As promised, this chapter is being devoted to an overnight trading system with multiple long positions, and, this is important, a much lower risk of loss per deal. The graph given below will illustrate the concept clearly:
I shall explain the graph. The graph begins when the price is at Rs. 356. It falls one division (each division is equal to 5%) to Rs. 339. Then it rises one division and touches Rs. 356. Our principle advises that the scrip be bought when it rises 5% from the recently formed bottom. Rs. 339 was the recently formed bottom. When the price rose to Rs. 356, we were to buy. Let us imagine that we have bought just one share at that time.
The price rises another division (that is, another 5%) to Rs. 374. Under our original scheme, we would not have done anything at all; we would have simply waited, holding the shares we had bought at Rs. 356. But in the present variant of the system, which envisages multiple long positions, we are to buy one share when the price touches Rs. 374. Thus we have 2 shares. In real situations, we might buy more than one share, but, here, for illustration, buying just one share would be enough.
The price rises another division and touches Rs. 393. We buy one more share at this level. Thus we hold 3 shares in all.
The price rises another division and touches Rs. 413. We buy one more share at this level. Now we hold 4 shares in all. We repeat this purchase at each of the levels of Rs. 434, Rs. 456, Rs. 479, Rs. 503, Rs. 529 and Rs. 556. Ten purchases of one share each have been made in all, and we now hold a total of 10 shares of the scrip.
Now comes the fall: the price falls one division (that is, 5%) from Rs. 556 to 529. Our system tells us to sell the scrip away whenever it falls 5% from the last formed high. As per our graph, Rs. 556 is the last formed high. When the price falls from Rs. 556 to Rs. 529, we have to sell all the 10 shares. Let us imagine that we sold all of them at Rs. 529.
The logic behind all these purchases and sales is that, as long as the price keeps climbing, we will go on making purchases at regular intervals, and when price starts falling, we will sell the whole holdings away.
We have definitely earned some imaginary profit on these imaginary purchases. Let us calculate it.
I hope the calculations given in the table above are transparent enough. The net profit earned was Rs. 748. It comes to 16.65% of the total buying cost of Rs. 4493. The 10th purchase, which was the last, ended in loss. As you can see from the last column, the gross loss of Rs. 27 (before accounting the brokerage) came to 4.86% of its respective buying cost of Rs. 556. This loss of Rs. 27 was equal to a mere 0.60% of the total buying cost of Rs. 4493.
One important point to note from this example is that the gross loss (gross loss here means loss before brokerage) from any single deal will not exceed 4.86% of its respective buying cost. The actual loss, after the brokerage is added, will be a little less than 5.5% of its respective buying cost.
One requirement of this system of multiple long positions is that we must first decide the maximum number of long positions we will create. In this particular illustration, we chose 10 positions. We could have selected a lesser number of positions; say 5 positions. If we decide that we will create a maximum of five positions only, then, we will be dividing our opening capital into five equal parts, and using each part for each position. Thus, if our maximum number of positions was just 5, we would have, in the example illustrated above, made the first five purchases only, and would not have made the purchases after the 5th.
In the illustrated example, we had chosen to create 10 long positions and had divided our opening capital into 10 equal parts. Let us imagine that our opening capital was Rs. 20000, and that we had divided it into 10 equal parts of Rs. 2000 each. Thus Rs. 2000 was available for creating each position. In order to find out the number of shares in the first position, we need to divide Rs. 2000 with the price at the level of the first position, which was Rs. 356. 2000/356 = 5 shares. So, we will buy 5 shares to create the first long position.
We will find out the number of shares in the second long position in a similar way: 2000/374 = 5 shares. I am giving below the number of shares in each of the positions from the first to the 10th:
Since a fraction of a share cannot be purchased, the decimals have to be omitted in these computations.
The number of shares was as high as 5 in the first position while the number went down to just 3 in the last three positions. This was because the price of the scrip had gone up, and the capital allocated for each of the positions remained fixed at Rs. 2000. When the scrip was cheaper, more shares could be bought; when the scrip became costlier, only a lesser number could be bought. However, the total cost of buying in every deal remained almost at the same level which was well within the allocated per-deal amount of Rs. 2000.
The single position system had been explained at length in several of the preceding chapters. The present chapter is devoted to the multiple positions system. We shall now compare this multiple positions system with the single position system. The whole opening capital is utilized for creating one single position in the single position system. If the price reverses without rising at all, 5 to 5.5% of the opening capital will be lost. This is because the gap between the selling trigger price and the last formed high is 5%.
In the multiple positions system, if we have chosen 10 as the maximum number of positions, and if we have divided our opening capital into 10 equal parts, then the risk of loss from one single deal will be around 0.50% only. This is because only one-tenth of the capital gets allocated to each deal. If our opening capital is Rs. 20000, we will have a risk of loss of 5% per deal in the single position system; this amounts to Rs. 1000 (Rupees one thousand) plus brokerage. The share of opening capital allocated for each of the 10 positions under the multiple positions system will be Rs. 2000; the maximum risk of loss we will have in one deal under this system will be just Rs.100 (Rupees one hundred) plus brokerage.
A much lower risk of loss is the main attraction of the multiple positions system. A much lower percentage of profit will be its main disadvantage. People can be of two different kinds: one might want higher profit and may be ready to undertake heavier risks. The other group may prefer much lower risks of loss and will be satisfied with a correspondingly lower profit.
I have already mentioned that in the single position system, we will have a risk of loss ranging over 5% of the opening capital. It is quite possible that the price moves violently up and down, and that more than one deal takes place on the same day, and that all the deals end up in loss. In every such deal, ending up in loss, the risk of loss can be 5% plus brokerage. The total loss which the multiple positions system might cause us on any given day is likely to be much less than the loss which we might suffer from the single position system.
If the price movement is favourable, the single position system will give our capital a much faster growth than what the multiple positions system will. The converse of the same is also true: when the price movement is unfavourable (showing frequent reversals), we will lose more amount in the single position system than in the multiple positions system.
So, each individual will have to select the system with which he or she feels at home; those who are ready for heavier losses, can select the single position system. Those who prefer small losses and small profits, can go in for the multiple positions system. Here is a caution: if the maximum number of deals selected is very high, say, 30, it will take a long time for the capital to grow. The greater the number of positions, the lower the profits, and the slower the growth.
Just for the sake of curiosity, let us calculate the net profit from the single position system, and compare the net profit with that of the multiple positions system. Had the single position system been followed, there would have been only one deal in the example given at the top of this chapter; its buying would have been made at Rs. 356, and the selling at Rs. 529. Rs. 173 would have been the gross profit, and Rs. 168, the net profit after brokerage. This net profit would have been equal to 48% of the opening capital of Rs. 356. In comparison, the net profit from the 10 deals in the multiple positions system was, if you haven’t forgotten, 16.65%
Under the single position system, there will be only a single deal. If it reverses (that is, if it ends in loss), the loss can be as high as 5.5% of the opening capital. Contrary to this, under the multiple positions system with a maximum of, say for instance 10 deals, only the 10th deal might end in gross loss; the remaining nine deals will not end in gross loss.
Though we might be ready to create 10 long positions, the upward moment might, at times, dissipate after rising one or two divisions. The example given above, in which the price rose 10 divisions at a stretch, was based on an actual price movement. However, such rosy situations have been rare and far apart in the past. The loss-deals may, more or less, match the profit-deals. The data in Chapter 5 shows that Reliance Capital had 67 profit-deals and 49 loss-deals over a period of eight years. This ratio looks good enough, but no one can guarantee that the same ratio will prevail always.
(To continue)
Investment In Equity 