Position Size Can Be
More Important Than the Entry Price
Too many traders focus only on the entry price and pay insufficient attention to the size of the position. Trading too large can result in good trades being liquidated at a loss because of fear.
On the other hand, trading larger than normal when the profit potential appears to be much greater than the risk is one of the key ways in which many of the Market Wizards achieve superior returns. Trading smaller, or not at all, for lower probability trades and larger for higher probability trades can even transform a losing strategy into a winning one.
For example, Edward Thorp, who started out devising strategies to win at casino games before achieving an extraordinary return/risk record as a hedge fund manager, discovered that by varying the bet size based on perceived probabilities, he could transform the negative edge in Blackjack into a positive edge. An analogous principal would apply to a trading strategy in which it was possible to identify higher and lower probability trades.
On the other hand, trading larger than normal when the profit potential appears to be much greater than the risk is one of the key ways in which many of the Market Wizards achieve superior returns. Trading smaller, or not at all, for lower probability trades and larger for higher probability trades can even transform a losing strategy into a winning one.
For example, Edward Thorp, who started out devising strategies to win at casino games before achieving an extraordinary return/risk record as a hedge fund manager, discovered that by varying the bet size based on perceived probabilities, he could transform the negative edge in Blackjack into a positive edge. An analogous principal would apply to a trading strategy in which it was possible to identify higher and lower probability trades.
These 16 Rules Will Make You A Better Trader
1. Never, Ever, Ever, Under Any Circumstance, Add to a Losing Position… not ever, not never! Adding to losing positions is trading’s carcinogen; it is trading’s driving while intoxicated. It will lead to ruin. Count on it!
2. Trade Like a Wizened Mercenary Soldier: We must fight on the winning side, not on the side we may believe to be correct economically.
3. Mental Capital Trumps Real Capital: Capital comes in two types, mental and real, and the former is far more valuable than the latter. Holding losing positions costs measurable real capital, but it costs immeasurable mental capital.
4. This is Not a Business of Buying Low and Selling High: It is, however, a business of buying high and selling higher. Strength tends to beget strength, and weakness, weakness.
5. In Bull Markets One Can Only Be Long or Neutral, and in bear markets, one can only be short or neutral. This may seem self-evident; few understand it, however, and fewer still embrace it.
6. “Markets Can Remain lllogical Far Longer Than You or I Can Remain Solvent.” These are Keynes’ words, and illogic does often reign, despite what the academics would have us believe.
7. Buy Markets That Show the Greatest Strength; Sell Markets That Show the Greatest Weakness: Metaphorically, when bearish we need to throw rocks into the wettest paper sacks, for they break the most easily. When bullish we need to sail the strongest winds, for they carry the farthest.
8. Think Like a Fundamentalist; Trade Like a Simple Technician: The fundamentals may drive a market and we need to understand them, but if the chart is not bullish, why be bullish? Be bullish when the technicals and fundamentals, as you understand them, run in tandem.
9. Trading Runs in Cycles, Some Good, Most Bad: Trade large and aggressively when trading well; trade small and ever smaller when trading poorly. In “good times,” even errors turn to profits; in “bad times,” the most well-researched trade will go awry. This is the nature of trading; accept it and move on.
10. Keep Your Technical Systems Simple: Complicated systems breed confusion; simplicity breeds elegance. The great traders we’ve known have the simplest methods of trading. There is a correlation here!
11. In Trading / Investing, An Understanding of Mass Psychology is Often More Important Than an Understanding of Economics: Simply put, “When they are cryin’, you should be buyin’!” And “when they are yellin’, you should be sellin’!”
12. Bear Market Corrections Are More Violent and Far Swifter Than Bull Market Corrections: Why they are is still a mystery to us, but they are; we accept it as fact and we move on.
13. There is Never Just One Cockroach: The lesson of bad news on most stocks is that more shall follow… usually hard upon and always with detrimental affect upon price, until such time as panic prevails and the weakest hands finally exit their positions.
14. Be Patient with Winning Trades; Be Enormously Impatient with Losing Trades. The older we get, the more small losses we take each year… and our profits grow accordingly.
15. Do More of That Which is Working and Less of That Which is Not: This works in life as well as trading. Do the things that have been proven of merit. Add to winning trades; cut back or eliminate losing ones. If there is a “secret” to trading (and of life), this is it.
16. All Rules Are Meant to be Broken… But only very, very infrequently. Genius comes in knowing how truly infrequently one can do so and still prosper.
2. Trade Like a Wizened Mercenary Soldier: We must fight on the winning side, not on the side we may believe to be correct economically.
3. Mental Capital Trumps Real Capital: Capital comes in two types, mental and real, and the former is far more valuable than the latter. Holding losing positions costs measurable real capital, but it costs immeasurable mental capital.
4. This is Not a Business of Buying Low and Selling High: It is, however, a business of buying high and selling higher. Strength tends to beget strength, and weakness, weakness.
5. In Bull Markets One Can Only Be Long or Neutral, and in bear markets, one can only be short or neutral. This may seem self-evident; few understand it, however, and fewer still embrace it.
6. “Markets Can Remain lllogical Far Longer Than You or I Can Remain Solvent.” These are Keynes’ words, and illogic does often reign, despite what the academics would have us believe.
7. Buy Markets That Show the Greatest Strength; Sell Markets That Show the Greatest Weakness: Metaphorically, when bearish we need to throw rocks into the wettest paper sacks, for they break the most easily. When bullish we need to sail the strongest winds, for they carry the farthest.
8. Think Like a Fundamentalist; Trade Like a Simple Technician: The fundamentals may drive a market and we need to understand them, but if the chart is not bullish, why be bullish? Be bullish when the technicals and fundamentals, as you understand them, run in tandem.
9. Trading Runs in Cycles, Some Good, Most Bad: Trade large and aggressively when trading well; trade small and ever smaller when trading poorly. In “good times,” even errors turn to profits; in “bad times,” the most well-researched trade will go awry. This is the nature of trading; accept it and move on.
10. Keep Your Technical Systems Simple: Complicated systems breed confusion; simplicity breeds elegance. The great traders we’ve known have the simplest methods of trading. There is a correlation here!
11. In Trading / Investing, An Understanding of Mass Psychology is Often More Important Than an Understanding of Economics: Simply put, “When they are cryin’, you should be buyin’!” And “when they are yellin’, you should be sellin’!”
12. Bear Market Corrections Are More Violent and Far Swifter Than Bull Market Corrections: Why they are is still a mystery to us, but they are; we accept it as fact and we move on.
13. There is Never Just One Cockroach: The lesson of bad news on most stocks is that more shall follow… usually hard upon and always with detrimental affect upon price, until such time as panic prevails and the weakest hands finally exit their positions.
14. Be Patient with Winning Trades; Be Enormously Impatient with Losing Trades. The older we get, the more small losses we take each year… and our profits grow accordingly.
15. Do More of That Which is Working and Less of That Which is Not: This works in life as well as trading. Do the things that have been proven of merit. Add to winning trades; cut back or eliminate losing ones. If there is a “secret” to trading (and of life), this is it.
16. All Rules Are Meant to be Broken… But only very, very infrequently. Genius comes in knowing how truly infrequently one can do so and still prosper.
Greed and Fear Are Two Sides of the Same Coin
Managing errant emotions is one of the most important trading skills that you can develop. Emotions are an inextricable part of being human and cannot be totally taken out of the trading equation. However, you wouldn’t “want” to take emotions out of your trading even if you could. Yes, negative emotions throw a monkey wrench into your process; for instance, anxiety, fear, greed, guilt, self-doubt, impatience, apathy, to name a few are what mangle your thinking. But what is also true is that positive emotions support effective decision making and follow-through. Emotions like inspiration, determination, patience, confidence, curiosity, and the satisfaction of viewing your trade run its course successfully are highly supportive to effective follow-through. So, if you became actually emotionless, you would be divesting yourself of the power of positive emotions. This, of course, begs another question and that is, “How can I maintain more of my positive emotions?” Well, the first thing that you want to do is to monitor your thinking. What and how you think is where emotions begin. Look at it this way. If, during a trade, you tell yourself things like “I don’t trade very well” or “This type of trade really turns against me” or “I’ll probably make a mistake on this trade.” Then, emotions of anxiety, trepidation, fear, and self-doubt, among others, is what follows. Emotions are connected to thoughts. If you think positive thoughts, then you will respond with an increase in positive emotions. On the other hand, if you think negative, power sucking thoughts, you will begin to feel in ways that are consistent with those negative thoughts. So, you must not only monitor your thoughts, you must change them when you become aware that they are negative. Changing negative thoughts can be challenging and difficult when you first begin the process; but if you remain diligent, you will begin to consistently reverse negative thinking.
Another thing that helps you to manage your emotions is to visualize or imagine an experience from your past where you felt uplifted, confident and inspired. These types of memories bring on positive emotional states. An emotional state is broader than a single emotion. For example, if you feel the emotion of anxiety, it involves just that feeling; however, if you are entangled in the “state” of anxiety, you will activate images that are anxiety producing, memories of times when you were anxious and various experiences involving anxiety. So, when you want to change your emotional states from negative to positive you’ll want to not only track what you are thinking; you’ll want to change the pictures in your mind. Now, you might be saying to yourself that this is difficult. One thing you want to remember is that you are already doing this kind of thinking and visualizing. Humans think in words “and” pictures most of the time, they just aren’t aware of it. In fact, when you get consistent negative results one of the things at play is “doom and gloom” visualizing, which is picturing all the ways that the trade will not go through.
So, the next time that you are feeling “greedy” or fearful it is very important to take an active role in finding out what you are thinking in order to change negative, unsupportive thoughts to positive powerful thoughts. Then access and activate vivid memories of events in your life where you felt determined, inspired, confident, happy and uplifted. These are just a couple of ways to help yourself plan your trade, trade your plan and follow your rules so that you create consistent results in your trading process. Remember, the definition of effective trading is not solely connected to profit and loss, but to consistent execution. Profit that is not associated with a plan and follow-through of all of your rules is profit that is not helping you become a better trader. These and many other tools, techniques and concepts are what we teach in Mastering the Mental Game Online and On-location courses at Online Trading Academy. Ask your Online Trading Academy Educational Counselor for more information. Also, get my book, “From Pain to Profit: Secrets of the Peak Performance Trader.”
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.
Gerald Loeb’s Timeless Wisdom (1899-1974)
I’m sure you’ve heard the expression, “the more things change, the more they stay the same.” Gerald Loeb used this phrase frequently. I’ve always had great respect for Mr. Loeb. True, he was an extraordinary investor and a best-selling author. But what I most respected him for was his business acumen. As one of the founding partners of E.F. Hutton, he was often quoted preaching to investors about the need to approach investing as a business and with a business mind.
Early on, I took his advice to heart. From the very beginning, I always made certain that I organized my investing activities in a manner that yielded timely investment reports and minimized taxes. I also sought out the best professional accounting, legal, tax and estate planning advice because this is what Gerald Loeb advocated.
Personally, his advice has been validated over the decades. Having known a large number of traders, I’ve observed that the most profitable ones have seldom been the smartest or boldest. They are usually organized individuals who are willing to focus on the small details. They are those people who are comfortable with routines and have the discipline to follow them. I’ve often noticed that they’re unpretentious as well – even humble at times.
If you stop and think about this, being free from pride and willing to be subservient to something like the market – which is so much bigger than any of us – allows one to remain open to listening to the market and letting the market itself show us the way. This same mode of openness is a common denominator in the management styles of many of America’s greatest business models. Gerald Loeb simply challenged the broader spectrum of stock market enthusiasts – from traders to hobbyist investors – to adopt this business mindset in their speculative activities.
With a sincere and abiding respect for Loeb’s many contributions to the investing arena, I also want to recognize just a few of my favorite market wisdoms from the “most quoted man on Wall Street” according to Forbes magazine.
- “You don’t need analysts in a bull market, and you don’t want them in a bear market.”
- “The most important single factor shaping security markets is public psychology.”
- “A willingness and ability to hold funds un-invested while awaiting the real opportunities is a key to success in the battle for investment survival.”
- “There is a saying, “a picture is worth a thousand words.” One might paraphrase this by saying a profit is worth more than endless alibis or explanations…prices and trends are really the best and simplest “indicators” you can find.”
- “Accepting losses is the most important single investment device to insure safety of capital.”
In closing, I remind you that the market is notorious for its cyclical emotional discord and all its event-based intrigue. But much like Gerald Loeb, I too challenge you to continue to trade with a spirit of tenacity, organization, business acumen and always a sense of controlled risk.
“6 Skills For Traders”
Whether it is day trading, scalping, or investing,there are fundamental skills that each trader should master. Skill-building activities will help you sharpen your ability to make money and cash in on critical market movements.
1. Don’t Be a Perfectionist
Consistent profits are achieved from winning more than you lose – not winning every single trade.There are plenty of professional traders who generate profits by winning just 10% of their trades by maximizing gains and minimizing their losses.
2. Stick to a Trading Plan
Developing a trading plan is extremely important.Day trading around your own set plan for each position will produce consistent profits. A trading plan planner should be your best friend when developing your own trading
style. The key is sticking to what you’ve written down on paper.
3. Know the Odds
You should know the payoff odds for each trade that you take.Scalping produces large gains from small movements with higher risk than swing trading. Your trading plan should include a way to regulate how much capital you’re willing to risk on each position – but you should never risk more than 2% of your total account value.
4. Complete Trading Plan
The skill to plan is the most important. A complete trading plan should be more than just “trade everyday from 9-3.” A plan should include how to act in upswings and downswings and how to protect your capital.
In many cases, a thin plan is worse than no plan at all.Stick to your guidelines to get the most out of each trade.
5. Ability to Keep Emotions Under Control
It’s hard not to be emotional with hundreds or thousands of dollars on the line each moment of the day.Think like you would in a survival scenario;you’ve got to be calm and keep your head above the water.
Many traders slip from their plan and take positions to cover losses only to lose more money. Over time,a complete trading plan will produce consistent profits,but only if you believe in it.
6. Know How the Market Responds
After getting some experience, you should be able to know how the market responds to certain events before they happen.
The Same Winning Principles
• You can risk too much and lose it all in your business, life, marriage, friendships or family. You have to measure the potential cost of every action. One affair can cost you your marriage, just like one big trade with too much risk can cost you all your capital.
• In business there are certain methods which bring in customers and turn a profit, and others which cause a business to turn away customers and lose money. Trading is similar: methods which turn a consistent and long-term profit are essential for success.
• Having unrealistic expectations in a marriage, job, or business will lead to unhappiness and failure just like it will in trading. You have to set realistic expectations so
you do not get discouraged easily and quit in any of these areas. You have to be satisfied that the results are worth your effort over the long term. You need to understand what to expect before you begin a marriage, a job, a business, or trading.
• Those who succeed in all areas of life are the ones who can manage stress the best. The best way to manage stress is to increase what you can handle step by step so that you grow into new circumstances. Another way to manage stress is to avoid actions which get you into situations you are uncomfortable with.
• Patience can pay big dividends in life. Patience is not inaction; it is simply knowing what you are looking for and taking action at the right time. Whether you are waiting for the right trade setup or the right person to marry, patience can protect you from irrational emotions and feelings. Wait for what you want, and when it is there go get it.
• In life, as in trading, people with written plans accomplish much more than people with no plans. Sit down when you are calm and rational and jot down goals to pursue. This will provide you with a map when life circumstances bring out your fears, greed, and other destructive emotions.
• Education does not end in school. To be successful in life or trading we must never stop learning. The market and the world are constantly advancing and changing and the only way to keep up is to keep learning.
• In life, the majority of gamblers are broke and the majority of good business owners become rich. The same principle is true in trading.
• In life, if you risk everything enough times you will eventually lose everything. Instead, just move in the direction of your goals every day, so even with setbacks, in the long run you will get to where you are going.
• Before making any decision in life, the question: “What do I have to lose?” is a serious question. This should precede, “What do I have to gain?” If the answer is: I could lose $100, but if I am right I could gain $500 and my odds of being right are 50% – then you have a good risk reward profile. If it is reversed, then you have a bad risk reward scenario and should pass. These are also questions you must ask in your marriage, job, business, or friendships before making decisions you regret.
• Failure to admit when you are wrong can be disastrous. When you are going down the wrong road it is better to turn back sooner rather than later. Never fight a war for a hill of bones, because even if you win, all you have is a hill of bones and regret over what it cost you.
• When you have won big prepare to take profits. Have an exit plan in place. If your house goes from $100,000 to $300,000, have a plan to sell and move. Do not just sit there and let it drop back down to $100,000. It is surprising how many people are in the right place at the right time and win what is equivalent to the lottery in stocks, a house, or a business but have no exit plan, so they ride it all the way up then all the way down again with almost nothing to show for it. Tragic.
• What most separates successful people from unsuccessful people in all areas of life is that they persevere until they are successful. Everyone has to overcome failures, but those who keep going are the ones with successful marriages, businesses, careers, and trading systems.
• People who are successful become experts in one area. They put in 10 years of learning and mastering one business, one career, one marriage, or one trading style. do not jump around and become a jack-of-all-trades and master of none.
• Successful people do what really leads to success, not what they believe will make them successful. They read books, study patterns, have mentors, and learn cause and effect.
• Winners base their actions on proven results, not on their own opinions or predictions. Feedback is crucial to them; people with strong opinions who believe they can predict what will happen reject feedback. Winners go with the flow of the trend causing their success.
• In life, those who are driven by their vision, passion, and plan usually end up where they want to be or close to it. Those who let their emotions and feelings take over and drive their decision-making usually end up where they do not want to be in life.
• I believe that people who realize they have made a mistake in a given situation and who cut those losses and try again will be much more successful than people who waste years on a marriage, business, or career that continuously gets worse. It is important to continue in a business or career that is successful until that trend changes.
The Market Is King
Technical traders base their current trade decisions on past price action, noting distinct historical patterns that have the possibility of replication. However, the outcome of two strategically similar trades are never exactly alike if for no other reason than those trading a specific stock now are not the same ones who traded it two months, or even two weeks or two days previous. The elements of uncertainty (e.g., changes in sentiment and differences of opinion) exert such an influence on stock prices that exact replication is impossible. Therefore, the market enjoys a “King Jester” status.
The market is king. We have no control over its directional bias, day to day actions, or its seemingly often illogical ways. The market will do what it wants, when it wants, how it wants, and for as long as it wants to whomever it wants. It is king.
The market, then, can act as it pleases, even as jester, behaving foolishly and mocking us, making fun of our grand designs played out in our charts and graphs with our clearly defined historical patterns. We give these patterns easily identifiable names such as head and shoulders, wedge, triangle, marshmallow stick, three black crows. You get the idea. Patterns make us feel all warm and fuzzy inside, secure in our confidence that the past will indeed repeat itself. But then King Jester takes the stage.
King Jester holds in one hand a crystal ball; in the other a chart, balancing and juggling the two. The jester entertains. The jester makes us laugh. But as all great jesters know the real joke is on us. The jester reveals our biases and the silly ways we plan our days and our lives, as if we really have that much control over either. So when we laugh we laugh at ourselves. After all, do we really believe the future is revealed in some chart? Sadly, there is always the heckler. The one who is serious about his fortune telling abilities. Mocking the King Jester. Making fun of him. Telling King Jester he is wrong or stupid or stupidly wrong. When King Jester drops the crystal ball or can’t read the chart for farsightedness, the heckler gets angry and makes fun of the King.
When the act is over and the curtains are drawn, it is the King Jester who gets the last laugh. The crystal ball is always cracked and the charts are 20/20 only after the fact. Expectations are dashed; hopes and dreams are postponed or diverted.
In the end, we can do little more than laugh with King Jester and laugh at the heckler…recognizing the wisdom of the former and the foolishness of the latter.
In the end, we plan our trades knowing that some will fail, some will succeed, and some will go on without us. Whatever the result, we laugh. We laugh with King Jester and we laugh at ourselves.
On Trading Psychology
… I didn’t always win. My plan of trading was sound enough and won oftener than it lost. If I had stuck to it I’d have been right perhaps as often as seven out of ten times. In fact, I always made money when I was sure I was right before I began. What beat me was not having brains enough to stick to my own game — that is, to play the market only when I was satisfied that precedents favored my play. There is a time for all things, but I didn’t know it. And that is precisely what beats so many men in Wall Street who are very far from being in the main sucker class. There is the plain fool, who does the wrong thing at all times everywhere, but there is the Wall Street fool, who thinks he must trade all the time. No man can always have adequate reasons for buying or selling stocks daily — or sufficient knowledge to make his play an intelligent play.
Sometimes the best play is to not play at all. When playing the market, you have to let the opportunities come to you, and take advantage of them when the odds are in your favor. If you don’t, you’ll get very frustrated — and you’ll lose money.
Be Imperfect
If you have a perfectionist mentality when trading, you are setting yourself up for failure, because it is a “given” that you will experience losses along the way. You must begin to think of trading as a game of probability. Your losses ( that you hope will return to breakeven) will kill you. If you cannot take a loss when it is small ( because of the need to be perfect), then you will watch that small loss grow into a larger loss and so on into a vicious cycle of more and more pain for the perfectionist. Trading on hope does not work. The markets can remain irrational for a lot longer than you can remain solvent.
The object should be excellence in trading, not perfection. Moreover, it is essential to strive for excellence over a sustained period, as opposed to judging that each trade must be excellent. This is a marathon…not a sprint.
The greatest traders know how to take cut losses and let winning positions run. Perfectionists often do exactly the opposite. They get in at the wrong time, stay in too long and then get out the wrong time. Perfectionists are always striving and never arriving. The market will find the flaw in a perfectionistic trader and exploit it day after day.
You Might be a Trend Following Trader if…..
“Trend
followers use reactive technical analysis. Instead of trying to predict
a market direction, their strategy is to react to the market’s
movements whenever they occur. This enables them to focus on the
market’s actual moves and not get emotionally involved with trying to
predict direction or duration.” -Michael Covel/ Trend Following
You Might be a Trend Following Trader if…..
- …you love buying break outs above resistance and new all time highs.
- …big trends make you happy not angry.
- …you do not trade the concept of something being overbought you just use a trailing stop.
- …your trading decisions are based on what is happening now, not your opinions, your fears of what will happen, or your hopes of what will happen later.
- …you risk a little capital over and over again to make a lot of capital eventually.
- …you are great at letting your winners run.
- …trend followers don’t need a story they follow actual price action.
- …you look for longs in a bull market and shorts in a bear market you are likely a trend follower.
- …higher highs and higher lows are one of your best indicators to go long.
Loss Aversion
Yes. If loss aversion is pervasive, then it should show up in regularities relating to price moves. The situation is complicated in futures where one person’s long profit when price goes up is the short’s loss. The endowment effect which is caused by loss aversion or the tendency to connect with what you own, could lead to holding something too long. The reference point effect, which is that people base their decisions on where they are, a variant of holding onto the status quo is also a factor. When there is a profit, a different type of endowment effect plays then when there is a loss. Especially when there has been a big loss and it turns into a profit, the loss aversion effect is greatest I believe.
Why isn’t this a choice between two diametrically opposed systems: either a buy and hold, where there is no special characteristics attached to the winner or the losers, or a mathematical system that has some predetermined dispositions at any time for a winner and a loser based on some quantitative criteria. When it’s something in between, that ambiguous choice and regret enter the picture.
Loss Aversion emanates from the desire to enjoy profits without having to respond to losses. It is a manifestation of an ill that returns can be generated without undergoing adverse excursions. Loss Aversion is placed within a fantasy that the majority suffers much more frequently.
Risk Aversion respects the law of diminishing marginal utility of risk. It acknowledges well that returns are feasible only upon a readiness to respond to adverse excursions.
The unwillingness to respond to adverse excursions results in all of the sins that traders can eventually end up doing, including losing more than what they are entitled to on any one adventure or set of adventures in the markets. Killing a position too soon is also a manifestation of loss aversion only, with a variant that one is averse to losing the profits away. I would surmise the opposite of this sinful loss aversion is not loss seeking behaviour, but merely loss acknowledging behaviour.
3 Dos and Don’ts Most Traders Learn
the Hard Way from Market Wizard Mark Minervini
How to Handle a Losing Streak
A losing streak usually means it’s time for an assessment. If you find yourself getting stopped out of your positions over and over, there can only be two things wrong:
1. Your stock selection criteria are flawed.
2. The general market environment is hostile.
Broad losses across your portfolio after a winning record could signal an approaching correction in a bull market or the advent of a bear market. Leading stocks often break down before the general market declines. If you’re using sound criteria with regard to fundamentals and timing, your stock picks should work for you, but if the market is entering a correction or a bear market, even good selection criteria can show poor results. It’s not time to buy; it’s time to sell or even possibly go short. Keep yourself in tune with your portfolio, and when you start experiencing abnormal behavior, watch out. Jesse Livermore said, “I’m never afraid of normal behavior but abnormal behavior.”
If you’re experiencing a heavy number of losses in a strong market, maybe your timing is off. Perhaps your stock-selection criteria are missing a key factor. If you experience an abnormal losing streak, first scale down your exposure. Don’t try to trade larger to recoup your losses fast; that can lead to much bigger losses. Instead, cut down your position sizes; for example, if you normally trade 5,000-share lots, trade 2,000 shares. If you continue to have trouble, cut back again, maybe to 1,000 shares. If it continues, cut back again. When your trading plan is working well, do the opposite and pyramid back up.
Following this strategy will help keep you from trading yourself into the ground when things turn sour, which they definitely will at some point. When you take a large loss or get hit repeatedly, there’s a tendency to get angry and try to get it back quickly by trading larger. This is a major mistake many traders make and is the complete opposite of what should be done. Don’t do it; trade smaller, not bigger. If you keep trading the same size over and over, even making small mistakes can lead to a death by a thousand cuts. Instead, scale back your trading size and raise the cash position in your portfolio.
A Practice That Will Guarantee Disaster
It would be bad enough to sit and watch your wealth disappear and do nothing to protect yourself by not using a stop loss, but it is even worse to put more money into a losing investment. Throwing good money after bad is one of the quickest ways to the poorhouse. This is called averaging down.
Brokers often talk their clients into buying more shares of a stock that shows a loss in an effort to sell more stock or rationalize the poor recommendations they made in the first place. They tell the client that it will lower their cost basis. If you liked it at $50, you’re going to love it at $40, right? Double up at $40 and your average price is now $45. Wow, what a deal! You now own twice the amount of stock, and you’ve doubled your risk. Your loss is still the same; you didn’t gain anything except maybe a double-size loss if the stock keeps sliding. How about buying at $30, then $20, and then $10? How ridiculous! There is no shame in losing money on a stock trade, but to hold on to a loss and let it get bigger and bigger or, even worse, to buy more is amateurish and self-destructive.
High-growth stocks that fall in value after you purchase them at a correct buy point do not become more attractive; they become less attractive. The more they fall, the less attractive they are. The fact that a stock is not responding positively is a red flag that the market is ignoring the stock; perception is not going in your direction. Maybe the general market is headed into a correction or, even worse, a major bear market.
For many traders, it’s tempting to buy a pullback because you feel you’re getting a bargain compared with where the stock was trading previously. However, averaging down is for losers, plain and simple. If this is the type of advice you’re getting, I suggest you get a new broker or advisor. This is simply the worst possible advice you can receive. Remember that only losers average losers.
Learn to Pace Yourself
When I come out of a 100 percent cash position, generally after a bear market or intermediate-term correction, I rarely jump right in with both feet. I think of each trading year as the opener of a twelve-inning game. There’s plenty of time to reach my goal. Early on, I take it slow with my main focus on avoiding major errors and finding the market’s theme. This is like an athlete warming up and assessing the competitive environment.
Themes can come in the form of how prices are acting in general, industry group leadership, overall market tone, and economic and political influences. I try to establish a rhythm and set my pace during this time. Like a golfer who has found his swing groove, once I find a theme and establish my trading rhythm, then and only then do I step up my exposure significantly. I wait patiently for the right opportunity while guarding my account. When the opportunity presents itself with the least chance of loss, I’m ready to strike. Patience is the key. My goal is to trade effortlessly.
If your trading is causing you difficulty or stress, something is wrong with your criteria or timing or you’re trading too large.
To trade with ease, you must learn to wait patiently until the wind is at your back. If you were going sailing, you wouldn’t go out on a dead calm and sit there floating in the water all day waiting for the wind to pick up. Why not just wait for a breezy day to set sail?
STOCK MARKET RULES: THERE ARE ONLY TWO!
Here are the guidelines:
You must write these rules down so that you will not forget them.
You must always follow these rules.
These rules will never change.
You must keep them forever.
These rules are never to be broken.
You must never add to these rules.
Here are the rules:
KNOW WHEN AND WHY TO BUY.
KNOW WHEN AND WHY TO SELL.
Now, take these rules and develop your trading methodology around them.
“If you don’t like their rules, whose would you use?” Charlie Brown
“A few strong instincts and a few plain rules suffice us.” Ralph Waldo Emerson
“You have to learn the rules of the game. And then you have to play better than anyone else.” Albert Einstein
A PERFECT EXPLANATION FOR
THE COLLECTIVE MADNESS OF CROWDS
All
I can say about the following is WOW, talk about THE perfect
explanation for the reason behind unreasonable and illogical crowded
moves in the stock market…
The most striking peculiarity presented by a psychological crowd is the
following: Whoever be the individuals that compose it, however like or unlike
be their mode of life, their occupations, their character, or their intelligence,
the fact that they have been transformed into a crowd puts them in possession
of a sort of collective mind which makes them feel, think, and act in a manner
quite different from that in which each individual of them would feel, think,
and act were he in a state of isolation. There are certain ideas and feelings
which do not come into being, or do not transform themselves into acts except
in the case of individuals forming a crowd. The psychological crowd is a
provisional being formed of heterogeneous elements, which for a moment are
combined, exactly as the cells which constitute a living body form by their
reunion a new being which displays characteristics very different from those
possessed by each of the cells singly.
following: Whoever be the individuals that compose it, however like or unlike
be their mode of life, their occupations, their character, or their intelligence,
the fact that they have been transformed into a crowd puts them in possession
of a sort of collective mind which makes them feel, think, and act in a manner
quite different from that in which each individual of them would feel, think,
and act were he in a state of isolation. There are certain ideas and feelings
which do not come into being, or do not transform themselves into acts except
in the case of individuals forming a crowd. The psychological crowd is a
provisional being formed of heterogeneous elements, which for a moment are
combined, exactly as the cells which constitute a living body form by their
reunion a new being which displays characteristics very different from those
possessed by each of the cells singly.
…and it was written by a psychologist in 1896!
Anyone care to guess who it is? And it is not Charles Mackay.
Retiring Wall Street Strategist Gives
Amazing Investment Advice Just Before He Quits
This is a bummer. Minack’s work was lucid and helpful.
But as a parting gift to clients, Minack wrote a two-page farewell note that contains the best investment advice you will likely ever receive.
What is this investment advice?
Don’t try to pick stocks
Don’t try to time the market
Just invest in a portfolio of low-cost, tax-efficient index funds
Now, before you go scrutinizing Minack’s note to find these bullet points, let me be the first to say that Minack does not actually explicitly articulate this advice.
Rather, he just demonstrates conclusively why any other investment strategy is idiotic.
For starters, Minack points out that, in the average year, 60% of actively managed mutual funds underperform their benchmark.
This means that, in any given year, you have a 40% chance of picking a fund that will beat the market. So if you try to pick a fund that will do this, the odds are already against you.
Then Minack notes that, over the 3-year period through 2012, a staggering 87% of funds lagged the market–a percentage of failure that is similar to the percentage in most three-year periods.
This means that, if you plan to hold your investment for 3 or more years, you have about a 1 in 9 chance of picking a fund that will beat the market.
Those are truly awful odds.
And it gets worse.
If you are like most people, in addition to trying to pick funds that will beat the market, you will try to pick times to be in the market (namely, when you think it’s going to go up.) And, if you’re like most people, you will not be able to pick good times consistently. (On the contrary…) As a result, you will pull money out of the market when you should be putting it in, and put money in when you should be pulling it out. And this will further bludgeon your returns.
If you are like most sophisticated rich investors, meanwhile, you will think that, by investing in hedge funds instead of dime-a-dozen mutual funds, you will have a much better chance of beating the market.
Instead, your chances will actually be much worse.
Why?
Because it turns out that the thing that causes the majority of funds to lag the market (mutual funds and hedge funds) is not poor stock-picking ability but fees.
On a gross basis, before subtracting costs and fees, about half of funds beat the market every year and half of funds lag it. (This is because funds basically are the market). Once you subtract costs and fees from both groups, however, the odds get much worse. And hedge funds generally charge much higher fees than mutual funds.
So, stock-picking, fund-picking, and market-timing are generally terrible ideas.
And now for the good news…
If, instead of trying to pick a fund that will beat the market, and pick times to be in the market, you just buy and hold a low-cost index fund, you will be guaranteed to beat 90% of funds over the long haul.
This is because, unlike actively managed funds, index funds have very low costs and fees. So they track the market, while, on average, the group of actively managed funds loses ground to costs and fees.
In contrast to your odds of picking a fund that will beat the market, having a 100% chance of beating the vast majority of actively managed funds are excellent odds.
Here’s the problem, though:
In my experience, it takes a lot of time to persuade even a smart person that it is much smarter to buy and hold low-cost tax efficient index funds than it is to try to beat the market or time the market.
After I left Wall Street in 2001, for example (I used to be a stock analyst), it took me about three years of reading Jack Bogle and the academic research and looking at historical performance to persuade myself of this. Eventually, however, the evidence became undeniable and overwhelming. And then I finally stopped trying to pick stocks and (for the most part) time the market and moved my own portfolio into index funds.
This is by far the best investment decision I have ever made.
Gerard Minack has done Morgan Stanley clients an incredible service by beginning to explain this reality to them as he leaves.
Hopefully, Morgan Stanley’s financial advisors will now pick up Minack’s torch and place their clients in low-cost tax-efficient index funds.
(And, if they don’t, I would urge Morgan Stanley clients to ask some hard questions of their Morgan Stanley financial advisors. It is not a theory that investing in low-cost index funds is a smarter strategy than trying to pick funds or stocks and trying to time the market. It is a demonstrable fact. With very few exceptions, anyone who tells you otherwise either doesn’t know what they are talking about or is selling something. If you want to read more on this, I actually wrote a book about it here.)
22 Things Happy Traders Do Differently
1. Don’t hold grudges.
Happy people understand that it’s better to forgive and forget than to let their negative feelings crowd out their positive feelings. Holding a grudge has a lot of detrimental effects on your wellbeing, including increased depression, anxiety, and stress. Why let anyone who has wronged you have power over you? If you let go of all your grudges, you’ll gain a clear conscience and enough energy to enjoy the good things in life.
2. Treat everyone with kindness.
Did you know that it has been scientifically proven that being kind makes you happier? Every time you perform a selfless act, your brain produces serotonin, a hormone that eases tension and lifts your spirits. Not only that, but treating people with love, dignity, and respect also allows you to build stronger relationships.
3. See problems as challenges.
The word “problem” is never part of a happy person’s vocabulary. A problem is viewed as a drawback, a struggle, or an unstable situation while a challenge is viewed as something positive like an opportunity, a task, or a dare. Whenever you face an obstacle, try looking at it as a challenge.
4. Express gratitude for what they already have.
There’s a popular saying that goes something like this: “The happiest people don’t have the best of everything; they just make the best of everything they have.” You will have a deeper sense of contentment if you count your blessings instead of yearning for what you don’t have.
5. Dream big.
People who get into the habit of dreaming big are more likely to accomplish their goals than those who don’t. If you dare to dream big, your mind will put itself in a focused and positive state.
6. Don’t sweat the small stuff.
Happy people ask themselves, “Will this problem matter a year from now?” They understand that life’s too short to get worked up over trivial situations. Letting things roll off your back will definitely put you at ease to enjoy the more important things in life.
7. Speak well of others.
Being nice feels better than being mean. As fun as gossiping is, it usually leaves you feeling guilty and resentful. Saying nice things about other people encourages you to think positive, non-judgmental thoughts.
8. Never make excuses.
Benjamin Franklin once said, “He that is good for making excuses is seldom good for anything else.” Happy people don’t make excuses or blame others for their own failures in life. Instead, they own up to their mistakes and, by doing so, they proactively try to change for the better.
9. Get absorbed into the present.
Happy people don’t dwell on the past or worry about the future. They savor the present. They let themselves get immersed in whatever they’re doing at the moment. Stop and smell the roses.
10. Wake up at the same time every morning.
Have you noticed that a lot of successful people tend to be early risers? Waking up at the same time every morning stabilizes your circadian rhythm, increases productivity, and puts you in a calm and centered state.
11. Avoid social comparison.
Everyone works at his own pace, so why compare yourself to others? If you think you’re better than someone else, you gain an unhealthy sense of superiority. If you think someone else is better than you, you end up feeling bad about yourself. You’ll be happier if you focus on your own progress and praise others on theirs.
12. Choose friends wisely.
Misery loves company. That’s why it’s important to surround yourself with optimistic people who will encourage you to achieve your goals. The more positive energy you have around you, the better you will feel about yourself.
13. Never seek approval from others.
Happy people don’t care what others think of them. They follow their own hearts without letting naysayers discourage them. They understand that it’s impossible to please everyone. Listen to what people have to say, but never seek anyone’s approval but your own.
14. Take the time to listen.
Talk less; listen more. Listening keeps your mind open to others’ wisdoms and outlooks on the world. The more intensely you listen, the quieter your mind gets, and the more content you feel.
15. Nurture social relationships.
A lonely person is a miserable person. Happy people understand how important it is to have strong, healthy relationships. Always take the time to see and talk to your family, friends, or significant other.
16. Meditate.
Meditating silences your mind and helps you find inner peace. You don’t have to be a zen master to pull it off. Happy people know how to silence their minds anywhere and anytime they need to calm their nerves.
17. Eat well.
Junk food makes you sluggish, and it’s difficult to be happy when you’re in that kind of state. Everything you eat directly affects your body’s ability to produce hormones, which will dictate your moods, energy, and mental focus. Be sure to eat foods that will keep your mind and body in good shape.
18. Exercise.
Studies have shown that exercise raises happiness levels just as much as Zoloft does. Exercising also boosts your self-esteem and gives you a higher sense of self-accomplishment.
19. Live minimally.
Happy people rarely keep clutter around the house because they know that extra belongings weigh them down and make them feel overwhelmed and stressed out. Some studies have concluded that Europeans are a lot happier than Americans are, which is interesting because they live in smaller homes, drive simpler cars, and own fewer items.
20. Tell the truth.
Lying stresses you out, corrodes your self-esteem, and makes you unlikeable. The truth will set you free. Being honest improves your mental health and builds others’ trust in you. Always be truthful, and never apologize for it.
21. Establish personal control.
Happy people have the ability to choose their own destinies. They don’t let others tell them how they should live their lives. Being in complete control of one’s own life brings positive feelings and a great sense of self-worth.
22. Accept what cannot be changed.
Once you accept the fact that life is not fair, you’ll be more at peace with yourself. Instead of obsessing over how unfair life is, just focus on what you can control and change it for the better.
10 Lessons for Traders
10) Those who are willing can be taught almost anything. 9) Great people want to help others achieve great success. 8) Success in business requires tremendous concentration. Outside distractions must be avoided. 7) Sometimes it is best to leave politics to politicians. 6) Everyone fails at some point in his life. The true winners rebuild after their failures. 5) To put on a trade when everything is going against you requires character and commitment. 4) Rules are rules. Stick to them. 3) Adapt with the times. Be willing to be malleable. 2) Always leave yourself outs. Never commit everything to one position or to one person.
And the number one lesson:
1) The market is bigger, stronger and badder than you. Always respect it for the beast it is.
The Difference Between a Speculator and a Gambler
Whereas the gambler is corrupt, distracted, moody, impulsive, excitable, desperate and superstitious.
It’s not the market that defines whether a participant is a Gambler or a Speculator, it’s his behavior.
