4 Stages Of A Bull Market
Sir John Templeton came up with the 4 stages of a bull market, reflected in the chart above. 
Source: Kimble Charting Solutions
13
Mar
21
Feb
Ignore Information, Listen to the Market!
Source: Stockscores.com Perspectives for the week ending January 23, 2013
This week’s Trading Lesson
In theory, information should make the stock market’s world go round. Information about companies and their ability to make money in the future is what should determine share price. As the market learns of new information, price is adjusted up and down to reflect the value of that information.
This implies that investors should focus their analysis on information so they can predict where share prices should go in the future.
While this makes good sense, I have found it to be extremely rare that investors who use information are able to consistently beat the stock market. With smaller retail investors (you and I) in particular, the use of information for making investing decisions is more destructive than it is beneficial. Here are ten reasons why:
1. Information is Usually Already Priced In – most investors use publicly available information. That means it is widely known and available to anyone considering the stock. If information is available to a large number of investors then we should expect that the market will have priced that information in to the stock. Therefore, the information has not value to us.
2. Information Usually Comes with a Bias – as a general rule, people do what they are financially motivated to do. If someone is encouraging you to purchase a stock, there is a good chance that they have some financial motivation to do so. Before you trust the information you receive, understand the financial motivation. If you find the reason, you will often usually find that there is a strong bias in the information being provided to you.
3.Trading on Truly Insider Information is Illegal – there are few risk free trades in the stock market, but trading on significant, inside information is one. You stand to make a lot of money buying stock in a company that will be acquired by another at a premium tomorrow. If you have that information and act on it, you are trading on inside information and that can land you in jail.
4. Gathering Good Private Information is Expensive and Time Consuming – there are investors who are able to uncover information that is not priced in to a stock but is not considered inside information. This private information is valuable because it can lead to market beating returns. However, gathering private information typically requires significant resources, knowledge and time. For small investors, it is not feasible to do this kind of work across a broad range of stocks.
5. Information Causes You to Ignore the Market’s Message – when you have an understanding of a company’s story, there is a tendency to fall in love with that story and ignore new information that goes against your outlook for the stock. This leads the committed shareholder to hang on to a losing position, allowing the loser to bog down the performance of the overall portfolio.
6. You May Not Have All of the Information You Need – the market tends to focus on two or three key information points that affect the price investors are willing to pay for it. An investor who does a thorough fundamental analysis of the stock may still have an incomplete understanding of the company’s business. If missing one of the key points, this investor can make a gross error in valuing the stock.
7. The Market May Not Be Trading On Fundamentals – in theory, stock price is based on the present value of future earnings expectations. In practice, there are often very non fundamental influences on share price. A large investor that has a liquidity crisis may be forced to unload a large position with little regard for price. Often, the laws of supply and demand affect share price even though theory tells us that they should not have an influence.
8. Your Interpretation May Not Be the Same as The Market’s – Our mood affects how we judge information and the same can be said for the market in general. Your fundamental analysis may be correct in an optimistic environment, but if the market is in a pessimistic mood, the investment can lead to losses. Even the market is wrong, it is right.
9. There Is No Standard for What Information is Worth – There are many formulas for determining what a company’s share price should. Many fundamental analysts look for stocks to trade at a certain multiple of their earnings with that multiple to be based on growth. However, there are great variations in accounting methods that can have a profound effect on how earnings are reported. More importantly, there is no rule that a company should trade at a certain multiple of earnings, that target multiple is just an opinion.
10. We Tend to Focus On Information That is Easy to Get – we often looks for the easiest way to achieve a goal. With information, there is a tendency to focus on the information that is front of us. Rather than work to find something to disprove our thesis on a stock, we instead look for information to strengthen our thesis. In doing so, we present our own biased outlook for our investment decisions that can often be very incomplete and wrong.
Ultimately, I look at the market’s interpretation of all available information when I look at a chart of price and volume. It shows not only every bit of information detail but also what the market thinks of it.
Become A Client
20
Feb
Stock Market Insight- Stop Thinking!
Source: Stockscores.com Perspectives for the week ending February 18, 2013
This week’s Trading Lesson
You cannot expect to do well in the market if you look at investing in a normal way. By definition, being average is doing what most other people do and since investing is largely a psychological game, doing what other people do is only natural. Average results come from normal people acting in normal ways.
To beat the market, you have to be different.
Not necessarily in a straight jacket bouncing off padded walls different, just a little off.
Here are 10 things that may help you be a better investor, some ways to think differently from the crowd in that pursuit to achieve market dominance.
1. Do not think about making money, think about losing money – the first step toward success is accepting that losing is part of trading. You will not be right all of the time, you can not always trade your way out of a bad situation. There will be times when you simply have to walk away with a loss. The key is to keeping the losses small and manageable. When the market proves you wrong, take the loss.
2. Do not think you can average down to win – it is a logical idea, add more to a losing position with the expectation that the market must eventually go your way. Many times this strategy will work but, when it does not work, the loss may be insurmountable. The market does not eventually have to go your way.
3. Do not think that your success is entitled – you may make a great trade, pick a really great stock and have a feeling like you really have the market figured out. Forget your gloating, no one ever has the market figured out. We must always remember that we have to work as smart for the next trade as we did for the last.
4. Do not think that talent is required – making money in any trading endeavor is a small part technical skill and a big part emotional management. Learn to limit losses, let winners run and be selective with what you trade. Emotional mastery is more important than stock picking skill.
5. Do not think that you can tell the market what to do – the market does not care about you, it does not know that you want to make a profit. You are the slave, the market is your master. Be obedient and do what the market tells you to.
6. Do not think you are competing against other traders – trading success comes to those who overcome themselves, it is you and your persistent desire to break trading rules that is the ultimate adversary. What others are doing is of little consequence, only you can react to the market and achieve your success.
7. Do not think that Fear and Greed can ever be positive – in life, fear can keep us from harm, greed can give us the motivation to work hard. In the market, these two emotional forces will lead to losses. If your decisions are governed by either or both you will most certainly find that your money escapes you.
8. Do not think you will remember everything you learn – every trade provides a lesson, some valuable education on what to do and what not to do. However, it is likely that your lessons will contradict one another and lead you to forget many of them. Write down the knowledge that you accumulate, return to this trading journal so that you can retain some value from the lessons taught by the market. Remember, the market is cruel, it gives the test first and the lesson after.
9. Do not think that being right will lead to profits – you may be exactly right about what the fundamentals are and what they are worth. However, timing is everything, if your expectations for the future are ill timed, you may find yourself losing more than you can tolerate. Remember, the market can be wrong longer than you can be liquid.
10. Do not think you can overcome the laws of probability – traders tend to be gamblers when they face a loss and risk averse when the have a potential for gain. They would rather lock in a sure profit and gamble against a probable loss even if the expected value of doing so is irrational. Trading is a probability game, each decision should be made on the basis of the best expected value and not what feels best.
Become a Client
12
Feb
Overcome Your Emotional Attachment to Money
Emotions
Source: Stockscores.com Perspectives for the week ending January 28, 2013
This week’s Trading Lesson
Stock traders go through many different phases in their quest to be a master of the market. Initially, the focus is on learning how to pick good stocks to buy or short sell. Countless books may be read, classes attended, computer software purchased or websites used in this quest to get the entry decision right. However, even those that can master the entry decision are not usually successful in the long term. Too much emphasis is placed on the entry decision.
Suppose you were a great stock picker and were able to pick stock trades that were profitable 90% of the time. Does that mean you will make money? Most people would think that it would because they fail to understand what is really important about trading successfully.
If 90% of your trades make you $100 and 10% of your trades lose you $1000, do you make a profit over a large number of trades? Some quick math shows that after 10 trades, you are losing $100 despite being right most of the time. In school you would get an A grade, in the trading, you have earned an F.
The key is to focus on how much you make when you are right versus how much you lose when you are wrong. A trader that is right 50% of the time, making $500 each time they are right but then only losing $100 the other 50% of the time makes $2000 every 10 trades. Not bad for a barely passing grade of 50%.
After a person learns to pick the right trades, this concept of reward for risk and expected value is the next big realization in the quest to become a successful trader. However, understanding this second phase of learning does still not assure the trader of success. The final phase is the most difficult to master.
Having the emotional mastery to have patience with your profits and no patience with your losers is the final step. While it seems easy to say that you have to follow your trading plan, actually doing so is much more difficult. The emotional attachment that most of us have to money is what makes it difficult to follow our rules. You can be a great stock picker, do well at managing risk and still not succeed as a trader if you fail at emotional mastery.
To achieve the final step, you must take the focus off of the money. The financial risk has to be taken out of the decision making process allowing you to apply the analysis techniques you developed in Phase 1 with the risk management techniques in Phase 2 without any emotional bias. Easy to say but hard to do, here are some techniques to help you achieve emotionless trading.
1. Don’t take more risk than you can tolerate – taking too much risk is the most common reason traders hang on to their losers and sell their winners too early. Taking too much risk attaches an anchor to your risk management techniques, hindering your ability to have a positive expected value on your trades.
You can change this by lowering the amount of risk that you take but many traders then find that there is not enough upside to motivate them to trade at all. Without a way to make good profits for the capital that you have, the trader may start to take on more risk as a way to chase performance.
However, you can increase the upside potential of your trades without adding more risk by scaling in to your positions. If you add to your winners as the trade is working in your favor, you increase the upside potential. However, you don’t have to take on added risk by doing this because you can use the profit of your initial positions to mitigate the risk of your additional positions. Add to your winners, never add to your losers.
2. Change your financial focus – I often advise that it is best not to look at the profit and loss summary for your trades. Doing so causes you to get wrapped up in the current gain or loss on your positions, heightening the fear or greed that you feel about the trade. Instead of making decisions based on the chart, you make decisions based on the financials.
I am not sure it is realistic for people to not check their trades and know whether they are making or losing money. Therefore, if you have to look at your trades, rather than focus on the current profit or loss, consider what you will make or lose if your trade is stopped out.
If you buy 1000 shares of a stock at $10 and the stop is at $9, you stand to lose $1000 even if the stock is trading at $10.25. That is the loss exposure you have at the exit door.
Suppose that this stock rises up to $12 and you move you stop up to $11. While your position is currently up $2000, if you get out on the stop you are actually only going to make $1000. You have to put your focus on the number that coincides with your exit point, not where you are at now.
If you think, “Hey, I am up $2000 on this trade!” and you start to attach your emotions to this number, you are going to be more likely to not exit if the stock falls back to $11, where you only make $1000. You had expectations for a $2000 profit, hoping it would go higher. Exiting at a lower price is painful and many people hang on, hoping for a turnaround.
Count on what you have, not what you are hoping for.
3. Write down a plan and trade it – the emotion of a trade can cause some mental breakdown in the execution of the trade because your emotion causes you to stray from your trading rules. Having a written plan to go to during confusion will help you stay on track.
The plan does not have to be long or sophisticated. I don’t think that a trading plan should be more than one page. In it, you should have your rules for entry, risk management, scaling and exit. There should also be a process of review so that you are constantly working to improve your rules and the execution of your rules.
Ideas have a greater value when you write them down, take the time to draft a trading plan before you make another trade.
Want Help Overcoming Your Emotions?
Become A Client
23
Nov
Chart Reading- Basic Concepts
Here are some simple rules of chart reading that I think anyone analyzing charts should keep in mind.
Prices That Fall in to Support Will Bounce at Support
Support and resistance are important concepts of chart analysis. Support is a floor price that has been formed by the market over time, it is a low price point where the price trend stopped going down and started to go up. Chart readers look for breaks through support as a signal that a down trend is beginning.
However, that is not always the case. If a stock’s price is falling day after day, it is likely to bounce around support but it may go through support temporarily. Therefore, don’t short breaks through support if the break comes after a number of days of downward price movement. Prices in free fall will usually bounce around support.
Prices that Consolidate Before Breaking Support Will Trend Lower
Here is how to apply the sell on a break of support rule. If prices are trending sideways with relatively low volatility at or near an area of price support and then make a downward move through support, the stock is likely going in to a downward trend. The difference here is that the downtrend is just starting with an initial break through support.
You can reverse these rules for resistance and upside breakouts as well.
Breakouts From Low Price Volatility are Reliable
What does it mean when stocks trend sideways with very little price volatility? It is more than just a boring chart, it means that buyers and sellers agree about what the stock is worth. It is a display of confidence in the value given to the stock.
Therefore, if the stock price breaks from this period of confidence, it implies that there is new information that justifies the price move. This usually comes in the early stages of a trend; as more investors learn about the new information, more people will jump in to the stock and carry it farther along its trend.
This means that identifying breaks from low price volatility is an important way to catch market beating trends early.
Prices That Run Away From the Trend Line Come Back to the Trendline
In the long term, prices tend to trend in a linear fashion. That means you can draw a straight line across the bottoms of an up trend or a straight line across the tops of a down trend.
However, along the way, prices will often move away from this straight line. This happens because investors get emotional and either chase the stock higher with greed or force the stock quickly lower with fear.
The emotion eventually comes out of the market, bringing the stock back to that linear, straight trend line.
This means that we should be aware of a short term price reversal the farther prices get from the linear trend line. A stock that runs away to the upside will eventually come down on a pull back. Prices that fall too quickly will eventually come up.
This rule works best with up trends, which tend to be more orderly and longer lasting than down trends.
All Available Information Is Shown In the Chart
Traditional investors who have heard me talk about the markets often shake their heads when they hear that I do not do any research in to what the company does before I buy a stock. They find it hard to believe that I can make money trading nothing more than the chart.
The chart of price change shows us every bit of fundamental information that is known by the market. Since most investors are acting on information to make their decisions, reading a chart is essentially reading their perceptions of the information that they have. A company that is doing well within their business will have a good looking chart because investors are pricing in the positive new information.
Falling Tops Are a Sign That Investors are Pessimistic
If investors believe that there is something wrong with a company’s ability to make money in the future, they will drive prices lower over time. This pessimism is best seen visually in a chart by looking for falling tops. The falling tops on the chart show that every time the buyers are able to push prices up, they are unable to push prices as high as they had the previous time. That is a sign that the sellers are in control of the market.
Rising Bottoms Are a Sign That Investors are Optimistic
Conversely, if the bottoms are rising on the chart, investors are optimistic and the buyers are in control. Each time the sellers are able to push prices down, they are unable to push them down as much as they had the previous time.
It is best to only buy stocks that are in the buyers’ control.
Up Trends Start Slowly
A stock that has been an under or non-performer will have investor’s doubt any time it shows some strength. Investors tend to judge a stock by what has happened in the past rather than what they expect for the future. The result is that stocks that are starting upward trends tend to do so slowly because investors doubt that the company deserves to go higher.
This means you have to be patient with up trends that are in their early stages as they will often have false starts. Doubting investors who own the stock will sell in to strength, not realizing that the company’s future is brighter than it has been.
Become a Client
Source: Stockscores.com Perspectives for the week ending May 19, 2012
14
Nov
10 Ways To Control Your Emotions On Wall Street
Emotions
Fear and greed drive investor decisions in destructive ways. People want to buy stocks that have been going up for some time because their market performance gives legitimacy to the story. A stock that is falling sharply brings out sellers eager to get out because of their fear that the stock will go lower.
You have to know the difference between a strong stock that is going higher and one that is near its top. Stocks that are falling can be sold before the fall farther, but at a certain point they get so low that they are worth considering. We have to learn to overcome our emotions so that we can buy stocks that are starting to go up and sell stocks when they start to go down.
Here are 10 things you can do to overcome your emotions and become a better investor:
1. Use Strategies that Work
Your approach to the market won’t have a hope if your analysis methods are not effective. There are many ways to analyze stocks, take one that you like and test it until you have confidence that it works.
2. Write a Trading Plan
Success has a better chance of happening when you write down a plan to get there. Make your plan include your rules for entry and exit, risk tolerances and a process for review. Adapt your plan over time as you find better ways to achieve success.
3. Manage Risk
Understand the risk in every trade you make and don’t take risks that you can not tolerate. If your exposure to loss is more than you are comfortable with you will inevitably break your discipline.
4. Limit Losses
You should always know where the exit door is in case something goes wrong. When you buy a stock, decide the point where the market will have proven your decision to enter wrong. If the stock falls to that price, get out. Don’t let small losses grow in to big losses.
5. Blame Yourself
There may be a good argument for why a loss you have suffered is someone else’s fault. The newsletter writer could have been wrong, the media could have been wrong, the government could have gone back on a promise, the company could be corrupt. Blaming others will never get your money back. You will not change the actions of others, you can only change your own. Therefore, blame yourself for everything that happens with your money and take steps to make it better.
6. Stop Falling in Love
The more you know about a company, the more likely you are to ignore the market’s message. Companies want you to own their stock; the more investors that they get to own their stock, the higher the price goes. As a result, there is a bias to the information that you are exposed to, if you listen too much you may miss activity in the market that is telling you that something is wrong.
7. Practice Patience
Up trends start slowly so you have to be patient when stocks are trying to start a long term trend. The profit is in the patience, hold on to strong stocks so long as they are showing strength. When looking at a company, avoid a short term outlook that can mislead you about the long term trend.
8. See the Other Side of the Story
Everything you know about a stock may tell you to buy it and you may do so with complete commitment. But, always ask yourself, “Why is someone willing to sell to me at this price.” If you understand their motivations for selling versus your motivations for buying, you can better determine who is right. Without an understanding of the other side of the trade you can not determine whether the other side is wrong.
9. Avoid the Herd
The crowd usually loses. When buying, look around at your fellow buyers. Are they well informed, smart investors or are they generally uninformed people watching 60 Minutes? Always try to be one step ahead of the herd.
10. Analyze Your Results
The market is always evolving, making constant evolution in your approach to the markets important. On a regular basis, analyze your trades and looks for patterns of self destruction. Make changes as necessary.
Source: Stockscores.com Perspectives for the week ending May 4, 2012
Become A Client
22
Jul
Long Term Look At The U.S. Stock Market: 1900-2012 (Summer)
Long Sideways Patterns Are Normal For The Stock Market:
This is one of my favorite charts because it clearly shows that we are in the middle of a long (12 yr) sideways pattern in the US stock market. These long sideways periods are “normal,” have happened before, and will happen again.
1900-2012
…And So Are Explosive Rallies!
The “good” news is that every long sideways pattern is followed by a monstrous rally! Another interesting observation is that the general public tends to lose interest in the market right before the explosive gains begin (Sound Familiar?). Stay tuned!
Our Services
28
Jun
7 Ways to Take Emotion Out of Trading
Emotions- We All Have’em!
I think that many traders have a hard time believing that they can make money by buying a stock and waiting. Most of us are not taught to make our money work for us but instead that we must work for our money. Go to a job, put in the time and you get a pay check. Work hard, your pay checks will grow. But the thought that you can make money by putting your feet up is a difficult thing for most to grasp.
With that mental programming, most of us have difficulty holding on to our strong stocks and letting the profits grow. If we buy a stock at $1 and it goes up to $1.20 in a couple of days we are likely to sell. In some ways we think of this fast return as good luck, not much different than buying a winning lottery ticket. We have a fear that someone is going to figure out that we have benefited from a mistake and so we better get out now before we get discovered.
This thinking is strengthened when we own a marginal stock and it goes down as quickly as it went up. If we take a marginal trade we should expect marginal results but somehow we only remember the negative feeling of watching a paper profit turn in to a loss. We tell ourselves that next time we will sell at the first sign of weakness and crystallize the gain. Avoiding pain is human nature.
Our next trade is of higher quality but we sell it on a short term weakness and lock in a quick but relatively small profit. While lost in self congratulations we realize that someone named Murphy is writing the laws of trading and we watch the stock march ever higher with us eating the stock’s dust. We have jumped off of a high speed bus that is headed for Profit City.
So what is behind this destructive behavior? It is that deep routed emotional response to danger that keeps us out of trouble but also makes us avoid a greater feeling of fulfillment.
Fear is what makes us sell our winners too early and hold our losers too long.
The best traders are not afraid of holding on to strong stocks, they are afraid of holding on to losing stocks. What do you do?
If you are a normal human being, you do the opposite. Think about the last loser that you owned. As the stock fell lower and lower, what was it that you told yourself over and over?
“It will bounce back eventually, I will just be patient.”
What your subconscious mind was really saying was, “It is much too painful to sell this loser and see that loss of my hard earned capital. I will hold on with the hope that it goes back to what I paid for it and then I will sell.” And of course, it continued lower because there was something wrong with the company and it deserved to go lower.
So what can be done to fight our destructive minds? How can we program ourselves to hold on to our winners and dump the losers? How can we trade without fear?
Here are my Seven Criteria for Fearless Trading:
Trade Quality
Our fears are confirmed when we enter marginal trades. If you only trade the best opportunities you will trade less but you will have greater success. This will put you on the road to fearless trading and help you to simplify the trading approach. Write down your rules and do nothing if every rule is not satisfied. When you consider a stock, look for a reason to avoid the trade. If you can’t find one then you have a trade worth taking.
Buy With Confidence
The rules that you trade with have to have a foundation of success. You have to believe in your rules or you won’t believe in holding the stock through the shakeout periods in the longer term up trend. Analyze and test the strategy until you have proven to yourself that it works. Then trade it slowly without a lot of risk so you can gain a greater level of confidence that it works.
Don’t Watch the Scoreboard
Sports fans don’t spend a lot of time watching the scoreboard during a game, it only matters when the game is over. In trading, the scoreboard is the profit and loss figure for your account. If you focus on the scoreboard it is likely that you will lose sight of what is happening in the game. As a technical trader, all that matters to me is what the chart is telling me.
Plan Your Losses
Before you enter a trade, figure out what needs to happen for you to consider the trade a loser. For me, that is a move through chart support; I plan to exit the trade when the stock goes through a psychological floor price on the chart. Understanding where that point requires some experience and knowledge but once you know how to identify support on the chart, plan your losses.
Plan the Trade
I find it helpful to predict pull backs. My rational side knows that stocks can not go straight up and that they must suffer pullbacks to recharge buyer interest and shake out weak holders. My emotional side feels fear when those pull backs happen. If I plan my trade and build in expectations for the counter trend pull backs I can deal with them better and have a greater chance of not succumbing to the fear when they do.
Don’t Fall in Love
I don’t want to know too much about what a company is doing because I have found that the more I like a stock the more likely I am to not listen to the message of the market. There is a lot of bias in the information that we receive about companies and what they are doing. The ultimate arbiter of truth is the market itself; we should have a greater faith in the opinions of thousands of market participants than a few biased sources of information.
Tolerate Risk
Without risk, there is no potential for return. To avoid trading with fear we have to be comfortable with the risk. If not, we will let fear guide our decisions and those decisions will probably be wrong. Therefore, do not take more risk on a trade than you are comfortable losing. Plan your losses based on how much you are willing to lose and let that determine the size of your positions.
The Profit is in the Patience
When a trade is working, let it work for you. A business owner does not fire her best employee. A hockey coach does not send his best player to the minor leagues. A company does not stop making their best products. Hang on to your best stocks with the same attitude. Hold the stock until there is a rational reason to exit the trade rather than selling because it feels good. If you are taking quality trades and trading without fear, you will feel better over the long run.
The time to get started on your reprogramming is now. Don’t expect to break habits built up over a life time in a couple of days. The battle against your fears is one that takes time win but with determination you can do it.
Source: Stockscores.com Perspectives for the week ending June 22, 2012
Click Here To Join Our FREE Newsletter
& Get A Professional Watchlist Sent To Your Inbox Each Week, Our Latest Blog Posts, Week-in-Review & Much More!
09
Jun
10 Ways To "Think" Like A Successful Investor
Think Less
Think Less
Source: Stockscores.com Perspectives for the week ending May 26, 2012
You cannot expect to do well in the market if you look at investing in a normal way. By definition, being average is doing what most other people do and since investing is largely a psychological game, doing what other people do is only natural. Average results come from normal people acting in normal ways.
To beat the market, you have to be different.
Not necessarily in a straight jacket bouncing off padded walls different, just a little off.
Here are 10 things that may help you be a better investor, some ways to think differently from the crowd in that pursuit to achieve market dominance.
1. Do not think about making money, think about losing money – the first step toward success is accepting that losing is part of trading. You will not be right all of the time, you cannot always trade your way out of a bad situation. There will be times when you simply have to walk away with a loss. The key is to keeping the losses small and manageable. When the market proves you wrong, take the loss.
2. Do not think you can average down to win – it is a logical idea, add more to a losing position with the expectation that the market must eventually go your way. Many times this strategy will work but, when it does not work, the loss may be insurmountable. The market does not eventually have to go your way.
3. Do not think that your success is entitled – you may make a great trade, pick a really great stock and have a feeling like you really have the market figured out. Forget your gloating, no one ever has the market figured out. We must always remember that we have to work as smart for the next trade as we did for the last.
4. Do not think that talent is required – making money in any trading endeavor is a small part technical skill and a big part emotional management. Learn to limit losses, let winners run and be selective with what you trade. Emotional mastery is more important than stock picking skill.
5. Do not think that you can tell the market what to do – the market does not care about you, it does not know that you want to make a profit. You are the slave, the market is your master. Be obedient and do what the market tells you to.
6. Do not think you are competing against other traders – trading success comes to those who overcome themselves, it is you and your persistent desire to break trading rules that is the ultimate adversary. What others are doing is of little consequence, only you can react to the market and achieve your success.
7. Do not think that Fear and Greed can ever be positive – in life, fear can keep us from harm, greed can give us the motivation to work hard. In the market, these two emotional forces will lead to losses. If your decisions are governed by either or both you will most certainly find that your money escapes you.
8. Do not think you will remember everything you learn – every trade provides a lesson, some valuable education on what to do and what not to do. However, it is likely that your lessons will contradict one another and lead you to forget many of them. Write down the knowledge that you accumulate, return to this trading journal so that you can retain some value from the lessons taught by the market. Remember, the market is cruel, it gives the test first and the lesson after.
9. Do not think that being right will lead to profits – you may be exactly right about what the fundamentals are and what they are worth. However, timing is everything, if your expectations for the future are ill timed, you may find yourself losing more than you can tolerate. Remember, the market can be wrong longer than you can be liquid.
10. Do not think you can overcome the laws of probability – traders tend to be gamblers when they face a loss and risk averse when the have a potential for gain. They would rather lock in a sure profit and gamble against a probable loss even if the expected value of doing so is irrational. Trading is a probability game, each decision should be made on the basis of the best expected value and not what feels best.
26
May
Hedge Fund Market Wizards— “Five Market Wizard Lessons” Jack Schwager
HFMW
This book should be a good! My copy just arrived and I’m looking fwd to reading it over the long weekend!
1. Interview with Jack: http://hw.libsyn.com/p/
2. “Five Market Wizard Lessons” after the jump
Jack Schwager:
“Five Market Wizard Lessons”
Hedge Fund Market Wizards is ultimately a search for insights to be drawn from the most successful market practitioners. The last chapter distills the wisdom of the 15 skilled traders interviewed into 40 key market lessons. A sampling is provided below:
1. There Is No Holy Grail in Trading
Many traders mistakenly believe that there is some single solution to defining market behavior. Not only is there no single solution to the markets, but those solutions that do exist are continually changing. The range of the methods used by the traders interviewed in Hedge Fund Market Wizards, some of which are even polar opposites, is a testament to the diversity of possible approaches. There are a multitude of ways to be successful in the markets, albeit they are all hard to find and achieve.
2. Don’t Confuse the Concepts of Winning and Losing Trades with Good and Bad Trades
A good trade can lose money, and a bad trade can make money. Even the best trading processes will lose a certain percentage of the time. There is no way of knowing a priori which individual trade will make money. As long as a trade adhered to a process with a positive edge, it is a good trade, regardless of whether it wins or loses because if similar trades are repeated multiple times, they will come out ahead. Conversely, a trade that is taken as a gamble is a bad trade regardless of whether it wins or loses because over time such trades will lose money.
3. The Road to Success Is Paved with Mistakes
Ray Dalio, the founder of Bridgewater, the world’s largest hedge fund, strongly believes that learning from mistakes is essential to improvement and ultimate success. Each mistake, if recognized and acted upon, provides an opportunity for improving a trading approach. Most traders would benefit by writing down each mistake, the implied lesson, and the intended change in the trading process. Such a trading log can be periodically reviewed for reinforcement. Trading mistakes cannot be avoided, but repeating the same mistakes can be, and doing so is often the difference between success and failure.
4. The Importance of Doing Nothing
For some traders, the discipline and patience to do nothing when the environment is unfavorable or opportunities are lacking is a crucial element in their success. For example, despite making minimal use of short positions, Kevin Daly, the manager of the Five Corners fund, achieved cumulative gross returns in excess of 800% during a 12-year period when the broad equity markets were essentially flat. In part, he accomplished this feat by having the discipline to remain largely in cash during negative environments, which allowed him to sidestep large drawdowns during two major bear markets. The lesson is that if conditions are not right, or the return/risk is not sufficiently favorable, don’t do anything. Beware of taking dubious trades out of impatience.
5. Volatility and Risk Are Not Synonymous
Low volatility does not imply low risk and high volatility does not imply high risk. Investments subject to sporadic large risks may exhibit low volatility if a risk event is not present in the existing track record. For example, the strategy of selling out-of-the-money options can exhibit low volatility if there are no large, abrupt price moves, but is at risk of asymptotically increasing losses in the event of a sudden, steep selloff. On the other hand, traders such as Jamie Mai, the portfolio manager for Cornwall Capital, will exhibit high volatility because of occasional very large gains-not a factor that most investors would associate with risk or even consider undesirable-but will have strictly curtailed risk because of the asymmetric structure of their trades. So some strategies, such as option selling, can have both low volatility and large, open-ended risk, and some strategies, such as Mai’s, can have both high volatility and constrained risk.
As a related point, investors often make the mistake of equating manager performance in a given year with manager skill. Sometimes, more skilled managers will underperform because they refuse to participate in market bubbles. The best performers during such periods are often the most imprudent rather than the most skilled managers. Martin Taylor, the portfolio manager of the Nevsky Fund, underperformed in 1999 because he thought it was ridiculous to buy tech stocks at their inflated price levels. This same investment decision, however, was instrumental to his large outperformance in subsequent years when these stocks witnessed a prolonged, massive decline. In this sense, past performance can sometimes even be an inverse indicator.
Source: The Big Picture