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Originally posted by billyjoe
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You’re absolutely on target Billyjoe. I think we all have PRIDE and if this is not kept in check it can ruin us in the trading world and in life in general. Hey we all should not be afraid of a losing trade. Provided we followed our plans. It is amazing how we all only wish to reveal that winning trade. I guess this might be human nature. Anyway we all will get spanked every now and then and this is just a fact of this game. We feel like we are “DA MAN” when we get a little. I’m the first to admit this and just as a day is long the market has a way of bring use back down to earth when our heads get to big. -
Why position sizing matters
By Teresa Lo
Size Matters
It was a long time ago, in a bull market far, far away. In the early 1980s, I was attending university, a teenager with a steady flow of income from fashion modeling. After considering the options available for my savings, I began my adventure in the capital markets by buying mutual funds simply because stocks were fundamentally cheap.
As the broad market indices marched skywards in the mid-1980s, stocks became severely overvalued. Fundamental analysis became less useful. By then, I had graduated and joined a brokerage firm. On October 19, 1987, I forever gave up on the idea of holding on for the long-term.
This is my twentieth year in the business. I still remember my first day at the second brokerage firm I ever worked in, a place called Brink, Hudson & Lefever Ltd. There was no Mr. Brink, no Mr. Hudson, but Gus, the grandson of Mr. Lefever, was still there, by then an old man himself.
As I did the new-employee walkabout, I noticed most of the folks in the bullpen had much in common. After I shook hands with a person, my boss would give me a quick backgrounder. Without exception, each one was a used to be, long past his glory days. I resolved on the spot that I would never end up in the same place.
I worked at Brink, Hudson & Lefever for only a few months. I gave myself a promotion by signing on as a stockbroker at a blue chip firm. Gus died some years later, presumably still glued to the ticker. BHL passed into history when the firm where I finished out my career ate it for breakfast one morning.
The evolution from the teenage mutual fund investor to a professional trader was a long one. In all, I spent twelve years toiling at brokerage firms before I set up my own shop. While I gained experience in sales and corporate finance on the job, what I learned about trading came mostly from observing clients and brokers vaporize accounts. I turned to books as well, but most of them were disappointing. My background was in the sciences and as such, I was able to identify facts that were nothing more than thinly veiled dogma and theories that could not even qualify as theses.
Position Sizing is Critical
In this business, it is necessary to think for yourself, act independently, and take advice from others with a very large grain of salt. That said, market participants tend to align themselves with one of two camps. The first one, fundamental research, tends to focus predominantly on analysis and selection criteria: the what. The second one, technical analysis, concerns itself with the when; timing is regarded by many to be the sole province of chartists.
In my opinion, the most important, albeit the most ignored and overlooked step, is how much. Investors refer to asset allocation while traders often call it money management. Regardless of your time horizon or analytical approach, position sizing may well be the crucial factor when it comes to profitability. At best, those who ignore this issue will underperform. At worst, they predestine themselves to leave the game broke. Appropriate position size is a shining example of the best defense is a good offense .
Traders and investors have a single goal: to take risks that justify the rewards. We must never forget that the market is a zero-sum game. For every winner, there must be a loser. Those that approach the market with all three bases covered are more likely to come out ahead than those who do not. In particular, proper position size can eliminate deadly financial fumbles. Money is simply the byproduct of a good overall strategy, the trophy of a game well-played.
Principles of Position Sizing
For my money management algorithm, I use a stop loss that accounts for the volatility and price of the stock. Avoid fixed percent trailing stops since some positions are more volatile than others. Avoid a fixed dollar stop for the same reason. Proper stop placement is very important. Equalize the volatility and price of the stock. For example, a $100 stock that fluctuates $2 per day is equivalent to a $50 stock that fluctuates $1 per day. A $10 stock that fluctuates 50 cents per day is equivalent to a $100 stock that fluctuates $5.00 per day. Limit the risk per trade to a certain percent of my account equity. I never exceed one percent risk. Let's look at an example. If an account has $5,000 in it, the distance between the entry price and the exit price should be no more than $50 when the trade is opened. Implement an anti-martingale betting strategy. When the account is growing, bet more. When the account is shrinking, bet less. If the hypothetical account makes $200 on the first trade, the balance becomes $5,200. On the next trade, one percent would be $52. If the hypothetical account is stopped out for a $50 loss on the first trade, the balance becomes $4,950. On the next trade, one percent would be $49.50.Comment
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great stuff, Runner! I love this thread!Comment
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Why Traders Lose
Brett Steenbarger put together a list of "common reasons why traders (and most other human beings!) fall short of being fully intentional":
1. Environmental distractions and boredom cause a lack of focus - All of us have limits to our attention span and these are easily taxed during quiet times in the market;
2. Fatigue and mental overload create a loss of concentration - The demands of watching the screen hour after hour make it difficult to be sharp, creating fatigue effects that are well-known to pilots, car drivers, and soldiers;
3. Overconfidence follows a string of successes - It is common for traders to attribute success to skill and failure to situational, external factors. As a result, a string of even random wins can lead traders to become overconfident and veer from trading plans--especially by trading too frequently and/or trading excessive size;
4. Unwillingness to accept losses - This leads traders to alter their trade plans after trades have gone into the red, turning what were meant to be short-term trades into longer-term holds and transforming trades with small size into large trades by adding to losers;
5. Loss of confidence in one's trading plan/strategy because it has not been adequately tested and battle-tested - It is difficult to tolerate even normal drawdowns unless you have confidence in your methods. This confidence does not come from mere positive self-talk. Rather, it is a function of testing your methods (historically and in real-time) and seeing in your own experience that they truly work;
6. Personality traits that lead to impulsivity and low frustration tolerance in stressful situations - Psychological research suggests that some individuals are more impulsive than others and less conscientious about adhering to plans and intentions. These personality traits often are accompanied by stimulation-seeking and a high degree of risk tolerance: a deadly combination.
7. Situational performance pressures - These include trading slumps and increased personal expenses that change how traders trade and lead them to place P/L ahead of making good trades. By worrying too much about how much money they make, traders can no longer follow markets with a clear head;
8. Trading positions that are excessive for the account size - This is much more common than is usually acknowledged. It creates exaggerated P/L swings and emotional reactions that interfere with cool, calm planful behavior;
9. Not having a clearly defined trading plan/strategy in the first place - Interestingly, many traders do not consider themselves to be discretionary traders, but in fact do not have a firm, explicit set of trading rules that they follow. It is difficult to be consistent with a plan (and to evaluate your consistency), if you don't have the plan clearly laid out;
10. Trading a time frame, style, or market that does not match your talents, skills, risk tolerance, and personality - All too often, traders veer from their plans because those plans are ones that they feel they *should* follow, but that don't truly come naturally to them. These departures from discipline are actually unconscious attempts to trade in a style that is more in tune with the trader's skills and talents.
Source: Brett SteenbargerComment
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Money Management & Risk Control
by Brandon Fredrickson
Here are a few quotes from some great traders and investors.
" I haven't met a rich technician" Jim Rogers.
"I always laugh at people who say "I've never met a rich technician" I love that! Its such an arrogant, nonsensical response. I used fundamentals for 9 years and got rich as a technician" Mary Schwartz.
"Diversify your investments" John Templeton.
"Diversification is a hedge for ignorance" William O'Neil.
"Don't bottom fish" Peter Lynch.
"Don't try to buy at the bottom or sell at the top" Bernard Baruch
"Maybe the trend is your friend for a few minutes in Chicago, but for the most part it is rarely a way to get rich" Jim Rogers.
"I believe the very best money is made at the market turns. Everyone says you get killed trying to pick tops and bottoms and you make all your money by playing the trend in the middle. Well for twelve years I have been missing the meat in the middle but I have made a lot of money at tops and bottoms." Paul Tudor Jones.
So here we have a group of guys who have collectively taken billions of dollars out of the market and they don't agree on a damn thing regarding how to make money. Not one. So what is a person to do? Is there anything they do agree on? Just one:
"My basic advise is don't lose money" Jim Rogers.
"I'm more concerned about controlling the downside. Learn to take the losses. The most important thing about making money is not to let your losses get out of hand." Marty Schwartz.
"I'm always thinking about losing money as opposed to making money. Don't focus on making money, focus on protecting what you have" Paul Tudor Jones.
"Rule number one of investing is never lose money. Rule number two is never forget rule number 1" Warren Buffet.
Money Management & Risk Control - Part 2
There really are a lot of ways to make money in the market. There are tons of seminars you can pay for that will tell you "How I made $1 quadrillion dollars in the stock market" and its sister book "How I Double my Money Every Hour" is available in many different forms too for only $29.95. All of these will tell you some patterns that will work sometimes and won't others. Some might have you going long with Jimmy Rogers, while others will have you doing it with Bernard Baruch, but when it gets right down to it the most critical part of making money, is not losing much. Your always going to take stops and lose some. But you don't want to lose much, because you won't make a penny tomorrow if you go broke today.
One of the most common mistakes traders will make is that of "risking the whole wad". There is not a faster way to have bad things happen to you than to do this. Studies have been done that suggest the most you should risk on any one trade is 2%. And most pros will tell you that is way too much and they risk 1/4 % to 1% on each trade. The idea here is that no one trades is going to really effect you either way. You're not going to get rich, but your also not going to have to sell the house, as has happened to people.
One other benefit of small positions is that it allows you some freedom from worry. If you are risking a fairly small amount, your not going to get shaken out. You're also not going to find yourself in a position where you say "Shesh, I can't lose this much money" and you turn bad trade into a terrible investment. So, if you are serious about this, if you want to make it long term you will practice sound money control. Before you ever enter a trade, the first thing you should ask yourself is how much am I risking here because, remember that while we are here to make money, we won't make any if we go broke.Comment
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Money Management & Risk Control - Part 3
The key to not going broke is to respect risk, take small positions that wont allow you to blow out. You must always keep in mind that in trading you are only playing the odds. You may have a setup that is correct 75% of the time but each trade is a random event. It doesn't take into account the last trade. If you have a 75% system, you can still be wrong 10 times in a row, and if you trade for any amount of time it will happen.
I once thought I had a foolproof way to make money at roulette. I would bet on black and red. I would sit at the table, and after the ball had landed on black or red 5 times in a row I would start to bet on the opposite color (so if it were 5 reds in a row I would start to bet on black) Then, if I was wrong, I would go ahead and double down, meaning that if my starting bet is $1, the next time I will be $2, then $4, then $8, then $16 etc... Eventually I would win, and would come out $1 ahead. So I am 13 years old and really thinking I have the Holy Grail. If its so easy for a 13 year old to figure out, why is it that all the casinos are not out of business and we are all millionaires. Simple. It does not work.
If we are flipping coins heads has a 50% chance of turning up on each roll, and so does tails. But each flip is independent of the last. The last coin toss has nothing to do with the one before it. It's a random event. There is a certain chance heads will occur on this roll, or that tails will. But which of them it is that comes up is a random occurrence. Each time you flip a coin it is one flip of a coin amongst the billions of times coins have been flipped. That's why you can roll 100 heads in a row if you do it long enough. That's why the first time I played roulette black came up 19 times in a row and I went home defeated.
Trading is the same. We have a certain percentage of our trades that will work out, and a certain percentage that will not. But your next trade has nothing to do with your last one. So even if you have the world's most accurate method, over time you will go broke if you don't practice good money management and risk control.Comment
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Henry To, CFA
Chartered Financial Analyst
Investing & Economy
On Jesse Livermore And His Legacy - Part 1 of 2 - Henry To, CFA
I am choosing to write a short biography of Jesse Livermore and his trading philosophies. Livermore was a great trader and speculator – always willing to learn, study and open to new ideas. He was also an eccentric man, unparalleled in his dedication to always gaining an advantage over all other traders and investors. So why Livermore? Is it because of the glamour of discussing such a man? No. Why not Gann? Or Buffet? Was there some type of “secret recipe” for his successes in both the stock and the commodities market?
Definitely not. I am choosing to discuss Livermore because I believe that the legacy left by Livermore is a very important and instructive legacy for the novice, the amateur, and even the professional trader. His teachings all throughout his books and biographies were all about basic trading philosophies such as trend-following, buying and holding in a bull market, industry analyses, following the leaders, identifying pivot points, and of course, risk management. All this did not come easily. It took Livermore literally years to nearly perfect his system and methods, and it requires intensive studying and effort in order to execute and to stay disciplined. This is what Livermore has emphasized all throughout his writings – that the stock market is not for the lazy nor the uninitiated. If one really wants to succeed in making money in the stock market over the long haul, then one will need to put in the necessary time and effort – not only in the studying of the stock market, but in the studying of one's own psychology and tolerances as well.
A more subtle but if not more important question for professional traders to ask is: If Livermore was so great, why did he ultimately lose his fortune again during the Great Depression and why was he not able to make a “comeback” again? This and the fact that Livermore had periodically suffered from depression throughout his life finally led to his suicide in 1940. What went wrong? Traders would often cite his lack of risk management, but I think it goes deeper than that. Perhaps he was getting older and lost his drive, but I believe there is a more important underlying theme and lesson to all this. I will discuss this in later paragraphs.
Early on, Jesse Livermore learned that in order to succeed in life, one needs to put in a great deal of time and effort to an endeavor that one enjoys doing. Of course, it didn't hurt that Livermore also had a great genius with crunching numbers and a great discipline for keeping records. It also didn't hurt in that Livermore was always willing to learn and was always receptive to new ideas. As a young lad, he chose the stock and commodities market as a way to keep score and to make his fortune, and this is what he did until the day that he died.
Livermore was a self-made man. He ran away from home at the age of only 14 and subsequently went to work as a quotation boy in Boston. He quickly learned the art of “reading the tape” and from here, he proceeded to trade in the bucket shops – and was so successful that he was practically banned from trading in all the major bucket shops in Boston. From the bucket shops, he relocated to New York and started trading on the Big Board in the office of E. F. Hutton. This was in the year 1897. By that time, Livermore had already gained a reputation as the “Boy Plunger” in all the bucket shops in Boston. He was only 20 years old.
Trading “legitimately” on the NYSE taught Jesse Livermore his first major lesson in how to consistently make money in the stock market. How? Within six months of opening his account in a legitimate brokerage firm, he had lost all his money – all $2,500 of it – approximately the equivalent of $60,000 in today's dollars. The average person will most probably swear off stock market speculation forever if he was to lose his entire fortune in the endeavor, but not so for Livermore. Of course, he was depressed. Any emotional being would be depressed on losing his entire fortune. But this unfortunate development only motivated Livermore to study his mistakes more carefully. He was able to beat the game in the bucket shops, so why not on the Big Board?
There are many lessons to be learned here. Let's start with the first lesson. Please note that I am not going to list them in any particular order. Each trader/speculator has to deal with their own trading flaws – some lessons may be more applicable than others to one trader but the same lessons may not apply to another type of trader – especially so if he has conquered them.
Jesse Livermore Lesson One
Livermore had no prior trading experience except for his trading experience in the bucket shops. His first mistake was his belief that he could directly apply his prior system of trading to trading in actual stocks on the New York Stock Exchange as well.
What were the differences? Why couldn't he directly apply his system of trading in the bucket shops to trading on the NYSE as well? Livermore studied the differences intently – major money and his future career were at stake here. He learned several things about the art of speculation. Among them were:
The greatest amount of money is made following the major trends – not in the day-to-day fluctuations of a stock or in a particular commodity. This fact was later compounded by his experience during the 1901 bull market. He had always been able to call significant bottoms in the stock market and had always be able to initiate long positions at the most opportune time. And yet, he would always sell his long positions after only making 10% or 20% hoping he will be able to get back in at lower prices. This usually does not happen. He eventually learned that in order to make money in the stock market, one will need to adopt a buy and hold strategy in a bull market and only sell when the bull market is on its last legs.
Livermore had a significant execution disadvantage by taking his actual business to the NYSE. Not only does he have go pay a high commission (compared to virtually none in the bucket shops although he got a severe handicap when he did trade there), there was also a significant delay between the time he places his order to when the order was actually executed. This disadvantage is severely magnified when one traded as often as Livermore did in his early days as a trader on the NYSE. Livermore was handed down the ultimate lesson in the art of execution during the final day of the Northern Pacific Corner on May 9, 1901. Livermore had anticipated a huge downside move in the morning and a subsequent one-day upside reversal. He was right, of course, but he ultimately lost his entire stake of $50,000 that day. Because of the huge volume during that day, the tape was nearly two hours behind; his brokers (who were very able) did place an order to short U.S. Steel and Santa Fe in the morning, but those orders did not get executed until two hours later. By then, both Steel and Santa Fe had already fallen by over two dozen points. When Livermore ultimately covered, he did so at levels that were two dozen points higher. This one-day plunder cost him his entire stake which it took him a long time to build up.
While his tape-reading skills were still important, they were not as important as studying the fundamentals of each company and the credit conditions of the stock market and the economy. His first successful “raid” on the stock market based on his sound, fundamental studies occurred during the Panic of 1907. As credit conditions tightened and as a number of businesses and Wall Street brokerages went bankrupt during the summer, Livermore could sense that something was wrong – despite the hopes of the public as evident in the still-rising stock market. Sooner or later, Livermore concluded, there will be a huge break of epic proportions. Livermore continued to establish his short positions, and by October, the decline of the stock market started accelerating with the collapse of the Knickerbocker Trust in New York City and Westinghouse Electric. J.P. Morgan eventually stepped in to avert the collapse of the banking system and the New York Stock Exchange, but only after Livermore managed to make more than one million dollars by shorting the most popular stocks (and covering on a plea from J.P. Morgan himself) in the stock market.
There are many lessons to be learned here by professional and amateur investors alike. While I have always maintained that the majority of traders and investors in the stock market usually under-perform the stock market, it is doubly true that virtually all traders who focus on the short-term eventually lose their capital. The successful daytraders are a rare breed – and the successful ones can only expect to obtain a return of 10% to 12% a year, at best. The amateur trader who expects a first-year 100% return by daytrading stocks just does not have a chance.
A more subtle lesson to be learned is the idea of evolution – evolving one's style to not only fit one's personality, but evolve to the point so that it will fit the market's personality as well. What made Livermore so successful during the first thirty years of the 20th century was this: Not only was he multi-talented in the traditional sense (his skills in analyzing long-term trends and fundamentals were as good as his skills in tape-reading and in daytrading), he was also multi-talented in the sense that he was able to evolve with the market very successfully. He had always been flexible in either trading the long side or short side – and he was also able to sit out in a market that was devoid of activity as well.Comment
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I will continue to use this thread to post what I believe to be nuggets that can possibly help a person overcome some of the challenges we all go through. You wont here any stocks or market action talk here. I’ll post until I feel it is time to stop. I do think the info is important to your success.Comment
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Jesse Livermore Lesson Two
Do not depend your analysis solely on “insider information.” Jesse Livermore learned this lesson the hard way – twice in all. The first lesson was moderately costly; the second lesson was to cost him his entire fortune:
Livermore had always been skeptical about the dependability on “insider information.” After all, why would top management tell outsiders that he was selling shares in his own company because he thinks business will be bad going forward (these were the days before insider-trading was made illegal)? Telling outsiders would only add more selling pressure to the stock, and vice-versa. The legendary trader, Bernard Baruch, had always maintained that insider information was useless, and that a person was doing him a favor if he would keep the insider information to himself and not reveal it to him. Livermore got his first real lesson sometime after he closed out his profitable short position in Union Pacific right before the 1906 San Francisco Earthquake. After three days of tape-watching, he concluded that the shares of Union Pacific were being accumulated. He started to accumulate shares in Union Pacific as well – only to be stopped by Ed Hutton, the great New York financier and owner of the E.F. Hutton brokerage house, and a personal friend. Hutton told Livermore that he had inside information and that the insiders have set up a pool and were dumping shares to him at a furious rate. Sooner or later, Union Pacific is going to tank. Despite his own beliefs and the reinforcements of all those beliefs from years of tape-watching, Livermore liquidated his 5,000 shares of Union Pacific at $162 – making only $10,000 in the process. The next day, the company announced a 10% dividend and the shares shot up by an additional ten points. The opportunity cost? $50,000 in additional profits which would be equivalent to over one million dollars today. Livermore did not get upset or emotional, but after this incident, he swore that he will never listen to insider information again and that he will only trust his tape-watching skills and instincts from now on.
The second lesson that was handed down to Livermore did not strictly involve insider information, although it was pretty darn close to it. It also taught Livermore a little about himself – his gullibility and his succumbing to another man's sale skills even though he practically knew all the facts of a product (in this case, it was the cotton industry). Let me clarify. This happened soon after the Panic of 1907 – when Livermore was trading successfully at a peak level and soon after he made a small fortune by nearly cornering the cotton market. Some weeks before, a man named Percy Thomas (who was also know as the “Cotton King”) had gone bankrupt in trying to corner the Cotton market, and hearing Livermore's exploits, Thomas would seek him out and ask Livermore to be his partner. Livermore refused to be Thomas' partner since he had always played a lone hand. However, Thomas was a man of knowledge (particularly in the cotton market, of course – where he supposedly had “spies” that would report crop conditions and the like to him as soon as they could) and a great charmer, and Livermore was soon put under his spell. Prior to Livermore meeting Thomas, Livermore was short cotton. After a month of listening to Thomas and falling under his spell, Livermore covered his short position and went long. This was the beginning of Livermore's downfall. With his judgment clouded, Livermore continued to average down on his long position even as Cotton fell. He even sold out his profitable wheat position in order to maintain his margin requirements in cotton and to even buy more cotton on the way down. After realizing what had happened, Livermore soon sold out – with a stake of only $300,000 left – 10% of what he had only some months ago. Livermore sold his apartment and his yacht and tried to recoup his losses in the stock market. By this time, however, his emotions were running wild and his trading skills were shot. Soon thereafter, Livermore was broke once again – not only losing his remaining stake of $300,000 – but now, he was in debt to the tune of over one million dollars. Livermore would ultimately establish himself once again, but this lesson further reinforced his beliefs that he should always play a lone hand, and that he should never tell anyone what he was doing or ask otherwise.
Jesse Livermore Lesson Three
The need to continuously evolve in the stock market. This was initially discussed in lesson one, but I believe this theme is important enough to warrant its own bullet point (no pun intended). In fact, this is probably the most important lesson that could be taught from Jesse Livermore's experience. The most popular rules such as “cutting your losses” and “don't put all your eggs in one basket” have often been cited, but what if one wants to be able to make money in the stock market over the long run? To this I say: “One needs to continuously evolve in the stock market to survive and to flourish.” This is definitely applicable to everyday life and one's career (if one is not a trader or investor) as well.
Jesse Livermore has been able to successfully trade the stock and commodity markets over a period of more than thirty years not only because of his intelligence, cool-headedness, trading skills, and his far-sightedness. He was able to do this successfully for such a long period of time primarily because he was able to evolve. He adopted a more long-term, buy-and-hold-like strategy when he shifted his trading from the bucket shops to the New York Stock Exchange. He was also eager to learn something new everyday. He was also flexible – whether on the long or short side or just being in cash. He figured out when there were opportunities in the stock market, and figured out what strategy to adopt and when there were not. He also made friends with very successful people – whether they were businesspeople or great financiers.
This is actually the heart of this commentary: the need to continuously evolve. In his ground-breaking work “Common Stocks and Uncommon Profits,” originally published in 1958, Philip A Fisher remarked that times have changed and that the way to make the most money over the long-run is to find great stocks and hold them for the long-run through thick and thin. The old way of speculating and making money by catching the inflection points of boom and bust cycles was gone with the advent of the Federal Reserve and the maturing of the SEC and the new regulations. I believe Jesse Livermore failed to see that. By the end of 1929, he had successfully maneuvered his way out of the Great Crash with a cash horde of over $100 million – becoming of the richest men in America. When Franklin Roosevelt came into office in 1932 – taking his “brain-trust” with him – and with the creation of the SEC in 1934, the stock and commodity markets adopted a different character – a character which Livermore had never seen in his entire life and a character which America had never seen before either. There is no documented history of the trades that Livermore during that time – all we knew is that he went bankrupt for the final time in his life during the 1930s and was never able to successfully make a comeback. Some say he lost his fortune going long sugar futures before FDR put a ceiling on the sugar price. Some say he lost his fortune going long after the crash and didn't get out in time – thinking that the 1929 “dip” would be one of the many similar busts that America had endured during the 19th century and the early parts of the 20th century before the creation of the Federal Reserve. The message is clear, however. The character of the market changed in a big way, and Livermore was not flexible enough to go along for the ride – despite the fact that he had successfully evolved his strategies and trading styles many times before in the past.
This is not unsimilar to the period immediately before the technology bubble burst in the spring of 2000. At the time, I stated that the technical indicators that were so successful in the late 1990s would not work anymore – primarily because that we were entering a secular bear market. Few believed me at the time. They continued to use their oversold technical indicators, buying technology stocks during the many dips along the way. They failed to evolve. Warren Buffett had mentioned in the past that only when the tide turns would it be obvious to see who was swimming naked.
The idea of evolution in the stock market continues to hold true today. In fact, with the advent of globalization and information technology, it is now even more imperative to evolve since trends can change much more quickly. Information is now instantaneous. Investors will need to be more nimble. Whereas Philip Fisher emphasized that timing was not too essential in the purchase of stocks in 1958, this has all changed today. Witness the meteoric rise and fall of Taser – all in a short time span of 12 months! Also witness the huge amount of cash that has been sitting on the balance sheet of Warren Buffett's Berkshire Hathaway over the last 24 months. Yes, the company has grown bigger, but as a percentage of total net worth, the amount of cash that Warren Buffett is currently holding is unprecedented. Ten years ago, Buffett would have been able to find opportunities to put this cash to work. Buffett had always been a great timer in the stock market (he had always had the great ability to evolve), and I believe he will be putting all his cash to work once he finds the best time to buy equities, bonds or whole companies. In a weird way, Livermore's trading/timing strategies may have been revived. The point is: Today, the timing of the stock market and individual stocks is all the more essential. And MarketThoughts.com is here to help. While the analyses of individual stocks and industries continues to be important today (and sites such as the Motley Fool does a good job of it), we also believe that the ability to time the stock market on at least the intermediate-term basis (and the ability to adapt to a different style of trading and to recognize which asset class to buy) is going to become more essential down the road. Through our twice-a-week commentaries and our DJIA Timing System, we will seek to complement our analyses of businesses, individual stocks and industries, with our proprietary technical indicators and our timing skills in the stock market.Comment
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25 Signs That Show You Know How to Handle Money - Article by Al Jacobs
The ability to master your money is not something that just happens. It takes time, training, and temperament. Whatever praise or criticism you may direct at the American public school system, one thing must be acknowledged: The handling of personal financial affairs is not a subject to which much attention is devoted. Whatever the average citizen knows about saving and investing did not come from the classroom. This is understandable, of course, if only because the typical classroom teacher is equally mystified by the world of money. Nonetheless, there are those among us who have figured out how it all works, and what it takes to prosper.
Are you one of those persons that has managed somehow to get the hang of it? If you recognize yourself in most of the twenty-five following scenarios, then you can confidently answer "yes" to that question.
1. Your credit card bill is paid in full each month with never a penny in interest incurred.
2. You understand that the variable annuity in which your neighbor just invested will prove to be a sad mistake.
3. Despite orchestrated furor by the media, you recognize that the $30 it costs to fill your vehicle’s gas tank is cheaper in today’s dollar that the $15 it cost 20 years ago.
4. You enjoy financial talk shows for their entertainment value while knowing that 95% of what’s said is nonsense.
5. The only type of life insurance that you’d ever consider purchasing is a term policy.
6. You’re not tempted to invest in something because of a hot tip you get from a friend or relative.
7. You have serious doubts that the 3-unit course in basic English composition offered at Eleganté University for $900 is any better than a similar course conducted at Midtown Community College for $60.
8. You are sufficiently sophisticated in real estate to know that the worst house in the best neighborhood beats the best house in the worst neighborhood.
9. You owe nothing on the vehicle you drive.
10. You have a pretty good idea by mid-November how much your income tax obligation for the current year will be.
11. When hearing that the S&P 500 Index just hit an all-time high, you are not inclined to call your broker with a buy order.
12. It’s beyond your comprehension why anyone not certifiably insane would purchase a timeshare property.
13. Your checking account balance never drops below the minimum limit that triggers a monthly service charge.
14. You’re aware that an option to pay your auto insurance premium in two installments, with a "modest convenience fee" instead of a single payment, probably works out as a loan at about a 25% interest rate.
15. Although you thoroughly enjoy the home in which you live, it’s considerably less expensive than you can afford.
16. You know practically nothing about the option market—and intend to keep it that way.
17. You feel instinctively that every dollar you contribute in FICA taxes to the Social Security system is a dollar lost to you forever.
18. Whenever you’re negotiating a purchase and qualify to receive a discount, you do not hesitate to ask for it.
19. You entertain no illusions that a financial advisor will provide sound counsel merely because of the Certified Financial Planner (CFP) designation held.
20. You make the maximum possible contribution to your retirement funds.
21. Whether your choice of wristwatch is a top-of-the-line Rolex, a fashionable Cartier, a respectable Bulova, or an economy Timex, you recognize that all are battery-operated, with a similar quartz movement, and none fail to keep excellent time.
22. You find it baffling why anyone would buy a lottery ticket.
23. You cannot remember when you last borrowed money for an unexpected emergency.
24. The newspaper advertisement offering a half-pound silver commemorative medallion from The Perfidious Mint, at the "special advance price of only 139 dollars," forces you to suppress a laugh.
25. You have no confidence in the concept of "Investor Confidence."
If the sentiments expressed in most of those situations do not reflect your thinking, you’re not in control of your financial destiny. In that case, you can use a little guidance.Comment
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Master the Four Fears of Trading
November 2002
Originally Published
in Stock Futures and Options Magazine
by: Price Headley
Merriam-Webster's dictionary defines fear as "an unpleasant, often strong emotion caused by anticipation or awareness of danger, going on to explain that fear...implies anxiety and usually the loss of courage." This definition of fear is useful in helping define the issues that traders face when coping with fear. The reality is that all traders feel fear at some level, but the key is how we prepare to address our concerns related to taking on risk as a trader. In this article I will review four major fears experienced by traders, and I'll take it a step further by noting how the outcomes of these fears create undesirable trading behaviors. Basically, my aim is to have you walk away with an understanding of these dangers so you can and implement strategies that will address your fears and let you get on with your trading plan.
Mark Douglas, an expert in trading psychology, noted in his book, Trading in the Zone, that most investors believe they know what is going to happen next. This causes traders to put too much weight on the outcome of the current trade, while not assessing their performance as "a probability game" that they are playing over time. This manifests itself in investors getting too high and too low and causes them to react emotionally, with excessive fear or greed after a series of losses or wins.
As the importance of an individual trade increases in the trader's mind, the fear level tends to increase as well. A trader becomes more hesitant and cautious, seeking to avoid a mistake. The risk of choking under pressure increases as the trader feels the pressure build.
All traders have fear, but winning traders manage their fear while losers are controlled by it. When faced with a potentially dangerous situation, the instinctive tendency is to revert to the "fight or flight" response. We can either prepare to do battle against the perceived threat, or we can flee from this danger. When an investor interprets a state of arousal negatively as fear or stress, performance is likely to be impaired. A trader will tend to ?freeze.? In contrast, when a trader feels the surge of adrenaline but interprets this as excitement or a state of greater alertness before placing a trade, then performance will tend to improve. Many great live performers talk of feeling butterflies just before they go on stage, and how they interpret this as a wake-up call to go out and perform at their highest level. That's clearly a more empowering response than someone who might interpret these butterflies as a reason to run back to his dressing room to get sick! Winners take positive action in spite of their fears.
1. Fear of Loss
Analysis Paralysis and Its Cousins
The fear of losing when making a trade often has several consequences. Fear of loss tends to make a trader hesitant to execute his trading plan. This can often lead to an inability to pull the trigger on new entries as well as on new exits. As a trader, you know that you need to be decisive in taking action when your approach dictates a new entry or exit, so when fear of loss holds you back from taking action, you also lose confidence in your ability to execute your trading plan. This causes a lack of trust in your method or,more importantly, in your own ability to execute future trades.
Thus, you can see how fear can set in place a vicious cycle of recurring doubt and, in turn, reinforce a traders' lack of confidence in executing new positions. For example, if you doubt you will actually be able to exit your position when your method tells you to get the heck out, then as a self-preservation mechanism you will also choose not to get into new trades. Thus begins the analysis paralysis, where you are merely looking at new trades but not getting the proper reinforcement to pull the trigger. In fact, the reinforcement is negative and actually pulls you away from making a move.
Looking deeper at why a trader cannot pull the trigger, I believe the root stems from a lack of confidence about the trading plan, which then causes the trader to believe that by not trading, he is moving away from potential pain as opposed to moving toward future gain. No one likes losses, but the reality is, of course, that even the best professionals will lose. The key is that they will lose much less, which allows them to remain in the game both financially and psychologically. The longer you can remain in the trading game with a sound method, the more likely you will start to experience a better run of trades that will take you out of any temporary trading slumps.
When you're having trouble pulling the trigger, realize that you are worrying too much about results and are not focused on your execution process. Make sure your have a written plan and then practice executing your plan.
Start with paper trades if you prefer, or consider trading smaller positions to get the fear of losing out of your system and get yourself focused on execution. When in the heat of battle and realizing you need to get in or out of a trade, consider using market orders, especially on the exit. That way you can't beat yourself up for not pulling the trigger on your trade.
Many traders may get too cute with a trade and try to work out of a position at a limit price better than the current market price, hoping they can squeeze more out of a trade. But as famed trader Jesse Livermore advised in the classic book Reminiscences of a Stock Operator by Edwin Lefevre, ?give up trying to catch the last eighth.? Keep it simple with a market order to exit allows you to bring closure when you need it, which reinforces the confidence-building feelings that come from following your trading plan. In the past when my indicators noted it was time to exit, I have experienced firsthand the pain of not getting filled at my limit, watching the option drop and then placing a new limit back where I should have exited at the market in the first place! Then I have realized I was not going to get filled there either, so I again kept lowering my limit until, in frustration, I placed a market order to exit much lower than I could have closed the position initially. Not only can you feel the pain of loss financially but, more important, you can chip away at your internal state of confidence and create frustration by not getting filled.
You should be more concerned about avoiding big losses and less concerned about taking small losses. If you can?t bear to take a small loss, you will never give yourself an opportunity to be around when a big winning idea comes along, as every trade you enter has the risk of first turning against you for a loss. You must execute by knowing what your risk is in each trade, and define parameters to make sure you can ride favorable trends correctly as well so that your winners will be larger than you losers. And never get stuck in the mindset of hoping a loser will come back to "breakeven," as that is one of the trader's most deadly mental fantasies. Billions of dollars have been lost by technology investors hoping their stocks would bounce back in recent years to allow them to escape the downtrend. That only led to even greater losses in most cases. That's how a short-term trader can become a long-term investor unintentionally, and that is a position in which you never want to put yourself.
Ask how well you trust yourself to execute your trading plan. You want to judge your effectiveness based on how well you get in and out of the market when your method gives entry and exit signals. You?ll need to be decisive, not hesitant, know in your heart that your method is well tested and that your risk is low compared to your likely reward. In other words, you must be fully prepared before you go into the heat of battle during a trading day. You need to know where you will enter and where you will exit if you are a discretionary trader. Or you need to know what system you are following and be prepared to enter and exit as the system dictates. This keeps you disciplined and focused on following a process that can generate favorable results over time.
2. Fear of Missing Out
Being a Part of the Crowd Isn?t
Everything It's Cracked Up to Be
Every trend always has its doubters, but I often notice that many skeptics of a trend will slowly become converts due to the fear of missing out on profits or the pain of losses in betting against that trend. The fear of missing out can also be characterized as greed of a sorts, for an investor is not acting based on some desire to own the security - other than the fact that it is going up without him on board. This fear is often fueled during runaway booms like the technology bubble of the late-1990s, as investors heard their friends talking about newfound riches. The fear of missing out came into play for those who wanted to experience the same type of euphoria.
When you think about it, this is a very dangerous situation, as at this stage investors tend essentially to say, "Get me in at any price - I must participate in this hot trend!? The effect of the fear of missing out is a blindness to any potential downside risk, as it seems clear to the investor that there can only be gains ahead from such a "promising" and "obviously beneficial" trend. But there's nothing obvious about it.
We remember the stories of the Internet and how it would revolutionize the way business was done. While the Internet has indeed had a significant impact on our lives, the hype and frenzy for these stocks ramped up supply of every possible technology stock that could be brought public and created a situation where the incredibly high expectations could not possibly be met in reality. It is expectation gaps like this that often create serious risks for those who have piled into a trend late, once it has been widely broadcast in the media to all investors.
3. Fear of Letting a Profit Turn into a Loss
I get many more questions from subscribers asking if it is time to take a profit than I do subscribers asking when they should take their loss. This represents the fact that most traders do the opposite of the "let profits run, cut losses short" motto: they instead like to take quick profits while letting losers get out of control. Why would a trader do this? Too many traders tend to equate their net worth with their self-worth. They want to lock in a quick profit to guarantee that they feel like a winner.
How should you take profits? Should you utilize a fixed target profit objective, or should you only trail your stop on a winning trade until the trend breaks?
Those who can accept more risk should consider trailing a stop on their trending position, while more conservative traders may be more comfortable taking profits at their target objective. There is another alternative as well, which is to merge the two concepts by taking some profits off the table while seeking to ride the trend with a trailing stop on the remaining portion of the position.
When I trade options, I usually recommend taking half of the position off at a double or more, and then following the half position still open with a trailing stop. This allows you to have the opportunity to ride my best trading ideas further, as these are the trades where I am mostly likely to continue being right. Yet, I am also able to get the initial capital at risk back in my pocket, which frees me from worrying about letting a profit turn into a loss; I am guaranteed a breakeven even if the other half position were to go to nothing overnight. My general rule for the remaining half position is to exit if it reaches my trailing stop of half its maximum profit on an end-of-day closing basis, or scale out of the remaining half position every time it doubles again.
I?m also a big fan of moving your stop up to breakeven relatively quickly once the position starts to move in your favor, by about five percent on a stock or by roughly 25 percent on the option. It is also critical to recognize the impact of time spent waiting for a position to move. If you are not losing but not yet winning after several trading days, there are likely better opportunities elsewhere. This is known as a "time stop," and it will get your capital out of non-performers and free it up for fresher trading ideas.
4. Fear of Not Being Right - All Too Common
Too many traders care too much about being proven right in their analysis on each trade, as opposed to looking at trading as a probability game in which they will be both right and wrong on individual trades. In other words, their overall method will create positive results.
The desire to focus on being right instead of making money is a function of the individual's ego, and to be successful you must trade without ego at all costs. Ego leads to equating the trader?s net worth with his self-worth, which results in the desire to take winners too quickly and sit on losers in often-misguided hopes of exiting at a breakeven.
Trading results are often a mirror for where you are in your life. If you feel any sort of conflict internally with making money or feel the need to be perfect in everything you do, you will experience cognitive dissonance as you trade. This means that your brain will be insisting that you cannot exit a trade at a loss because it ruins your self-image of perfection. Or if you grew up and feel guilty about having money, your mind and ego will find a way to give up gains and take losses in the markets. The ego?s need to protect its version of the self must be let go in order to rid ourselves of the potential for self-sabotage.
If you have a perfectionist mentality when trading, you are really setting yourself up for failure, because it is a given that you will experience losses along the way in trading. Again, you have to think of trading as a probability game. You can't be a perfectionist and expect to be a great trader. If you cannot take a loss when it is small because of the need to be perfect, then the loss will often times grow to a much larger loss, causing further pain for the perfectionist. The objective should be excellence in trading, not perfection.
In addition, you should strive for excellence over a sustained period, as opposed to judging that each trade must be excellent. The great traders make mistakes too, but they are able to keep the impact of those mistakes small, while really riding their best ideas fully.
For the trader who is dealing with excessive ego challenges (yet, who wants to admit it?), this is one of the strongest arguments for mechanical systems, as you grade yourself not on whether your trade analysis was right or wrong. Instead you judge yourself based on how effectively you executed your system?s entry and exit signals. This is much easier for those traders who want to leave their egos at the door when they start to trade. Additionally, because we are raised in a highly competitive culture, the perception of a contest or competition will also bring out your ego's desire to win and beat others.
You will be better off seeing trading as a series of opportunities that will become apparent to you, and your task is to create a plan that finds opportunities with potential rewards that are several times greater than the risks you incur.
Be sure you are writing down your reasons for entering each trade, as the ego will play tricks and come up with new reasons to hang on to losing positions once the original reasons have evaporated. One of our survival mechanisms is remembering the good and omitting the bad in our minds, but this is dangerous in trading. You must acknowledge the risk and use a stop on every trade to admit when the analysis is no longer timely. This helps prevent undesirable situations where you get stuck in a position because you did not adhere to your original stop. This is a bad use of capital being tied up in an under-performing position, when there are likely to be many better opportunities elsewhere. Trading without stops is an ego-driven approach that hopes to avoid accountability for a losing trading idea. This is an unacceptable behavior to the successful trader, who knows he must limit risk with stops to stay in the game for the next trading opportunity.
In summary, your trading plan must account for the emotions you will be prone to experience, particularly those related to managing fear. As a trade, you must move from a fearful mindset to mental state of confidence. You have to believe in your ability as well as the effectiveness of your plan to take profits that are larger than the manageable losses. This builds the confidence of knowing that you are on the right track. It also makes it easier to continue to execute new trades after a string of losing positions. Psychologically, that's the critical point where many individuals will pull the plug, because they are too reactive to emotions as opposed to the longer-term mechanics of their plan. If you?re not sure if you can make this leap, know that you can if you start small.
Too many investors have an "all-or-none" mentality. They're either going to get rich quick or blow out trying. You want to take the opposite mentality - one that signals that you are in this for the longer haul. This gives you "permission" to slowly get comfortable and to keep refining your plan as you go. As you focus on execution while managing fear, you realize that giving up is the only way you can truly lose. You will win as you conquer the four major fears, to gain confidence in your trading method and, ultimately, you will gain even more confidence in yourself.Comment
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4. You enjoy financial talk shows for their entertainment value while knowing that 95% of what’s said is nonsense.
99% are nonsense.
21. Whether your choice of wristwatch is a top-of-the-line Rolex, a fashionable Cartier, a respectable Bulova, or an economy Timex, you recognize that all are battery-operated, with a similar quartz movement, and none fail to keep excellent time.
I bought a quartz Rolex in Hong Kong one time. It lasted a couple of months.Comment
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A while back I got a trial subscription to some of Price Headley's newsletters. His trades were just awful and he misrepresented his track record. Same with Bernie Schaeffer and Tobin Smith. Just awful. They must have trained at the the same boiler room. PT Barnham would be proud.
Originally posted by Runner View PostComment
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Originally posted by lemonjello View Post
lemon,
Funny you should mention Schaeffer. Did you notice who got last place with a pick that was -63.01% this year in the celebrity division of the Pick of the Year Contest ? I don't think I could pick that bad if I tried. It was right down the toilet for MWY from January--December. I've noticed after a particularly bad year these guys often change the name of their newsletter and mention some great pick from their past. Out of the hundreds of symbols they list at least one or two will do great each year.
---------------billyjoeComment
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