51. Hope Is a Four-Letter Words Cook advises that if you ever find yourself saying, “I hope this position come back,” get out or reduce your size.
52. The Argument Against Diversification Diversification is often extolled as a virtue because it is an instrumental tool in reducing risk. This argument is valid insofar as it is generally unwise to risk all your assets on one or two equities, as opposed to spreading the investment across a broader number of diversified stocks. Beyond a certain minimum level, however, diversification may sometimes have negative consequences.
53. Caution Against Data Mining If enough data is tested, patterns will arise simply by chance – even in random data. Data mining – letting the computer cycle through data, testing thousands or millions of input combinations in search of profitable patterns – will tend to generate trading models (systems) that look great but have no predictive power. Such hindsight analysis can entice the researcher to trade a worthless system.
54. Synergy and Marginal Indicators Shaw mentioned that although the individual market inefficiencies his form has identified cannot be traded profitably on their own, they can be combined to identify profit opportunities. The general implication is that it is possible for technical or fundamental indicators that are marginal on their own to provide the basis for a much more reliable indicator when combined.
55. Past Superior Performance Is Only Relevant If the Same Conditions Are Expected to Prevail It is important to understand why an investment (stock or fund) outperformed in the past. For example, in the late 1990s a number of the better performing funds owed their superior results to a strategy of buying the most highly capitalized stocks. As a result, the high-cap stocks were bid up to extremely high price / earnings ratios relative to the rest of the market. A new investor expecting these funds to continue to outperform in the future would, in effect, be making an investment bet that was dependent on high-cap stocks becoming even more overpriced relative to the rest of the market.
56. Popularity Can Destroy a Sound Approach A classic example of this principle was provided by the 1980s experience with portfolio insurance (the systematic sale of stock index futures as the value of a stock portfolio declines in order to reduce risk exposure). In the early years of implementation, portfolio insurance provided a reasonable strategy for investors to limit losses in the events of market declines. As the strategy became more popular, however, it set the stage for its own destruction. By the time of the October 1987 crash, portfolio insurance was in wide usage, which contributed to the domino effect of price declines triggering portfolio insurance selling, which pushed prices still lower, causing more portfolio selling, and so on. It can even be argued that the mere knowledge if the existence of large portfolio insurance sell orders below the market was one of the reasons for the enormous magnitude of the October 19, 1987 decline.
57. Like a Coin, the Market Has Two Sides – but the Coin Is Unfair Just as you can bet heads or tails on a coin, you can go long or short a stock. Unlike a normal coin, however, the odds for each side are not equal.
58. The Why of Short-Selling With all the disadvantages of short selling, it would appear reasonable to conclude that it is foolhardy to ever go short. Reasonable, but wrong. The key to understanding the raison d'etre for short selling is to view these trades within the context of the total portfolio rather than as standalone transactions. With all their inherent disadvantages, short positions have one powerful attribute: they are inversely correlated to the rest of the portfolio (they will tend to make money when long holdings are losing and vice versa). This property makes short selling one of the most useful tools for reducing risk.
59. The One Indispensable Rule for Short Selling Although short selling will tend to reduce portfolio risk, any individual short position is subject to losses far beyond the original capital commitment. Because of the theoretically unlimited risk in short positions, the one essential rule for short selling is: Define a specific plan for limiting losses and rigorously adhere to it.
60. Identifying Short-Selling Candidates (or Stocks to Avoid for Long-Only Traders)
Galante, whose total focus is on short selling, looks for the following red flags in finding potential shorts:
- High receivables (large outstanding billings for goods and services)
- Change in accountants
- High turnover in chief financial officers
- A company blaming short sellers for their stock's decline
- A company completely changing their core business to take advantage of a prevailing hot trend.
- The stocks flagged must meet three additional conditions to qualify for an actual short sale:
> Very high P/E ratio
> A catalyst that will make the stock vulnerable over the near term
> An uptrend that has stalled or reversed
61. Use Options to Express Specific Price Expectations
Prevailing option prices will reflect the assumption that price movements are random. If you have specific expectations about the relative probabilities of a stock's future price movements, then it will frequently be possible to define option trades that offer a higher profit potential (at an equivalent risk level) than buying the stock.
62. Sell Out-of-the-Money Puts in Stocks You Want to Buy
This is a technique used by Okumus that could be very useful to many investors but is probably utilized by very few. The idea is for an investor to sell puts at a strike price at which he would want to buy the stock anyway. This strategy will assure making some profit if the stock fails to decline to the intended buying point and will reduce the cost for the stock by the option premium received if it does reach the intended purchase price.
63. Wall Street Research Reports Will Tend to Be Biased
A number of traders mentioned the tendency for Wall Street research reports to be biased. Watson suggests the bias is a result of investment banking relationships—analysts will typically feel implicit pressure to issue buy ratings on companies that are clients of the firm, even if they don't particularly like the stock. Lauer, who was himself an analyst for many years, pointed out the pressure on analysts to issue recommendations that are easily saleable (popular, ultra liquid stocks), not necessarily those with the best return/risk prospects.
64. The Universality of Success
This chapter was intended to summarize the elements of successful trading and investing. I believe, however, that the same traits that lead to success in trading are also instrumental to success in any field. Virtually all the items listed, with the exception of those that are exclusively market specific, would be pertinent as a blueprint for success in any endeavor.
May 31, 2010
Stock Market Wizard Lessons (Items 31-50)
31. The Need for Self-Awareness
Each trader must be aware of personal weakness that may impede trading success and make the appropriate adjustments. Awareness alone is not enough; a trader must also be willing to make the necessary changes.
32. Don’t Get emotionally Involved
Ironically, although many people are drawn to the markets for excitement, the Market Wizards frequently cite keeping emotion out of trading as essential advice to investors. If you let your emotions get involved, you will make bad decisions.
33. View Personal Problems as a Major Cautionary flag to Your Trading
Health problems or emotional stress can sometimes decimate a trader’s performance. The morale is: Be extremely vigilant to signs of deteriorating trading performance if you are experiencing health problems or other personal difficulties. During such times, it is probably a good idea to cut trading size and to be prepared to stop trading altogether at the first sign of trouble.
34. Analyze Your Past Trades for Possible Insights
Analyzing your past trades might reveal patterns that could be used to improve future performance.
35. Don’t Worry About Looking Stupid
Never let your market decisions be restricted or influenced by concern over what others might think.
36. The Danger of Leverage
If you are too heavily leveraged, all it takes is one mistake to knock you out of the game.
37. The Importance of Position Size
Superior performance requires not only picking the right stock, but also having the conviction to implement major potential trades in meaningful size. The point is that all trades are not the same. Trades that are perceived to have particularly favorable potential relative to risk or a particular high probability of success should be implemented in a large size than other trades. Of course, what constitutes “large size” is relative to each individual, but the concept is as applicable to the trader whose average position is one hundred shares as it is to the fund manager whose average position size is one million shares.
38. Complexity Is Not a Necessary Ingredient for Success
Some of the patterns and indictors that Cooks use to signal trades are actually quite simple, but it is his skill in their application that accounts for his success.
39. View Trading As a Vocation, Not a Hobby
As both Cook and Minervini said, “Hobbies cost money.” Walton offered similar advice, “Either go at it full force or don’t go at it at all. Don’t dabble.”
40. Trading, Like Any Other Business Endeavor, Requires a Sound Business Plan
Cooks advices that every trader should develop a business plan that answer al the following essential questions:
- What market will be traded?
- What is the capitalization?
- How will orders be entered?
- What type of drawdown will cause trading cessation and revaluation?
- What are the profit goals?
- What procedure will be used for analyzing trades?
- How will trading procedures change if personal problems arise?
- How will the working environment be set up?
- What rewards will the trader take for successful trading?
- What will the trader do to continue to improve market skills?
41. Define High-Probability Trades
Although the methodologies of the traders interviewed differ greatly, in their own style, they have all found ways of identifying high-probability trades.
42. Find Low-Risk Opportunities
Many of the traders interviewed have developed methods that focus on identifying low-risk trades. The merit of a low-risk trade is that it combines two essential elements: patience (because only a small portion of ideas will qualify) and risk control (inherent in the definition).
43. Be sure You Have a Good Reason for Any Trade You Make
As Cohen explains, buying a stock because it is “too low” or selling it because it is “too high” is not a good reason. Watson paraphrases Peter Lynch’s principal that if you can’t summarize the reasons why you own a stock in four sentences, you probably shouldn’t own it.
44. Use Common Sense in Investing
Taking a cue from his role model, Peter Lynch, Watson is a strong proponent of commonsense research. As he illustrated through numerous examples, frequently, the most important research one can often do is simply trying a company’s product or visiting its mall outlets in the case of retailers.
45. Buy Stocks That Are Difficult to Buy
Minervini says, “Stocks that are ready to blast off are usually very difficult to buy without pushing the market higher.” He says that one of the mistakes “less skilled traders” make is “wait[ling] to buy these stocks on a pullback, which never comes.”
46. Don’t Let a Prior Lower-Priced Liquidation Keep You From Purchasing a Stock That You Would Have Bought Otherwise
Walton considers his willingness to buy back good stocks, even when they are trading higher than where he got out, as one of the changes that helped him succeed as a trader. Minervini stresses the need for having a plan to get back into a trade if you’re stopped out. “Otherwise,” he says, “you’ll often find yourself … watching the position go up 50 percent or 100 percent while you’re on the sidelines.”
47. Holding on to a Losing Stock Can Be a Mistake, Even If It Bounces Back, If the money Could Have Been Utilized More Effectively Elsewhere
When a stock is down a lot from where it was purchased, it is very easy for the investor to rationalize, “How can I get out now? I can’t lose much more anyway.” Even if this is true, this type of thinking can keep money tied up in stock that are going nowhere, causing the trader to miss other opportunities. Talking about why he dumped some stock after their prices had already declined as much as 70% from where he got in, Walton said: “By cleaning out my money than I would have if I had kept [these] stocks and waited for a dead cat bounce.”
48. You Don’t Have to Make All-or-Nothing Trading Decisions
As an illustration of this advice offered by Minervini, if you can’t decide whether to take profits on a position, there’s nothing wrong with taking profits on part of it.
49. Pay Attention to How a Stock Responds to News
Walton looks for Stocks that move higher on good news but don’t give much ground on negative news. If a stock responds poorly to negative news, then in Walton’s words “[it] hasn’t been blessed [by the market].”
50. Insider Buying Is an Important Confirming Condition
The willingness of management or the company to buy its own stock may not be a sufficient condition to buy a stock, but it does provide strong confirmation that the stock is a good investment. A number of traders cited buying as a critical element in their selection process.
Each trader must be aware of personal weakness that may impede trading success and make the appropriate adjustments. Awareness alone is not enough; a trader must also be willing to make the necessary changes.
32. Don’t Get emotionally Involved
Ironically, although many people are drawn to the markets for excitement, the Market Wizards frequently cite keeping emotion out of trading as essential advice to investors. If you let your emotions get involved, you will make bad decisions.
33. View Personal Problems as a Major Cautionary flag to Your Trading
Health problems or emotional stress can sometimes decimate a trader’s performance. The morale is: Be extremely vigilant to signs of deteriorating trading performance if you are experiencing health problems or other personal difficulties. During such times, it is probably a good idea to cut trading size and to be prepared to stop trading altogether at the first sign of trouble.
34. Analyze Your Past Trades for Possible Insights
Analyzing your past trades might reveal patterns that could be used to improve future performance.
35. Don’t Worry About Looking Stupid
Never let your market decisions be restricted or influenced by concern over what others might think.
36. The Danger of Leverage
If you are too heavily leveraged, all it takes is one mistake to knock you out of the game.
37. The Importance of Position Size
Superior performance requires not only picking the right stock, but also having the conviction to implement major potential trades in meaningful size. The point is that all trades are not the same. Trades that are perceived to have particularly favorable potential relative to risk or a particular high probability of success should be implemented in a large size than other trades. Of course, what constitutes “large size” is relative to each individual, but the concept is as applicable to the trader whose average position is one hundred shares as it is to the fund manager whose average position size is one million shares.
38. Complexity Is Not a Necessary Ingredient for Success
Some of the patterns and indictors that Cooks use to signal trades are actually quite simple, but it is his skill in their application that accounts for his success.
39. View Trading As a Vocation, Not a Hobby
As both Cook and Minervini said, “Hobbies cost money.” Walton offered similar advice, “Either go at it full force or don’t go at it at all. Don’t dabble.”
40. Trading, Like Any Other Business Endeavor, Requires a Sound Business Plan
Cooks advices that every trader should develop a business plan that answer al the following essential questions:
- What market will be traded?
- What is the capitalization?
- How will orders be entered?
- What type of drawdown will cause trading cessation and revaluation?
- What are the profit goals?
- What procedure will be used for analyzing trades?
- How will trading procedures change if personal problems arise?
- How will the working environment be set up?
- What rewards will the trader take for successful trading?
- What will the trader do to continue to improve market skills?
41. Define High-Probability Trades
Although the methodologies of the traders interviewed differ greatly, in their own style, they have all found ways of identifying high-probability trades.
42. Find Low-Risk Opportunities
Many of the traders interviewed have developed methods that focus on identifying low-risk trades. The merit of a low-risk trade is that it combines two essential elements: patience (because only a small portion of ideas will qualify) and risk control (inherent in the definition).
43. Be sure You Have a Good Reason for Any Trade You Make
As Cohen explains, buying a stock because it is “too low” or selling it because it is “too high” is not a good reason. Watson paraphrases Peter Lynch’s principal that if you can’t summarize the reasons why you own a stock in four sentences, you probably shouldn’t own it.
44. Use Common Sense in Investing
Taking a cue from his role model, Peter Lynch, Watson is a strong proponent of commonsense research. As he illustrated through numerous examples, frequently, the most important research one can often do is simply trying a company’s product or visiting its mall outlets in the case of retailers.
45. Buy Stocks That Are Difficult to Buy
Minervini says, “Stocks that are ready to blast off are usually very difficult to buy without pushing the market higher.” He says that one of the mistakes “less skilled traders” make is “wait[ling] to buy these stocks on a pullback, which never comes.”
46. Don’t Let a Prior Lower-Priced Liquidation Keep You From Purchasing a Stock That You Would Have Bought Otherwise
Walton considers his willingness to buy back good stocks, even when they are trading higher than where he got out, as one of the changes that helped him succeed as a trader. Minervini stresses the need for having a plan to get back into a trade if you’re stopped out. “Otherwise,” he says, “you’ll often find yourself … watching the position go up 50 percent or 100 percent while you’re on the sidelines.”
47. Holding on to a Losing Stock Can Be a Mistake, Even If It Bounces Back, If the money Could Have Been Utilized More Effectively Elsewhere
When a stock is down a lot from where it was purchased, it is very easy for the investor to rationalize, “How can I get out now? I can’t lose much more anyway.” Even if this is true, this type of thinking can keep money tied up in stock that are going nowhere, causing the trader to miss other opportunities. Talking about why he dumped some stock after their prices had already declined as much as 70% from where he got in, Walton said: “By cleaning out my money than I would have if I had kept [these] stocks and waited for a dead cat bounce.”
48. You Don’t Have to Make All-or-Nothing Trading Decisions
As an illustration of this advice offered by Minervini, if you can’t decide whether to take profits on a position, there’s nothing wrong with taking profits on part of it.
49. Pay Attention to How a Stock Responds to News
Walton looks for Stocks that move higher on good news but don’t give much ground on negative news. If a stock responds poorly to negative news, then in Walton’s words “[it] hasn’t been blessed [by the market].”
50. Insider Buying Is an Important Confirming Condition
The willingness of management or the company to buy its own stock may not be a sufficient condition to buy a stock, but it does provide strong confirmation that the stock is a good investment. A number of traders cited buying as a critical element in their selection process.
May 29, 2010
Stock Market Wizard Lessons (Items 16-30)
16. You Can’t Be Afraid of Risk
Risk control should not be confused with fear of risk. A willingness to accept risk is probably an essential personality trait for a trader.
17. Limiting the Downside by Focusing on Undervalued Stocks
A number of the traders interviewed restrict their stock selection to the universe of undervalued securities. One reason all these traders focus on buying stocks that meet their definition of value is that by doing so they limit the downside. Another advantage of buying stocks that are trading at depressed levels is that the stocks in this group that do turn around will often have tremendous upside potential.
18. Value Alone Is Not Enough
It should be stressed that although a number of traders considered undervaluation a necessary condition for purchasing a stock, none of them viewed it as a sufficient condition. There always had to be other compelling reasons for the trade, because a stock could be low priced and stay that way for years. Even if you don’t lose much in buying a value stock that just sits there, it could represent a serious investment blunder by tying up capital that can be used much more effectively elsewhere.
19. The important of Catalysts
A stock can represent great value and still stagnate for years, tying up valuable capital. Therefore, an essential question that needs to be asked is: What is going to make the stock go up? For example, Masters has developed an entire trading model based on primarily on catalysts. Through years of research and observation, he has been able to find scores of patterns in how stocks respond to catalysts. Although most of these patterns may provide only a small edge by themselves, when grouped together, they help identify high-probability trades.
20. Most Novice Traders Focus on When to Get in and Forget About When to Get Out
When to get out of a position is as important as when to get in. Any market strategy that ignores trade liquidation is by definition incomplete. A liquidation strategy can include one or more of the following elements:
Stop loss points – Detailed in item 15
Profit objective – A number of traders interviewed will liquidate a stock (or index) if the market reaches their predetermined profit target.
Time stop – A stock (or index) is liquidated if it fails to reach a target within a specified time frame.
Violation of trade premise – A trade is immediately liquidated if the reason for its implementation is contradicted. For example, when IBM, which Cohen shorted in anticipation of poor earnings, reported better-than-expected earnings, Cohen immediately covered his position. Although he still took a large loss on the trade, the loss would have been significantly greater if he had hesitated.
Counter-to-anticipation market behavior – See item 21
Portfolio considerations – See item 22
Some of these elements may make sense for all traders; others are very dependent on a trader’s style.
21. If Market Behavior Doesn’t Conform to Expectations, Get Out
A number of traders mention that if the market fails to respond to an event (Eg: earning report) as expected, the will view it as evidence that they are wrong and liquidate their position.
22. The Question of When to Liquidate Depends Not Only on the Stock but Also on Whether a Better Investment Can Be Identified
Investable funds are finite. Continuing to hold one stock position precludes using those funds to purchase another stock. Therefore, it may often make sense to liquidate an investment that still looks sound if an even better investment opportunity exits.
23. The Virtue of Patience
Whatever criteria you use to select a stock and determine an entry level, you need to have the patience to wait for those conditions to be met.
24. The Important of Setting Goals
Dr. Kiev. is a strong advocate of the power of setting goals. He contends that believing that an outcome is possible makes it achievable. Believing in a goal, however is not sufficient. To achieve a goal, Kiev says, you need not only to believe in it, but also to commit to it. Promising results to others, he maintains, is particularly effective.
Dr. Kiev. Stresses that exceptional performance requires setting goals that are outside a trader’s comfort zone. Thus, the trader seeking to excel needs to continually redefine goals so that they are always a stretch. Traders also need to monitor their performance to make sure they are on track toward reaching their goals and to diagnose what is holding them back if they are not.
25. This Time is Never Different
Evert time there is a market mania, the refrain is heard, “This time is different,” followed by some explanation of why the particular bull market will continue, despite already stratospheric prices.
As this book was being written, there was an explosive rally in technology stocks, particularly Internet issues. Stocks with no earnings, or even a glimmer of the prospect of earnings, were being bid up to incredible levels. Once again, there was no shortage of pundits to explain why this time was different; why earnings were no longer important (at least for these companies). Warnings about the aspects of mania in the current market were mentioned by a number of the traders interviewed. By the time this manuscript was submitted, many of the Internet stocks had already witnessed enormous percentage declines. The message, however, remains relevant because there will always be some market or sector that rekindles the cry, “This time is different.” Just remember: It never is.
26. Fundamentals Are Not Bullish or Bearish in a Vacuum; They are Bullish or Bearish Only Relative to Price
A great company could be a terrible investment if its price rise has already more than discounted the bullish fundamentals. Conversely, a company that has been experiencing problems and is the subject of negative news could be great investment if its price decline has more than discounted the bearish information. “A good company could be a bad stock and vice versa.”
27. Successful Investing and Trading Has Nothing to Do with Forecasting
Lescarbeau, for example, emphasized that he never made any predictions and scoffed at those who claimed to have such abilities. When asked why he laughed when the subject of market forecasting came up, he replied: “I’m laughing about people who do make predications about the stock market. They don’t know. Nobody knows.”
28. Never Assume a Market Fact Based on What You Read or What Others Say; Verify Everything Yourself
When Cook first inquired about the interpretation of the tick (the number of New York Exchange stocks whose last trade was an uptick, minus the number whose last trade was a downtick), he was told by an experienced broker that if the tick was very high, it was a buy signal. By doing his own research and recording his own observations, he discovered that the truth was exactly the opposite.
29. Never, Ever Listen to Other Opinions
To succeed in the markets, it is essential to make your own decisions.
30. Beware of Ego
Walton warns, “The odd thing about this industry is that no matter how successful you become, if you let your ego get involved, one bad phone call can put you out of business.”
Risk control should not be confused with fear of risk. A willingness to accept risk is probably an essential personality trait for a trader.
17. Limiting the Downside by Focusing on Undervalued Stocks
A number of the traders interviewed restrict their stock selection to the universe of undervalued securities. One reason all these traders focus on buying stocks that meet their definition of value is that by doing so they limit the downside. Another advantage of buying stocks that are trading at depressed levels is that the stocks in this group that do turn around will often have tremendous upside potential.
18. Value Alone Is Not Enough
It should be stressed that although a number of traders considered undervaluation a necessary condition for purchasing a stock, none of them viewed it as a sufficient condition. There always had to be other compelling reasons for the trade, because a stock could be low priced and stay that way for years. Even if you don’t lose much in buying a value stock that just sits there, it could represent a serious investment blunder by tying up capital that can be used much more effectively elsewhere.
19. The important of Catalysts
A stock can represent great value and still stagnate for years, tying up valuable capital. Therefore, an essential question that needs to be asked is: What is going to make the stock go up? For example, Masters has developed an entire trading model based on primarily on catalysts. Through years of research and observation, he has been able to find scores of patterns in how stocks respond to catalysts. Although most of these patterns may provide only a small edge by themselves, when grouped together, they help identify high-probability trades.
20. Most Novice Traders Focus on When to Get in and Forget About When to Get Out
When to get out of a position is as important as when to get in. Any market strategy that ignores trade liquidation is by definition incomplete. A liquidation strategy can include one or more of the following elements:
Stop loss points – Detailed in item 15
Profit objective – A number of traders interviewed will liquidate a stock (or index) if the market reaches their predetermined profit target.
Time stop – A stock (or index) is liquidated if it fails to reach a target within a specified time frame.
Violation of trade premise – A trade is immediately liquidated if the reason for its implementation is contradicted. For example, when IBM, which Cohen shorted in anticipation of poor earnings, reported better-than-expected earnings, Cohen immediately covered his position. Although he still took a large loss on the trade, the loss would have been significantly greater if he had hesitated.
Counter-to-anticipation market behavior – See item 21
Portfolio considerations – See item 22
Some of these elements may make sense for all traders; others are very dependent on a trader’s style.
21. If Market Behavior Doesn’t Conform to Expectations, Get Out
A number of traders mention that if the market fails to respond to an event (Eg: earning report) as expected, the will view it as evidence that they are wrong and liquidate their position.
22. The Question of When to Liquidate Depends Not Only on the Stock but Also on Whether a Better Investment Can Be Identified
Investable funds are finite. Continuing to hold one stock position precludes using those funds to purchase another stock. Therefore, it may often make sense to liquidate an investment that still looks sound if an even better investment opportunity exits.
23. The Virtue of Patience
Whatever criteria you use to select a stock and determine an entry level, you need to have the patience to wait for those conditions to be met.
24. The Important of Setting Goals
Dr. Kiev. is a strong advocate of the power of setting goals. He contends that believing that an outcome is possible makes it achievable. Believing in a goal, however is not sufficient. To achieve a goal, Kiev says, you need not only to believe in it, but also to commit to it. Promising results to others, he maintains, is particularly effective.
Dr. Kiev. Stresses that exceptional performance requires setting goals that are outside a trader’s comfort zone. Thus, the trader seeking to excel needs to continually redefine goals so that they are always a stretch. Traders also need to monitor their performance to make sure they are on track toward reaching their goals and to diagnose what is holding them back if they are not.
25. This Time is Never Different
Evert time there is a market mania, the refrain is heard, “This time is different,” followed by some explanation of why the particular bull market will continue, despite already stratospheric prices.
As this book was being written, there was an explosive rally in technology stocks, particularly Internet issues. Stocks with no earnings, or even a glimmer of the prospect of earnings, were being bid up to incredible levels. Once again, there was no shortage of pundits to explain why this time was different; why earnings were no longer important (at least for these companies). Warnings about the aspects of mania in the current market were mentioned by a number of the traders interviewed. By the time this manuscript was submitted, many of the Internet stocks had already witnessed enormous percentage declines. The message, however, remains relevant because there will always be some market or sector that rekindles the cry, “This time is different.” Just remember: It never is.
26. Fundamentals Are Not Bullish or Bearish in a Vacuum; They are Bullish or Bearish Only Relative to Price
A great company could be a terrible investment if its price rise has already more than discounted the bullish fundamentals. Conversely, a company that has been experiencing problems and is the subject of negative news could be great investment if its price decline has more than discounted the bearish information. “A good company could be a bad stock and vice versa.”
27. Successful Investing and Trading Has Nothing to Do with Forecasting
Lescarbeau, for example, emphasized that he never made any predictions and scoffed at those who claimed to have such abilities. When asked why he laughed when the subject of market forecasting came up, he replied: “I’m laughing about people who do make predications about the stock market. They don’t know. Nobody knows.”
28. Never Assume a Market Fact Based on What You Read or What Others Say; Verify Everything Yourself
When Cook first inquired about the interpretation of the tick (the number of New York Exchange stocks whose last trade was an uptick, minus the number whose last trade was a downtick), he was told by an experienced broker that if the tick was very high, it was a buy signal. By doing his own research and recording his own observations, he discovered that the truth was exactly the opposite.
29. Never, Ever Listen to Other Opinions
To succeed in the markets, it is essential to make your own decisions.
30. Beware of Ego
Walton warns, “The odd thing about this industry is that no matter how successful you become, if you let your ego get involved, one bad phone call can put you out of business.”
Stock Market Wizard Lessons (Items 1-15)
1. There is no Single True Path for succeeding in the markets
The methods employed by great traders are extraordinarily diverse. Some are pure fundamentalists; others use only technical analysis; and still others combine the two methodologies. Some traders consider two days to be long-term, while others considers two months to be short-term. Some are highly quantitative, while others rely primarily on qualitative market decision.
2. The Universal Trait
One trait that was shared by all the traders is discipline.
Successful trading is essentially a two-stage process:
a. Develop an effective trading strategy and an accompanying trading plan that addresses all contingencies.
b. Follow the pan without exception. No matter how sound the trading strategy, its success will depend on this execution phase, which requires absolute discipline.
3. You Have to Trade Your Personality
It is critical to trade a style that matches your personality. There is no single right way to trade the markets; you have to know who you are. Successful traders invariably gravitate to an approach that fits their personality. Trading is not a one-size-fits-all proposition; each trader must tailor an individual approach
4. Failure and Perseverance
Although some of the traders in this book were successful from the start, the early market experiences of others were marked by complete failure. Despite their horrendous beginnings, these traders ultimately went on to spectacular success. How were they able to achieve such a complete metamorphosis? Of course, part of the answer is that they had the inner strength not to be defeated by defeat. But tenacity without flexibility is no virtue. Had they continued to do what they had been doing before, they wold have experiences the same results. The key is that they completely changed what they were doing.
5. Great Traders Are Marked by Their FlexibilityEven great traders sometimes have completely wrongheaded ideas when they start. They ultimately succeed, however, because they have the flexibility to change their approach.
Market are dynamic. Approaches that work in one period may cease to work in another. Success in the markets requires the ability to adapt to changing and altered realities.
6. It requires Time to Become a Successful Trader
Experience is a minimum requirement for success in trading, just as it is in any other profession, and experience can be acquired only in real time.
7. Keep a record of Your Market Observations
Although the process of gaining experience can't be rushed, it can be made much more efficient by writing down market observations instead of depending on memory.
8. Develop a Trading Philosophy
Develop a specif trading philosophy - an integration of market concepts and trading methods - that is based on your market experience and is consistent with your personality (item 3). Developing a trading philosophy is a dynamic process - as you gather more experience and knowledge, the existing philosophy should be revised accordingly.
9. What is your Edge?
Unless you can answer this question clearly and decisively, you are not ready to trade. Every trader in this book has a specific edge.
10. The Confidence Chicken-and-Egg Question
One of the strikingly evident traits among all the Market Wizards is their high level of confidence. Any hesitation in the answer should be viewed as a cautionary flag.
11. Hard Work
The irony is that so many people are drawn to the markets because it seems like an easy way to make a lot of money, yet those who excel tend to be extraordinarily hard workers - almost to a fault.
12. Obsessiveness
There is often a fine line between hard work and obsession, a line that is frequently crossed by the Market Wizards. It may well be that a tendency toward obsessiveness in respect to the markets, and often other endeavors as well, is simply a trait associated with success.
13. The Market Wizards Tend to Be Innovators, Not Followers
14. To Be a Winner You Have to Be Willing to Take a Loss
The people who are successful in this business are the people who are willing to lose money.
15. Risk Control
a. Stop-Loss points - This approach allows them to limit the potential loss on any position to a well-defined risk level.
b. Reduce the position - "If you think you're wrong, or if the market is moving against you and you don't know why, take in half. You can always put it on again. If you do that twice, you've taken in three-quarters of your position. Then what's left is no longer a big deal."
c. Selecting low-risk positions - Some traders reply on very restrictive stock selection conditions to control risk as an alternative to stop-loss liquidation or position reduction.
d. Limiting the initial position size - "A common mistake trader make is that they take on too big of a position relative to their portfolio. Then when the stock moves against them, the pain becomes too great to handle, and they end up panicking or freezing."
"Never make a bet you can't afford to lose"
e. Diversification - The more diversified the holdings, the lower the risk. Diversification by itself, however, is not a sufficient risk-control measure, because of the significant correlation of most stocks to the broader market and hence to each other. Also, too much diversification can have significant drawbacks.
f. Short-selling - Although the common perception is that short-selling is risky, it can actually be an efficient tool for reducing portfolio risk
g. Hedge Strategies - Some traders use methodologies in which positions are hedged from the onset. For these traders, risk control is a matter of restricting leverage, since even a low-risk strategy can become a high-risk trade if the leverage is excessive.
The methods employed by great traders are extraordinarily diverse. Some are pure fundamentalists; others use only technical analysis; and still others combine the two methodologies. Some traders consider two days to be long-term, while others considers two months to be short-term. Some are highly quantitative, while others rely primarily on qualitative market decision.
2. The Universal Trait
One trait that was shared by all the traders is discipline.
Successful trading is essentially a two-stage process:
a. Develop an effective trading strategy and an accompanying trading plan that addresses all contingencies.
b. Follow the pan without exception. No matter how sound the trading strategy, its success will depend on this execution phase, which requires absolute discipline.
3. You Have to Trade Your Personality
It is critical to trade a style that matches your personality. There is no single right way to trade the markets; you have to know who you are. Successful traders invariably gravitate to an approach that fits their personality. Trading is not a one-size-fits-all proposition; each trader must tailor an individual approach
4. Failure and Perseverance
Although some of the traders in this book were successful from the start, the early market experiences of others were marked by complete failure. Despite their horrendous beginnings, these traders ultimately went on to spectacular success. How were they able to achieve such a complete metamorphosis? Of course, part of the answer is that they had the inner strength not to be defeated by defeat. But tenacity without flexibility is no virtue. Had they continued to do what they had been doing before, they wold have experiences the same results. The key is that they completely changed what they were doing.
5. Great Traders Are Marked by Their FlexibilityEven great traders sometimes have completely wrongheaded ideas when they start. They ultimately succeed, however, because they have the flexibility to change their approach.
Market are dynamic. Approaches that work in one period may cease to work in another. Success in the markets requires the ability to adapt to changing and altered realities.
6. It requires Time to Become a Successful Trader
Experience is a minimum requirement for success in trading, just as it is in any other profession, and experience can be acquired only in real time.
7. Keep a record of Your Market Observations
Although the process of gaining experience can't be rushed, it can be made much more efficient by writing down market observations instead of depending on memory.
8. Develop a Trading Philosophy
Develop a specif trading philosophy - an integration of market concepts and trading methods - that is based on your market experience and is consistent with your personality (item 3). Developing a trading philosophy is a dynamic process - as you gather more experience and knowledge, the existing philosophy should be revised accordingly.
9. What is your Edge?
Unless you can answer this question clearly and decisively, you are not ready to trade. Every trader in this book has a specific edge.
10. The Confidence Chicken-and-Egg Question
One of the strikingly evident traits among all the Market Wizards is their high level of confidence. Any hesitation in the answer should be viewed as a cautionary flag.
11. Hard Work
The irony is that so many people are drawn to the markets because it seems like an easy way to make a lot of money, yet those who excel tend to be extraordinarily hard workers - almost to a fault.
12. Obsessiveness
There is often a fine line between hard work and obsession, a line that is frequently crossed by the Market Wizards. It may well be that a tendency toward obsessiveness in respect to the markets, and often other endeavors as well, is simply a trait associated with success.
13. The Market Wizards Tend to Be Innovators, Not Followers
14. To Be a Winner You Have to Be Willing to Take a Loss
The people who are successful in this business are the people who are willing to lose money.
15. Risk Control
a. Stop-Loss points - This approach allows them to limit the potential loss on any position to a well-defined risk level.
b. Reduce the position - "If you think you're wrong, or if the market is moving against you and you don't know why, take in half. You can always put it on again. If you do that twice, you've taken in three-quarters of your position. Then what's left is no longer a big deal."
c. Selecting low-risk positions - Some traders reply on very restrictive stock selection conditions to control risk as an alternative to stop-loss liquidation or position reduction.
d. Limiting the initial position size - "A common mistake trader make is that they take on too big of a position relative to their portfolio. Then when the stock moves against them, the pain becomes too great to handle, and they end up panicking or freezing."
"Never make a bet you can't afford to lose"
e. Diversification - The more diversified the holdings, the lower the risk. Diversification by itself, however, is not a sufficient risk-control measure, because of the significant correlation of most stocks to the broader market and hence to each other. Also, too much diversification can have significant drawbacks.
f. Short-selling - Although the common perception is that short-selling is risky, it can actually be an efficient tool for reducing portfolio risk
g. Hedge Strategies - Some traders use methodologies in which positions are hedged from the onset. For these traders, risk control is a matter of restricting leverage, since even a low-risk strategy can become a high-risk trade if the leverage is excessive.
May 27, 2010
Using GMMA
TRADING RULES
The GMMA indicator develops four main trading rules, but remember, it is not a stand-alone indicator. It is most useful as a confirming entry signal, although it can assist with timing exits. The direction of the move should be confirmed with the results of other indicators and price plots. The trading rules for the GMMA are:
1 When the bands from both groups begin to narrow down and converge, prepare for price action as the agreement on valuation collapses.
2 Trade in the direction of the crossover. Go long if the crossover is on the upside and short or exit long positions with downside crossovers.
3 The long-term averages confirm the trend direction.
4 The bubbles created by the short-term group of averages show the favorable exit points. Judging the top is difficult, so look for the leading two or three averages to converge or come together. Confirm this early signal with other indicator readings.
The GMMA indicator develops four main trading rules, but remember, it is not a stand-alone indicator. It is most useful as a confirming entry signal, although it can assist with timing exits. The direction of the move should be confirmed with the results of other indicators and price plots. The trading rules for the GMMA are:
1 When the bands from both groups begin to narrow down and converge, prepare for price action as the agreement on valuation collapses.
2 Trade in the direction of the crossover. Go long if the crossover is on the upside and short or exit long positions with downside crossovers.
3 The long-term averages confirm the trend direction.
4 The bubbles created by the short-term group of averages show the favorable exit points. Judging the top is difficult, so look for the leading two or three averages to converge or come together. Confirm this early signal with other indicator readings.
May 10, 2010
Most of the actions required to trade successfully are counter-intuitive
Extracted from the book: Trading in a Nutshell, Stuart McPhee
Like so many things in life, the path to success or the steps we need to take to achieve success are not obvious to us. So, if we don't take the time to learn the basic fundamentals of trading, we will most likely drift down the path of so many traders, which will result in frustration, emotional stress and almost certainly lost money.
The other thing to realise and appreciate is that so many decisions and actions that are required of us are counter-intuitive.
- As we are trading to make money, it is intuitive to think about and focus on making money. It is counter-intuitive to focus on protecting the money that we have.
- If we open a trade and it moves into a losing position, it is intuitive to hold on to that trade in the hope that it will soon return to break-even and we can close the trade with minimal loss. It is counter-intuitive to close that losing trade at a loss as it denies ourselves the opportunity of at least breaking even and getting our money back.
- If we open a trade and it moves into a profitable position, it is intuitive to close that trade to realise the profit and keep the money or, at the very least, move our stop close to the price. It is counter-intuitive to hold off from closing the trade, providing it the opportunity to continue moving higher.
- If we experience a losing streak of several losing trades in a row resulting in a decrease in our trading capital, it is intuitive to commit more money into the next few trades in order to win our money back sooner. It is counter-intuitive to scale back the size of your trades in order to manage your risks and protect your capital.
- Finally, when you first start trading, it is intuitive to think that your decision to enter a trade, being the first decision you make, is the most important and will ultimately affect whether your trade is a winner or loser. It is counter-intuitive to think that other things like the size of your trade and where your exit is are more important.
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