THE MANIC OBSESSION WITH STOPS AND TARGETS

Today’s fast moving times with relentless bombardment of information coming at you from TV and WhatsApp and also from the myriad websites on the market has probably led to a situation where most of the market participants have now got mind-washed to thinking in very short term. Trading activity, as a result, has exploded. Brokers are fanning these trends because the churn means survival for them and they are pressing more and more technical calls to their clients in an attempt to keep the trading mill functioning actively. My company too has an advisory wing and even though we cover a wider spectrum of time horizon, the max enquiry we get is for intraday trades.

What this is leading to is to create a heightened focus on stops and targets. Today, TA has almost become synonymous with an SMS that carries stock, entry, stop and target! Probably most people think that this is all that TA is capable of doing! Leaving that erroneous impression alone for the moment, I want to focus on the aspect of this manic obsession with stops and targets. I see this happening all around me and even though I don’t subscribe to this manic obsession, I too am forced to be part of it if I want to be part of the mainstream! The minute you give a recommendation, people, almost automatically, ask you what is the stop and what is the target. They don’t even bother to see whether the call is for the day or the week or the month or even for a year. They still want a stop and target!

Mind you, hardly anyone follows these stops and targets! Most people don’t want to set a stop because many don’t believe in setting one and are probably asking for it because they are supposed to. Even if the stop is mentioned, no one observes it. Similarly, hardly anyone is able to wait for the target once the trade moves into a profit. Particularly, when multiple targets are given, chances are that most people will be out before even the first of the targets are reached. Often, after a certain profit has accrued on the stock recommendation, advisors suggest a moving or trailing stop. But how many people really use a trailing stop? I would wager that it would be less than 1% of traders who would be doing that.

Setting of stops itself is so arbitrary, even by advisors. They set them by how much they think their clients can ‘afford’ to lose rather than base it on some sound principle. The textbooks have often said that a trade should be around 2:1 or even 3:1 for a reward to risk ratio. Advisors work out the stop from looking at what the reward can be! This is like placing the cart before the horse. Reward is what the market may choose to give you. But risk is something that you choose to apply and so it is more real of the two. The reward is only an expectation. Hence working out a stop based on the reward (which is only a probability) would be one of the silliest things to do. Small wonder, then, that a lot of stops do get hit.

Another curious aspect that I have gleaned from my analysts and sales people is that most day traders want to play the futures markets. But when asked, they answer that they have about a lac or max two lacs to trade with. This is a ridiculous amount of capital to want to play the futures markets where the margin element on even a single contract is almost a lac. Now, any advisor will flash at least 5-7 calls per day. He will measure his success on the basis of how many of those calls did well. However, for the trader (with a small capital) who is able to take just one or two calls, is now forced to choose from the selection of trades offered by the service. Here his own biases and prejudices come into play. Again, no surprise to see that clients are almost always disappointed with the “poor performance” of their advisors. The actual fault lies in the lack of capital that forces some action that the advisor cannot factor into his equation!

Lack of capital also forces the trader to focus intensely on the risk aspect. As a result, he cannot “afford” recommendations with large stops. Add to this the lot size of the future contract and the figure balloons! As a result, the trader is neither able to observe the stops or take some of the suggested trades or wait for the targets mentioned. How can he then be expected to profit except by luck?

I believe the lack of capital is one of the main reason why people are so obsessed with stops and targets because it conveys to them what is their risk and helps them assess whether the trade is to be taken. The focus should really be on the possibility of the trade working out. So analysis and entry is important. A high probability trade does not test the stop levels and often goes to the target. Focus should be in getting those high probability trades and for this the analysis has to be of high quality. Next, the focus should be on having the requisite amount of capital so that one is able to pick the right asset class and the right amount of quantity. If one looks at this, then chances of getting spooked out of a position is much less.

Any recommendation has a probability of coming thru or failing. Good analysis increases the probability of success. Correct capital availability increases the possibility of the trade being carried to fruition. Move away from the obsession with stops and targets and instead, focus on analysis, probability of success and getting the right amount of capital.