Trading is against human nature: Rakesh Jhunjhunwala

'Trading is against human nature,' says Rakesh Jhunjhunwala, while talking about his investment approach in the stock markets. He says:

All risk taking is associated with two human conditions, viz the greed for profits and the fear of losses. The ability to strike the right balance between fear and greed is the most vital determinant of profitable risk taking. Human nature operates on the chance of a gain rather than maximizing gains.

There is lack of focus on the magnitude of gains and losses, which is why I maintain that successful trading and investing requires you to go against the basic tenets of human nature. We are programmed to learn, and we learn to a pain. But in trading and investing, you have to learn to take a loss.

In trading, the first and the last principle is that trading is trend and price based, and not opinion based. This requires you to square an unfavorable trade regardless of your opinion. This means that if I buy a stock at Rs 100, and then the price falls to Rs 95, I take my loss and square off my trade. This is counter-intuitive to most people. This is the one common quality of all successful traders.

I have tried to rationalize this many times, and am always reminded of Winston Churchill, the British prime minister who led the country into WWII, who said, "You have to lose many a battle to win the war". I think anybody who wants to trade should not only remember what Churchill said, but also what George Soros says, "It's not important whether you are right or wrong, it more important how much you lose when you are wrong and how much money you make when you are right".

Great fortunes are made by the occurrence of the unknown, and the first portend of the unknown is price, price and only price. Good trading requires three qualities: broad idea of direction, knowing what and how much to risk, and knowing when and how to take a loss.

To be successful in investing, many elements have to fall into place. But four things are critical. There has to be an attractive, addressable, external opportunity; a sustainable competitive advantage; scalability and operating leverage; and the management should be of high quality and integrity. All have to be present but they still constitute only 50% of our necessary requirement. It is important what one buys, but it is more important at what price one buys.

In The Smart Manager, I have talked about my ten commandments of investing. The top three are:

- Be an optimist. It's a necessary quality for investing success

- Expect a realistic return. Balance fear and greed

- Invest on broad parameters and the larger picture. Make it an act of wisdom, not intelligence

I am happy to say that a loss in investing has been a rare occurrence in my career, and the key to it is that I am an investor who focuses obsessively on value. Therefore, I may have made a mistake in buying NIIT in 2001, but I still made a profit.