Jamal Mecklai: How to quit smoking

MARKET MANIAC

The sharp fall in the rupee over the past month has, once again, caught almost everybody by surprise. Even more surprising is that this is not new "" every six or eight months or so, the rupee does a flip, a shimmy, a double take and most companies are left staring at the red on their books, wondering whether there is a better way.

Well, Steven, there is.
It's called risk management, and to do it you have to break four common habits.

First of all, you have to forget about the market. Don't ever ask anybody where she thinks the rupee will go tomorrow, next week, in six months or a year. Unless you do this, you can't manage risk.

Secondly, you have to fix the exchange rate that gives you the minimum acceptable profit for every transaction (or portfolio of transactions). If you don't do this, you can't manage risk.

Third, you have to be willing to pay some money upfront to buy options. If you aren't willing to do this, you can't manage risk.

And, finally, don't be greedy; set a maximum gain target (or several such targets, each at higher levels), and stick by it. If you're too greedy, you can't manage risk.

That's it. Four habits we all live with. Breaking them is not, but living with them is harmful to our financial health.

So, are you ready?
Are you sure? OK, let's look at each of these in a little more detail.

One, no talk about the market. This is very difficult. It is almost a reflex act "" a habit "" to look at today's price and think about what your imports will cost or what you will get for your exports. And try as you might, it's hard to hide from today's price "" CNBC is everywhere, your friends and business associates are always talking about it, your boss wants to know what you think, and so on.

The best way to deal with all of these is to just smile inscrutably and say, "It's 42.60 (or whatever) today, isn't it? Hmmm". Do not hazard a guess, do not hazard a thought, and try not to listen when they tell you what they think.

Easier said than done, I know, but you need to get into the habit.

Next, fix your target rate. Again, this is very difficult to do, because the target rate needs to be worse than today's rate, and human nature being what it is, nobody wants to think about things getting worse than today. But, you need to look at it differently.

Think about swimming in the ocean. When you go to the beach, you have an implicit target that you don't want to drown. So, you look at the water, and, if it's too rough "" threatening your target "" you don't get into the sea. So, too, if the market is too rough, you don't get into the market, or, if you already have an exposure in the market, you exit by hedging. On the other hand, if it's a relatively calm day, you go into the water readily; so, too, when volatility is low, you can stay unhedged. But at all times you need to be vigilant, keeping an eye on how far you are from the shore or how the market is moving. And, just like you don't "" unless you are extremely strong or extremely foolish "" let the beach go too far out of sight, you shouldn't let the market get too close to your target. Depending on your strength and risk appetite, you need to decide how close is too close. Is it till your profit margin thins to 5%? To 2%? To zero?

You decide. But, set your target (and don't change it).
The third requirement is that you put some money on the table to buy options. Again, difficult "" it's almost instinctive to not want to pay for something intangible. Well, that may not be strictly true "" people do buy insurance, after all. But, somehow, in markets, certainly in India, many companies are uncomfortable with paying a premium for options. At best, they want zero cost options, not recognising what they know as a certainty "" if you pay nothing, you (generally) get nothing.

You need to be willing to pay to buy options. Period.
Fourthly, you need to set "" and respect "" a take profit level. This may be the most difficult habit to break. Every one of us has seen mark-to-market (paper) profits decline "" and, often, disappear "" as the market turns sour while we watch, frozen, unable to push the button. As my father taught me, nobody went broke from booking a profit. Learn how to push the button "" set a take profit level (or several, say, stepping up where you hedge 25% at each one rupee gain) and, critically, act on it.

There you go. That's it. That's all you have to do. Change these four habits and you will find that you are able to consistently protect your profit margins and capture some value from the market.

And, of course, once you break these habits, it will be that much easier to quit smoking.