Mikhail Tyazhlov: successful trader and his secrets

incompoint.tv

2004

Mikhail Tyazhlov, Executive Director at IC «IT Invest»: Successful trader and his secrets

Each successful trader has his or her own secrets, in other words, the particular ways to live in the stock market that he or she made up for him- or herself in order to make some money, that is from one side. On the other side, of course, there are some absolutely general things which people have to abide by and some set of rules which people have to keep.

There is sort of three pillars, three global things that people definitely need to follow, and one of these pillars is risk management. That is to say, those people who are active in the stock market necessarily control their risks. Another pillar is the market analysis. Certainly, you need to understand market analysis in the following way: you have to understand the economics, you have to keep track of politics in order to work actively; these things make influence on quotations of securities and, correspondingly, on people’s income. The third pillar is the trading psychology: in many cases, the market behaviour is seemingly counterintuitive.

There are different risk management methods, as big investment funds, generally, operate with investment portfolios when completing a big blocks of stocks in a way to make a portfolio risk lower than the market risk. Of course, a private investor, as a rule, cannot follow this practice. However, risk management is indispensable. This means, every time a person makes any deals, he or she must have a clear vision of his or her expected money income from these deals and the risks he or she assumes in roubles.

For example, a person decided for him- or herself: here, I am carrying a risk of a thousand roubles, of ten thousand roubles, of one hundred thousand roubles or dollars, and I definitely have to follow this. Those people who do not control the risk just leave the market; this is an indisputable fact. Another thing is that there is another way to live in the stock market, a passive way. This passive way also includes risk management; however, it is rather peculiar. This refers to passive investment. Active work in the stock market implies monitoring of each position, monitoring of the whole portfolio and, accordingly, risk management within this monitoring.

There is another way to live – a passive investment; when a person, let us say, invests a relatively small portion of his or her income in stocks without having the intention to sell them sooner than in five-ten years. This is called passive investment. Risk management is present here too, and the risk management is, really, such that the risks are one hundred percent.

I will give an example from the west. Let us say, an investor had bought the stocks of Enrol Company, he or she has lost all the money because it had turned bankrupt. Now, there is a bankruptcy risk for Yukos. The person buying its stocks now is carrying the risk of the company’s bankruptcy. There are valuations saying that the residual value of Yukos is not equal to zero, unlike Enrol’s, which had it negative. Moreover, in equilibrium, the price of stocks is about 200 or 50 roubles.

However, these valuations heavily depend on the claims that the Ministry of Taxation is going to make to Yukos, and, generally speaking, other things may happen. Here, there will be risk, and the risk management will be in the fact that a person risks with a small part of his or her funds. In addition, as part of such approach, it is absolutely forbidden, for example, to sell the apartment and buy Yukos counting on the idea that it is certainly going to grow.

A broker is a person who just puts the client in the securities market, his or her income makes the client who pays the commission for the deals. As a rule, notwithstanding the conventional wisdom that a broker is a central person on the market, this is a big mistake. Central persons on the market are investors, and when you see that the quotations increase a lot or decrease a lot, this does not mean that the brokers decided to bend the market in one way or another in order to make money on it by robbing the poor investors; there is a cliché, with which I strongly disagree, that everything depends on the clients’ orders.

A trader is a person who makes deals in somebody's behalf. He or she may make deals pursuing own benefits; then, this is a private trader, a private investor. Investment companies also have traders who make deals on behalf of the company. However, regarding the amount of funds, it is, generally, insignificant if compared to the amount of funds brought to the market by investors.

A broker is just a professional intermediary who helps the client to enter the market. A trader is a person who makes deals.

For example, there is some good news. Everybody is waiting for Russia to enter the WTO in a little while. There is a wonderful news, and the newspapers write how everything is going to be fine, how wonderful it is all going to be. The quotations are suddenly starting to decrease. This is the most typical reaction; this happens quite often. Here is the thing: you have to know that the market sometimes behaves in a different way from how you expected it to behave at first thought. Alternatively, there may be an awful news, some very bad events may happen, as far as the quotations are concerned; the market is not growing any more, and then it begins to grow. In such cases, the professionals say, “We buy rumours and sell facts”.

It has a relation with the fact that there are several categories of players at the market, and the biggest, the most prominent players, as a rule, plan their exit from the positions, and at each expected good news, they will have prepared sales for these good news with a view to the good news agitating the new investors; those people who wanted to buy the stocks finally decide on doing this. At this good news, very big players are going to sell their stocks. It will not at all necessarily happen that the stocks will depreciate because there may be more money, more new money.

However, as a rule, a good news is followed by profit taking of big professional players. However, if there is not enough money, the quotations just start to decrease. Then there emerges a paradox that we have entered the WTO, our companies get better and better, today is better than yesterday, and tomorrow will be better than today, but the quotations decrease.

In any trading system, if a person works at the stock market, those things he or she is going to do, the logic he or she is going to follow will make his or her trading system. It necessarily must include three things: risk management, market analysis and trading psychology; these things you have to know. You can learn it out of books, study at some courses. However, in order to realize these things in a fast and safe way, communication with a professional is preferable. It is clear that one can learn everything on one's own, but it is better to talk to someone, just learn from someone how he or she sees the market right now, how the market works now.

Every person, every trader combines these three pillars, firstly, in different proportions, secondly, with some peculiarities. Moreover, certainly, a final set of trading systems is going to be infinitely diverse. Moreover, it may happen that in the same deal, one person buying and another selling, both are right and both win. Here is how the market works.

In 1960s in the United States of America, (there was no stock market in Russia) the stocks grew when the signs of inflation appeared. The logic was as follows: the stocks are, in certain sense, inflation-free asset because all things that stand behind the company’s stocks are is in kind. That is why if the inflation speeds up, then it seems that the cost of property grows. In the 1960s, the assets grew with the signs of increasing inflation, in other words, if we had an inflation-oriented trading system, it would command to “buy”.

The time has passed, and the economists explained to everybody that it was not the case. When the inflation grew in the economics, it is bad because it means high cost of borrowed funds, not the capital but borrowed funds, and the company feels bad. After that with growth of inflation, the stocks began to decrease. This is only an example of change in the perceptions of market participants about how the stocks should behave. They really started to behave in a different way.

Now, let us go back to the secrets of stock trading, to the rules that you have to observe in order to trade successfully. Rule number one: always trade in the direction of the main market trend. Trend is a friend. And, as the professionals say, a sideways trend, when there is no definite trend in the market, the prices do not change, that is the prices change all the time, now a little bit up and then a little bit down, a sideways trend is an enemy.

When the market grows, it is relatively easy to make money on it, and everybody make money in it. When the market falls, only few people make money on it, and it is difficult to make money in the declining market. It has a relation to many things, but it is too early for us to dig into them. In other words, this is what it means: if a trader, let us say, wants to hold a position for a week, then the ideal place for him or her to enter this position will occur when a set of conditions coincide. The first one. There must be a global trend in the market, an upward trend lasting for a month or three months, or a year. A local trend of daily quotations, daily fluctuation of price must also be upward.

It is desirable for the hourly trend to also be upward, namely, at that moment, for the last hours, the stocks should go up too. When they all go one way, it is a good sign, a good way to take a position, to hold it, let us say, for a few days or weeks. If the investor plays that the stocks will grow up in a year, then a very good moment for a purchase is a local decrease in the quotation.

The very concept of a trend emerged from the technical analysis. A person coming to the market asks, “Do the quotations increase or decrease?” The answers will differ depending on the time scale, namely, on the length of the schedule he or she sees on the computer screen, because the quotations may increase. In general, globally, the stocks grow. Here, say, let us look at the American prices for American assets for the last 30 years or for 100 years, we will see that they are only growing. This is a kind of a global trend, there is no escape from it, it only goes up, and this is a trend.

It is related to the fact that the economics is efficient, the companies make profit, and that is why the company’s capitalization first used to be 1,000 USD, then 10,000 USD, then 100,000, then one million, and so on and so forth. If you look at the same quotations in another time scale, you will see that they may go upwards or downwards. Globally, let us suppose that the stocks grow in a year scale and fall in a month scale. Therefore, it may occur that, let us say, Russian stocks, that is Russian stocks are in a long-term and very strong upwards trend. This trend started to form in 1998-99s, and it is still going on.

In other words, we have a six-years upwards trend. If we look at this situation in a scale of a few weeks, the quotations go down. If I look at the situation in five minutes scale, I will say, “Oh, five minutes ago the quotations were there, or fifteen minutes ago the quotations decreased, and now they are increasing again.” That is the very concept of a trend, technical analysis gives it a more tight definition, but within the subject I am talking about, we can use a simple intuitive concept of “What are we doing? Increasing or decreasing?” Here, we are increasing, and it means the stocks are going up.

Rule number two. You have to buy assets that are expensive: they are going to become even more expensive, and you should not buy assets that are cheap: they may become even cheaper. This rule, as any formal statement, by no means always works, but there is some general approach, and the reason is simple. Yes, the history knows plenty of cases, when the stocks grew several-fold and then grew several-fold again.

The general approach, the overall calculation is as follows: I come to the market and see a stock that grew by 10% yesterday, the day before yesterday it grew by another 10%, or the stock which price does not change. My first intuitive desire is to buy a stock that is not growing counting that it will grow up. In fact, I have to buy a stock that have already grown: it will grow even more. The principle is very simple: it is growing for a reason. If it is growing, it means that some big players have interest in it. It is much easier for a small investor to jump on the train and play the game of some big participants than to play against them. For this reason, it is very difficult for a private investor to work with information. He or she has essentially less information than the professional participants have.

One might just not know about many things. These might be some market rumours or some bad situation of a fundamental company. That is why it does not grow, stays in one place, and the quotations stay the same. In other words, the second rule is to buy expensive stocks: they will become more expensive, and sell cheap ones: they will become even cheaper.

Rule number three. I have mentioned it when I told about the indispensable necessity to study trading psychology, the psychology of market participants; the rule is to buy with rumours and to sell with the news. It has a connection with the behaviour of professional participants, with the ongoing game between the professionals and non-professionals. As a rule, if you have found a news on the front page of Vedomosti newspaper, it is just too late to use it for trade. This means, the professionals will buy assets beforehand, they will buy assets with rumours of the upcoming entrance to the WTO, with rumours of rating.

At the time we enter the WTO and get the investment rating, in principle, it will be too late to buy: the professionals will have already bought everything. This means, only those for whom it was a surprise will be going to buy then, those for whom it will be a hit in the head, “Hey guys, it turns out we have entered the WTO, and I did not know about that.” Therefore, it is too late to just buy. We had this case in our practice when this happened in the American stock market, when yahoo financial portal published the news, “Attention guys, there is the arbitration!”

It turns out, the leading article described some financial transaction at the equity market as the result of which it was possible to buy one asset, to sell another one, and to get a fair rate of return, let’s say, of 30% annual interest without a risk, which was a lot at the time for Americans in the stock market, and now for our market it is a rather fair rate of return. If we found out this opportunity by ourselves, we would definitely have played it. Only the fact that it was published by yahoo financial portal, and it was already too late to use it if everybody knew about it stopped us.

There is this historical anecdote. They say, a famous banker Morgan managed to liquidate a significant part of his assets invested in stocks shortly before the crisis. There were some claims to him in view of this. Therefore, he told the following tale to the senate commission investigating the abusive practice. He told that on his way to the stock exchange, he stopped by to get his shoes polished, and the shoe shiner asked him how he was, how he sew the prospects of stocks of the railway companies.

After that, Mr. Morgan said that he came to the stock exchange and ordered his broker to sell all his assets. When a show shiner came to the market, I had nothing to do in there. Here is the tale, but in every joke, there is only some part of a joke, but all the rest is the truth; this example illustrates the rule that when everybody already has the asset, then nobody needs it anymore, and it is too late to buy it. The second rule. The third rule is “Buy with the rumours, and sell with the news”.

The forth rule: plan your trade and stick to your plans. The stock market just loves to deceive people. Generally speaking, nobody can avoid these deceptions. This means, if a person you know who works at the stock market claims that he or she has never suffered loss, he or she just lies. There are no such people in the world, at least, I do not know of any such person. If I find such person, I will be very much surprised.

It is just impossible to predict market behaviour with 100% probability, as all kind of events take place. Moreover, the interpretation of these events may change. In other words, things may take place and make panic in the market, and it is very difficult not to give way to panic. This deceitful component of the market one has to struggle with, not only with the market but also win oneself. Since one sees that yesterday he or she was going to buy this stock for 10, and today one sees it for 8, then it is very difficult not to buy it. Dear God, it is only yesterday when I was going to buy it for 10, and today it is already 8, 20% cheaper. To withstand these market influences, escape the impositions the worst of which are the internal deceptions.

The most terrible thing happens when a person enters a position, sees it becoming loss-making, and his or her trading system orders him or her to close it, he or she is obliged to close it, and it is very difficult to close a loss-making position. The worst nightmare of a professional trader is not to take a loss, I mean, people get used to it, they get used to the fact that not all deals are profitable. This professional nightmare, a professional terror, as the traders say, is to throw yourself into the gutter. This means to sell the stocks, and to sell them at minimal price. Here I have sold the stocks, and the price turned around and went up. This is just such kind of a nightmare, in other words, a nightmarish experience. People are psychologically afraid of this; everybody is afraid of this.

However, when the market goes against you, and you hold a wrong position, you necessarily need to close it and after that step aside, take a break, and take another look of the market. It may happen that you need to come back to this position, but deviation from your plans, from you trading plans, your risk management, is a wrong thing to do. If the risk management says that maximal loss from this position may be such and such, you have to follow it literally. The only way to escape it and sail right through these reefs is to plan the trade carefully, defining for yourself the points of entry and the points of exit from the position. Moreover, what is at least as difficult, you have to follow these plans.

When I started to work at the stock market, I just wrote them on paper. I just wrote, took a piece of paper and wrote - for this stock, the points of entry are such and such, and the points of exit are such and such. After that, I plainly followed these plans; my trade was not always successful. I mean, of course, I had losses, but this is the way one may go improving as a trader and improving one’s trading style.

The points of entry to and exit from the position will depend on the game that the investor is going to play. I mean, if the game is such that in 10 years, Russia will form a developed capitalist society, then the point of entry is the whole, loosely speaking, current year, and you may enter as you are. If the game is such that, let us say, Rostelecom will pay good dividends on 11 May, the point of entry was several weeks ago, and the point of exit will be immediately before the dividends are received.

These are two absolutely different games. One game, generally speaking, is an investment game calculated for a wide, a long period of time. The second game is very short – it is played in a week. There are games that people play, for example, by taking the position for 15-20 minutes. There are players who take a position for 5 minutes. These are all players playing different games; they have different points of entry; they are obliged to play using technical analysis in different ways.

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