Ride the Cycles January 8, 2008

More good trading advice from Quint Tatro today:

I am not so sure people would believe me nor give me much credibility if my common theme was “Making money in the market is easy.” The irony of it all is that I feel making money in the market is easy but keeping it is the hard part.

Whenever I meet a new trader my primary goal is to impart to them what I have learned over the years to help them grow, but my job as a teacher is much easier if a person can simply stick with trading long enough to experience a few market cycles. The bottom line is that when you are a trader there will be certain times when the moons align and stocks do exactly as you desire them to do.

Then, all of a sudden, out of the clear blue, things change. Reversals set in, stocks that went up every day now fall back to Earth and the general mood abruptly shifts from euphoria to disgust.

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We have all met a person that tries their hand at trading during one of these euphoric cycles, putting some capital on the line only to see it grow rapidly. They increase their exposure, not understanding risk management, and sooner or later they are squashed like a little bug when the market turns on them. Unfortunately, when a person goes through this cycle they are often done with trading forever. They immediately feel as if the game is rigged against them and trading stocks is a sucker’s play.

Markets have and always will move in cycles. The key for every trader is to first realize, recognize and respect this choosing to trade with the trend or go with the wind at your back. If you favor the long side, as most do, then learning when to step aside and let the market run its course is extremely valuable.

Jessie Livermore, one of the greatest traders of all time, used to say that “you can beat a horse race, but you can’t beat the races.” He would often say this as he was preparing to embark on one of his many trading vacations when he simply didn’t have an edge on the market.

Dave Landry says that every trading methodology has its “sweet spot”. Knowing and understanding your methodology, knowing when it works best, and when it doesn’t work well is key to trading that methodology successfully, regardless of the method. If you’re a trend follower, for example, choppy markets will be very difficult for you. Being able to recognize those difficult market environments will help you, and allow you to back off and preserve your capital by trading smaller or not trading at all.

One of the hardest things for a trader to do is to stop trading. The general understanding is that successful traders are always in motion, seeking out trades long, short or a mix of both. While there are many who follow this path, the most successful traders I have ever come across know when to play and when to sit. They have no desire to risk hard earned gains or deplete unnecessary capital when the market does not favor their style.

The biggest challenge for participants is to actually recognize when these trends are changing. I have often found that probing individual stocks is the best method for learning of what the market is truly doing but it can also be an extremely dangerous thing to do as small losses can mount creating substantial damage.

Typically, whenever I start to see trades not act as I would desire them to, I immediately reduce my position sizing dramatically. I will continue to incur small nicks but I seek to limit them and chalk them up to research expenses.

Eleven Rules January 6, 2008

From Guy Lerner, of The Technical Take, comes this excellent commentary:

11 Rules For Better Trading In 2008

Trading in the markets is a process, and there is always room for self improvement. So as we start the new year, here are my 11 rules that help me navigate the markets. By no means is this list exhaustive or exclusive.

Rule #1
Be data centric in your approach. Take the time and make the effort to understand what works and what doesn’t. Trading decisions should be objective and based upon the data.

Rule #2
Be disciplined. The data should guide you in your decisions. This is the only way to navigate a potentially hostile and fearful environment.

Rule #3
Be flexible. At first glance this would seem to contradict Rule #2; however, I recognize that markets change and that trading strategies cannot account for every conceivable factor. Giving yourself some wiggle room or discretion is ok, but I would not stray too far from the data or your strategies.

Rule #4
Always question the prevailing dogma. The markets love dogma. “Prices are above the 50 day moving average”, “prices are breaking out”, and “don’t fight the Fed” are some of the most often heard sayings. But what do they really mean for prices? Make your own observations and define your own rules. See Rule #1.

Rule #5
Understand your market edge. My edge is my ability to use my computer to define the price action. I level the playing field by trading markets and not companies.

Rule #6
Money management. Money management. Money management. It is so important that it is worth saying three times. There are so few factors you can control in the markets, but this is one of them. Learn to exploit it.

Rule #7
Time frame. Know the time frame you are operating on. Don’t let a trade turn into an investment and don’t trade yourself out of an investment.

Rule #8
Confidence and conviction. Believe in your strategies and bet wisely but with conviction. There is nothing more frustrating than having a good strategy work as you expect, yet at the end of the day, you have very little winnings to show for your efforts.

Rule #9
Persistence. It takes persistence to operate in the markets. Success doesn’t come easy, and if it does, then I would be careful. Even the best strategies come with losses, and they always seem to come when you get the nerve to make the big bet. Stay with your plan. If you have done your home work, the winning trades will follow.

Rule #10
Passion. In the end, trading has to be about your bottom line, but you have to love what you do and no amount of money is worth it if you aren’t passionate about the process. No matter how much success you enjoy, in the markets you can never stop learning.

Rule #11
Take care of yourself. No amount of money is worth it if your health is failing or you have managed to alienate yourself from family and friends in the process.

The pointer comes via The Big Picture. Thanks Barry. Great stuff.

A Baker's Dozen January 3, 2008

From Barry Ritholtz, of The Big Picture fame, comes a list of thirteen “Lessons from 2007″.

Here are the bullet points – go check out the full column for Barry’s ‘elaboration’:

• Ignore market rumors
• Buy sector strength (Corollary: avoid weak sectors):
• Never blindly follow the “Big Money” (a/k/a Professionals make dumb mistakes also):
• Day-to-day stock action is noise
• P/E matters less than you think
• Ignore deteriorating fundamentals at your peril
• Nothing is more costly than chasing yield
• Know what you own
• Simple is better than complex
• Stick to what you do best
• Fess up!
• Risk management matters
• The Trend is still your friend

Small Things Matter January 1, 2008

For all of you traders out there putting together your New Year’s resolutions, here are some thoughts on trading psychology from Joe Ross at TradingEducators.com:

Ask many experienced traders to describe their most profitable trade, and you’ll hear a fantastic story. It’s usually purely chance. I know it was that way for me on a number of occasions. For example, the trader may have been going long on a large position when suddenly a report came out that shocked the market. Prices shot up as the public heard the news, and the trader made a killing. These stories are thrilling. They inspire you to sharpen your trading skills and master the markets. Who doesn’t want to be at the right place at the right time? But if you want to be a profitable, consistent trader, you can’t sit around waiting for a fantastic trading opportunity to present itself. Most of the time, trading is about making trade after trade to the point that it seems boringly routine. Rather than seek out big, exciting trades, it’s important to remember that small trades matter a lot.

As thrilling as big trades seem to be, it’s the smaller trades that keep you in business. It’s not unusual for traders to feel they have reached a plateau when trading. They make trade after trade and little seems to happen. They don’t suddenly find the Holy Grail of trading and achieve the great wealth and status they’ve dreamed about. Whether they realize it or not, however, they are still making progress. Each new observation of the market, each trade they execute, no matter how small, adds to their wealth of knowledge. They intuitively learn what to do and what not to do. They may see a slight variation in chart pattern that creates an inefficiency in price and learn just how far the pattern can deviate from the norm and still forecast the most likely movement of prices. On another day, they may learn a new way to place a protective stop so that they protect their risk, yet don’t get stopped out prematurely. These small everyday, seemingly insignificant experiences matter a lot.

Trading is challenging. Few survive trading over many years. The traders who do survive, however, know how to stay focused and patient. They don’t go for quick thrills, and unrealistically huge profit objectives. They know that losing is easy and can happen in the blink of an eye, but rebuilding capital usually takes a lot of work over a long period of time.

Instead of going for risky, exciting trades, you must seek out high probability setups, take steps to protect your capital, and execute your trades decisively, according to your trading plan. You may not have an exciting tale to brag about, but you take home steady profits–you get paid to trade. And when you make trade after trade, the small profits add up, and you end up with big profits in the end.

So when you feel that your earnings have reached a plateau, don’t get discouraged. As long as you are making profits, and staying in business, you’re continuing to develop your trading skills. You’re adding to your knowledge base. You’re developing a more intuitive feel for how the markets operate. It may not seem like you’re making the profits of a trading wizard, but if you keep at it, you’ll be one of the rare few that join the ranks of winning traders.
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Trade what you see, not what you think!