would be a challenge for me, Jantinder 🙂
Hi,
My Question is:
1.If we exclude, Recency Bias or Illusion of Control for consideration, then how we can trade..?
For better understanding, In Recency Bias, you have taken CCD as example and you have mentioned Traders trying to bottom fish so the latest candle is green.
Perfect. My Point is, If we take Recency Bias then there is no need of “How to bottom fish” / “Buy when all sell” / “Resistance, Support” technical s or questions. Right..?
It looks contradicting for me. Please guide me on the same.
The two are different –
1) S&R – trade is done or not done based price action, which is a reflection of the market consensus
2) Recency Bias – Mainly stems from your own interpretation of the Price.
Things like bottom fishing etc – again these are your own interpretation of the price.
Hello karthik,
In trading bais 2 example, from 100000 rs 65000 spent for margin remaining is 35000rs but it is mentioned 45000 it is confused me. Please update it if possible, anyway you gave wonderful exampls and great ideas.
Thank you,
Regards,
Ravindra Reddy Kalluri
Thanks, Ravindra, let me check this!
Dear Sir,
What is PRICE ACTION STRATEGY?
I did not find anything on this strategy in Varsity?
Is this a new strategy has come?
I have read some Articles on PRICE ACTION STRATEGY, it is very powerful and simple, without any indicator or moving averages?
I would be grateful to you if you could provide your input on this strategy and I should learn this?
best regards,
Jayesh Khatri
The whole of Technical Analysis is about Price action 🙂
What about dividend given by MRF, Dividend comes to bank account, In his case since shares were in physical form, where did dividend go ?
In case of the physical form, the dividend will be accrued and kept in a separate account for a certain time I guess.
I went through almost all the chapters of Zerodha Varsity and enjoyed the reading for the quality of representation and logical thinking of the writer and after this I tried positional trading in two occasions (one in Bank of Baroda and the other in Bharat Electronics) following religiously the guide lines of Varsity (Six check points),but failed in both the situations.Then I myself have developed a very simple strategy to trade with just one stock -BPCL and quiet unexpectedly this is giving profit to me on regular basis.Now I am curious to know – how much wealth has been generated by the author himself in order to see whether theoretical conviction and practical hurdle convege or not, as I have seen that the persons generating huge wealth generally don’t want to come to the limelight and the persons always staying in the limelight advising people regarding the stock market on the media and online have really failed to make considerable wealth from the market.After this comment,my academic status may be questioned and for this I have to inform that at present I am working as an executive staff in the largest and wealthiest financial corporation of India having a pure science background upto post graduate level.
Arun, don’t worry, no one will question you on your credibility here. If you have found a method to trade, good for you. I’m the author of almost all the content here. I’m sharing my experience without holding back on anything. I’ve had my fair bit of success and failure in the markets. I’ve survived for over 14 years in the market trading and investing and everything bit of my earning is related to markets. Hopefully, this should give you some answers.
Hi Sir, Could you please let me know how can I transfer stocks that I currently hold in ‘physical form’ to be converted in my DEMAT account with Zerodha? Also, please let me know the cost and time involved in this process. Thanks in advance,
Check this, Gaurav – https://support.zerodha.com/category/your-zerodha-account/transfer-of-shares-and-conversion-of-shares/articles/how-do-i-convert-physical-share-certificates-into-demat-form
Hey Karthik!
Greetings!
With the emergence of the COVID 19 (the word with which even I have become annoyed ) I think that the market doesn’t really follow the charts (as per my observations) and even the indicators and goes only as per the news and the other global markets. And I think this is not only with the COVID 19 (I’m so sorry for using the ‘C’ word again) but generally when the market volatility increases like when the government announced the new tax cut rates for companies the markets don’t follow the charts for some time.
So what should be the stance of a trader in such tense situations?
Wishing you and your family a happy quarantine 🙂 =and a pleasant wfh experience.
Ram, this is true. When you have fundamental news of any sort, TA does not work. By fundamental I mean news which has the impact of moving markets. So looking at charts, drawing averages etc does not really help. Look for the market sentiment and take action accordingly.
Karthik, where can we learn about Volatility Trading?
Varsity Sir 🙂
Hi Karthik,
Varsity by You (Zerodha) has been a great study for me. Since I am not trading in options and futures some of the examples were hard to understand almost nil due to them being explained in futures and options. I skipped that part.
You were bang-on on the CCD related news, look at where it is trading today at 20 Rs. Hats-off to your prediction.
Also due to the pandemic, I guess you would say this is the best time to be investing in EQ and do FA instead of TA. Please suggest.
I’d prefer FA for investments, there are no questions on that 🙂
Hey Karthik sir,
I was watching Nikhil sir’s interview on your story the other day (what a fabulous person he is) and he was explaining how he started trading at the age of 17 doing some technical in the first couple of years, followed by fundamental, some quant and then market sentiment. While explaining how he identifies opportunities for True Beacon he explained that according to him that individually technical, fundamental etc, etc is useless alone but should be used together. He also added that he considered market sentiment more sacred than the others. So my questions are-
1) How can we use a combination of all the above things?
2) Does market sentiment mean analysing the situation and then trusting your gut?
3) How can you capture the market sentiment and be ahead of the markets?
P.S- Waiting for your interview eagerly 🙂
Yes, he is a fabulous guy 🙂
1) There is no particular path to this. As you gain more experience, the better you get at combining everything.
2) Yup, your gut calls get better with more experience
3) With experience, this will happen, it is just that you won’t know when 🙂
Not sure if I have enough to be worthy of an interview 🙂
Thank you so much Karthik Sir!
Happy learning, Ram 🙂
Hi karthik,
Thanks for great content!
Would you please tell what is your trading setup and how you keep it simple without getting confused in all indicator?
Which indicators are best for trarding?
Regards
Our company policy prohibits us from trading, hence I don’t trade any more. However, my screen while trading was super simple – candlestick chart + MAs with volume at the bottom.
Oh so mostly price action theories.
Thanks for replying.
Regards.
Good luck, Tejas!
Zerodha varsity is written in a simple manner so that anyone with common sense can understand it. I remember Icici direct used to charge thousands of rupees for each module which was presented in the most complicated way, making its clients believe that option trading is very complicated . Thank you zerodha , you have done a great job.
Happy learning and trading, Jensen 🙂
Excellent work by the writer.
Happy learning, Kunal!
Hello Sir,
There are thousands of market analyst all over the news/twitter etc. So many of these people giving their suggestions etc.
What makes me different/special that I could enter this business and be successful?
How does one overcome this before entering the stock market as a full time occupation.
Your own conviction and understanding of the subject.
Dear Sir,
After you graduated from telecom engineering, how did you convince your family and friends that you would be successful in this line of work?
You must have gotten the ‘What makes you better than the big fund houses and brokerages and tv analyst questions’??
Family and friends were easy, the bigger challenge was to convince myself 🙂
Sir,
It is possible for you to describe your day to day life.
I’m sure initially you must have traded live options/short term trades a lot but now you must just initiate spread positions and hold them to expiry correct?
Do you just maintain a holding portfolio and remain a passive investor and spend most of your day to day work working on varsity and other zerodha products or do you actively trade often in your free time?
Tejas, I have my long term investments. Apart from that, the bulk of my time is spent working on various things at Zerodha. Dont actively trade these days since no one at Zerodha is permitted to trade. But I do take up swing positions, wherein I hold a stock for a few weeks/months.
Dear Sir,
For example, do you hedge your long term investments against nifty or do you just leave it the way it is?
I assume your long-term investments are fundamentally based while your swing short positions are technically based?
Lets say you are holding X stock in your portfolio and you see it as a very long term position. In the short term it is bearish, so do you sell the share or sell future, buy put if applicable for that stock or do you just let it be the way it is and don’t touch your stock.
Not really, Tejas. My long term positions are unhedged, swing positions at times are hedged.
Dear Sir,
Thank you for responding.
Sorry for asking too many questions about your personal life as I would like to create a life like you one day.
Lets say that you have been holding HDFC bank for 2-3 years and you think of holding it for a very long time. Recently HDFC bank got bad news as RBI prevented from creating new cards and new financial service accounts till it fixes some problems. This is fundamentally a issue for the company with a short term to medium term view (1-3 quarter duration). Obviously this led to a slow movement of HDFC bank’s price and affected its quarterly results.
Would you sell HDFC bank for the short term and buy it on a later date? Or would you just ride this out and ignore this?
Not really, Tejas. I’d evaluate the extent of damage the news would impact the company and then decide. If it has long term unfavourable ramifications, then I’d rather not continue holding. Hold otherwise.
Thank you for your valuable insight sir.
Hello Sir,
I hope you and your family are doing well.
How much of your general capital have you split between long term investments and your various swing positions. Do you trade derivatives in your swing positions?
Since you are heavily involved and actively watch the stock market would you invest in mutual funds or invest in a PMS?? Generally those are for people who do not have much idea about the stock market correct?
We are doing good, hope the same with you 🙂
About 80-85% is long term mutual funds (via SIPs), rest in swing positions. No derivatives. No PMS for me 🙂
Hello Sir,
This really confuses me.
For someone who is so knowledgeable in the market, why would put 80% of your captial in MFs?
Like example most large-cap MFs contains the usual suspects of Reliance, HDFC bank, HDFC, ICICI bank, Baj Finance, Axis bank. Wouldn’t it be more cost-effective and more return promising if you would invest in said companies your self than a MF?
Why no derivatives despite being so knowledgeable about derivatives?
Do you not hold any long-term equity positions for LTCG?
Thanks so being so open sir.
I truly hope you and your family stay safe
Employees aren’t permitted to actively trade in Zerodha, Tejas. So had to stop. This is what I do now – Mutual funds + SGB + Stocks (investments) + stocks (short term trade, for few weeks to months).
Hi, what was the whatsapp group that you had mentioned about? Is it possible for us to join?
Sir,
I watched your video on sensibull YouTube channel, You said your mistake is overtrading, when you lost money in trading , you traded again and again. Currently, I am doing this mistake in trading equity intraday. Intraday trading is my favourite and I love catching the small movements in a stock. But I have a target in my mind I have to make X amount in a day. And chasing this I take many trades to make that X amount and I end up doing overtrading. I taken First Option trade of my life in USD INR and made a profit of 175rs , Second time when I taken it I lost 756 rs. 🙂 If I take trading as a serious business , that I have to make X amount Rs a day and I can lose Y amount Rs a day for taking my trades. Please share your experience How can I overcome from this. 🙂
It is very hard, the only way around this is self realization. You need to understand that this over trading does not take you anywhere and the sooner you get out of it, the better it would be.