Why Traders & Investors unable to beat the market

In this article, we will cover

• Buying Naked Options like Lottery tickets
• Inability to Stop Losses
• Revenge trades
• Poor Risk Management
• Focussing on win rate instead of portfolio outperformance

Indian stock markets are currently trading in uncharted territory – Benchmark indices are close to Highs - but for most of the domestic retail and small investors, there is hardly anything to celebrate. Their portfolio has hardly moved in line with the benchmarks. An internal survey conducted at Samco, with over 2 Lakh plus retail accounts, showed that the majority of the traders and investors could not beat the Nifty-500 in the last quarter and in the last week. The majority of the investors and traders don’t realize that they are in the market to outperform it. Their purpose is not to produce returns in line with the market but to generate that extra alpha, which keeps them ahead of others and the markets. If as an investor or trader, you aren’t able to produce alpha and generate uncorrelated results, why not just hand over your money to the Fund Manager? This will achieve essentially the same results without taking the burden of managing your money and the stress involved in it. Even if you do not want to hand over your funds to the specialist, why not just invest in index funds benchmarked to stock market indices, which have beaten most fund managers, most of the time? This gives rise to another question, individual investors aren’t able to beat the markets?  Individual investors while pursuing their journey in the stock market make certain common mistakes, which act as a roadblock to reaching the destination of generating alpha and beating the markets.

•   Buying Naked Options like Lottery tickets

One of the biggest reasons that cause investors to underperform even benchmark returns are buying out of money call or put options like lottery tickets with the hope of multiplying money overnight. There is a common misconception that options are more-safer than Futures. Nothing could be further than the truth. For example, today is Wednesday and you think Nifty will be trading at the 19,000 level on the expiry day at the end of the month, so you will buy a call option. The lot size of Nifty is 75 and let us assume that the premium is Rs 100 per unit, this means you purchase Nifty call for Rs 7,500. This is like buying a lottery ticket. Now, if Nifty doesn’t cross 19,000 on the day of expiry, and in 90% of the cases, money Options decay and expire worthless. So, that Rs 7,500, which was paid as a premium becomes zero in one day. This is a loss of 100% of capital. Just because the amount may appear smaller in absolute terms doesn’t mean that there’s a lesser risk where in fact there is a high probability of permanent loss of capital. How can such losses be avoided? It can be avoided by deploying the right strategies not only for the Options but also for the Futures trading. You cannot have Buy and decay strategy in Options but instead, trade via a variety of hedged strategies. Specifically, while trading in F&O, using Options strategies like Call spread, Bear spread, Strangles, Straddle, and other varieties of Option strategies that one can deploy, which will cover and manage risk in a better way.

•   Inability to Stop Losses

The second most common mistake investors make is, they resist pulling stop losses in losing trades as they are always in pursuit to optimize their win rate. People have a perception that if I pull a stop loss, it will create an impression that I am accepting that I was wrong; and nobody likes to accept that.

•   Revenge trades

The third biggest mistake is that immediately after a losing trade, they resort to revenge trades in the hope of covering up for earlier mistakes and making big reckless trades, and that results in such a large drawdown in their investment journey making it almost impossible or difficult to return to the point from where they had begun.

•   Poor Risk Management

In order to avoid such mishaps, one has to adhere to ideal risk management, which is lacking most of the time in individual investors’ investment strategies. This is the fourth mistake they make. Their position sizing (exposure taken in the market) is either too big or too diversified. This results in a deviation from achieving the target to generate Alpha. What is required is nothing else but a mix of optimal position sizing and stop loss. Correct position sizing and correct entry-and-exit strategy including a pre-defined stop loss are key to a successful strategy.

•   Focussing on win rate instead of portfolio outperformance

Recently, a new crop of investors has entered the market, which believes that they are trying to make money but in due course, what they are trying to do is; they are trying to achieve a high win rate. They always want to win and don’t want to lose money in trading. In that process, they indulge in locking in small gains, hanging on to losers, and averaging, which they think, will improve their win rate. However, all of these activities have nothing to do with making money. Making money is achieving outperformance. You have to achieve outperformance in most time periods, maybe three out of four quarters or seven months out of 12, you should outperform, and so on. The measures suggested above will go in a long way for traders and investors to underperform. Will discuss the ways how to outperform markets in my next column.  The author is the founder & CEO of Samco Ventures.

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