Are you among those traders who like to take a punt when their hunch is strong? Do you have a clear view of what your profit target is on a single trade and the maximum stop loss? Congratulations! You have the profile of a classic Indian trader.

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Whether you use corporate actions as your triggers, technical analysis, results, exotic WhatsApp groups or plain vanilla fundamental analysis, our research indicates that you try and make a profit target of not more than 2–3 percent before you exit the trade. You would also have a strict stop loss of not more than 1-2 percent in the opposite direction before you exit.

This article is not on psychology. It is on how one can’t harness human nature to do things better.

Given limited capital in the account, to gain a large bang for the buck, the ideal segment to turn to is the F&O market where one can take a position in futures at a 4-6 times leverage. For example, if you have Rs 5 lakh cash in your portfolio, you can take a position that is Rs 30 lakh in value. If the position goes 2 percent in your favour, you stand to gain Rs 60,000 in place of Rs 10,000. If it goes 1 percent against, you stand to lose 30,000 and not 5,000.

Once one enters trade, they spend the next few hours or days imagining what would be bought with the Rs 60,000 profit, while frantically praying that it doesn’t happen to be Rs 30,000 loss.

Also Read: June F&O series begins with 79% rollover from May

The problem here is not in the view, but in the nature of the instrument chosen. Let us take the example of Tata Motors which took a joy ride after its earnings results were announced. The stock was up by 8.6 percent from its previous close of Rs 372.3. It opened gap up at Rs 387 and went all the way up to Rs 419.35 before ending the day at Rs 404.3 when the market itself came crashing down. The graph of the day’s trade is given below.

Now, assuming you picked the trend right. You took a bullish position on the stock and expected to book a 2 percent profit when the stock moved by Rs 8 upwards. You had a 1 percent stop loss to insulate yourself against a downfall. The lot size of Tata Motors is 1,425 with a notional value of around Rs 5.75 lakh per lot. If you had traded three lots with the above parameters, your expected profit was Rs 5,75,000×3×2 percent = Rs 34,500. The max loss you were willing to take was Rs 5,75,000×3 ×1 percent = Rs 17,250.

At the end of the day, you saw Tata Motors was up 8.6 percent. You almost booked your tickets to Manali on the profits, before you checked the P/L to see that you are actually Rs 17,250 down. How did this happen?

Notice that even when the share is rising during the day, it does not go up in a straight line. Keeping a 1-1.5 percent stop loss on a volatile stock is nothing better than a gamble. Even a minor fluctuation in the opposite direction will trigger your stop loss and get you out of the trade before you can blink. This is a classic fallacy seen with multiple traders who feel their trades have high discipline, but in reality, are nothing better than a coin toss.

Imagine the same trade in options. If your profit target was just 2 percent, and you were confident of the results, all you had to do was to short an out of the money Put Option which in this case was 4-5 percent below the market price that yielded a capture of Rs 8 per unit for most of the day.

Also Read: Nifty suffers biggest fall in an F&O series in two years — here's what to expect in June

For example, when the share price was at Rs 400 if you had shorted three lots of the Rs 380 Put Option with the May 26 expiry which had an Rs 8 yield per unit, the amount you captured would have been 8×1425×3 = Rs 34,200. All you had to be confident about was that Tata Motors would not fall by more than 5 percent by the time of expiry. As long as this event would transpire, the entire Rs 34,200 could be pocketed. One could have also exited the trade at Rs 4-5 when the CMP reached Rs 419, booking a 50 percent of max profit.

This is often a far safer way to trade a strong directional view in place of putting in small stop losses in a see-saw market.

The author, Shiva Subramaniam, is a member of the Investing Committee of Whitespace Alpha. The views expressed are personal.