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.”

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