Not What You Think February 24, 2009

…or what you’re told.

As a follow-up to the previous post on retirement accounts, BMB would like to point – again – to John Mauldin’s column from this past weekend. We mentioned it here previously with regards to the beginning of the piece, where John outlined the problems unfolding in Eastern Europe.

But the latter half of the article dealt very well with the real truth about long-term returns in the stock market. As a matter of fact, the second part of the article was published separately at Minyanville, under the title “How to Time the Market (Really)”.

If you’re one of those that it still reciting the ‘buy-and-hope-hold’ mantra, it’s probably worth your time to read it.

Contrary to the studies that show investors they can expect 7% or 9% or 10% by staying in the market for the long run, the stock market isn’t paradise either. Like Texas summers, the stock market often seems like the anteroom to investment hell.

Historically, average investment returns over the very long term (we’re talking 40-50-70 years) have been some of the best available, but the seasons of the stock market tend to cycle with as much variability as Texas weather. The extremes and the inconstancies are far greater than most realize. Let’s examine the range of variability to truly appreciate the strength of the storms.

In the 103 years from 1900 through 2002, the annual change for the Dow Jones Industrial Average reflects a simple average gain of 7.2% per year. During that time, 63% of the years reflect positive returns, and 37% were negative. Only five of the years ended with changes between +5% and +10% — that’s less than 5% of the time. Most of the years were far from average — many were sufficiently dramatic to drive an investor’s pulse into lethal territory!

Almost 70% of the years were “double-digit years,” when the stock market either rose or fell by more than 10%. To move out of “most” territory, the threshold increases to 16% — half of the past 103 years end with the stock market index either up or down more than 16%!

Read those last two paragraphs again. The simple fact is that the stock market rarely gives you an average year. The wild ride makes for those emotional investment experiences which are a primary cause of investment pain.

The stock market can be a very risky place to invest. The returns are highly erratic; the gains and losses are often inconsistent and unpredictable. The emotional responses to stock market volatility mean that most investors do not achieve the average stock market gains, as numerous studies clearly illustrate.

Simply Put February 9, 2009

Trading can be difficult at times, especially when the market is a mess. But there are two simple things to remember: know when to sell, when not to, and cut your losses so you can stay in the game.

From Deron Wagner this morning:

Even if you make a lot of mistakes in your trading business, you’ll still be net profitable at the end of the year if you simply do two things right; cut your losing trades as soon as they hit their stops and let your winners ride until there is a technical reason to sell. The challenging part, of course, is applying this in actuality, not only understanding it theoretically.

It's In There February 3, 2009

More today from Quint Tatro on becoming a better trader — he tells us why he lets the charts do the talking:

When I think of a stock chart, I’m reminded of the old spaghetti sauce commercial where a woman stirring a big pot was being asked over and over about certain ingredients. “Basil?” “It’s in there.” “Oregano?” “It’s in there.” And so on. Stock charts are very similar to that pot of sauce: They’re nothing more than a collaboration of all public information, and debatably, all private information as well. “Insider selling? It’s in there. Insider buying? It’s in there. Earnings growth? It’s in there.” And so on.

While I do review news to understand what’s going on, and I also study fundamentals, I rarely will let these things alter my decision-making, choosing to stick solely with the chart as my final guide. Typically, after someone joins me on Tickerville.com and starts to trade alongside me, at some point I’ll face some good questions that always go back to the spaghetti-sauce commercial: “Quint, what do you think of the recent insider selling? Quint, what do you think of last quarters earnings? Quint, what do you think about management?” I always instruct the individual that I’m rarely (if ever) concerned with these things and will always choose to stay focused on the chart. Why? You got it – because, “it’s in there.”

While a chart is nothing more than historical price and volume plotted between 2 axis lines, if viewed properly it’s the window into how people really feel about the company and its prospects for the future. Furthermore, because of human nature and the greed factor, many will debate that it also holds the secrets to the future, as charts so often mysteriously give hints when something big is coming.

People are often baffled when a stock goes on a big run only days before a major announcement, or starts to fall on no news only a few days before a terrible quarter is announced. However if you want to interpret what’s happening to create this, the bottom line is, the chart was telling you something was coming.

—

Charts can be broken down into time frames, of which we’ll speak more on tomorrow. For the time being, most are saying to remain very cautious. When stocks like General Electric (GE), Microsoft (MSFT) and 3M (MMM) are trading at multi-year lows, it’s definitely something to respect.

Regardless of who you are or what level of trader you are, I firmly believe that learning to stick with the chart (and the chart alone) will go a long way in making you a better trader.

Respect the Trend February 3, 2009

More simple, but useful, trading advice from Quint Tatro:

One of my favorite trading tales involves a very wise, veteran trader who, when asked his thoughts on the market, would simply respond by saying “It’s a bull market,” or “It’s a bear market.” Younger traders simply seeking out a hot tip from the seasoned pro would often leave discouraged – or even annoyed, believing they were being fed a line. JL himself didn’t understand until years later the wisdom that was actually being dispensed with those words: The veteran was simply relaying the path of least resistance, or the trend for the general market, and therefore giving the trader an incredible edge in determining one of the many variables that makes up stock trading.

—

Traders should equate the general market to that of a big river with individuals stocks as floating logs. If ones objective was to ride in the general direction of the current, they would not stand on the bank looking for a log that was bucking that trend? Furthermore, even if they found one that temporarily headed in the wrong direction, more than likely it would only be a matter of time before the log reversed course and also headed in the way of all the other logs.

—

Traders would be wise to understand there are 3 directions a market can travel; up, down or sideways. As long as we trade stocks, this will be true – and just as valuable as Livermore’s seasoned trading friend’s advice was then it would be today.

Markets, like rivers, don’t change courses overnight – or even in a few days. It often takes many months if not years to properly establish a trend. Simply pull back any weekly chart over the past couple years and assess where the trend is going. If you aren’t quite sure, then more than likely cash remains the place for you.

Understand this basic, yet key, principle of trading, and you will already be well ahead of most.