Thursday, August 28, 2014

Increasing Your Odds

When something is important enough, you do it even if the odds are not in your favor.Elon Musk

Trading is a profession where you can often times find yourself working against the prevailing odds. It's not like anyone can walk in off the street and start making profits on a consistent basis. Unless you take evasive action against adverse market forces, you may fall victim to overwhelming odds. Skilled traders, however, know how to put the odds in their favor, and you can too.


Trading brings out two emotions, self-doubt and overconfidence, you need to balance these two emotions carefully. Newer traders are usually optimistic at first, that is quite normal, but soon find out that trading is difficult. The markets are in many respects unpredictable and winning streaks often turn into losing streaks. The original overconfidence easily turns to disappointment and self-doubt. Avoid becoming too pessimistic or you'll never be able to pick yourself up and try again. What usually happens, though, is that you become overly arrogant to protect your ego. You may try to psych yourself up and try to beat the odds. Thinking optimistically is good, use your optimism effectively. Do not arrogantly think you know how to trade before you've built up the necessary skills. Do not take unnecessary risks and think that you can beat the markets with shear will. Persistence without the proper amount of skill will get you nowhere. Study, practice, and learn in order to build up the necessary level of skill to trade consistently. Set learning goals rather than performance goals. In other words, reward yourself for learning techniques at first, and when you are ready, you can set an overall profit goal.


Acknowledge your risks up front. Trading involves risk, learn to admit it. Traders try for the big profits, and they are ready to take the risk and the responsibility. The difference between the professionals and the amateurs is that risk is carefully managed. Since you are trying to capitalize on winning odds, your survival depends on your anticipation of a string of losing trades. That means looking at the risk to reward ratio before entering a trade, making sure that you have a large enough account to take the risk, and if you do not, reduce your position size to suit your account or stand aside and wait for a trade you can take. Risk management is a trader's secret weapon, use is to survive over the long haul.


Finally, you must use reliable trading strategies. This is so much easier said than done. You can not expect to profit if your trading strategy is flawed. But it is hard to know when it's flawed or just not working because of less than optimal market conditions for that strategy. All the trading books and experts warn "Do not abandon a trading strategy prematurely." It is not wise to jump from strategy to strategy, but what is "prematurely"? Based on probability theory, even a winning strategy can produce a string of losers and a severe drawdown, so sticking with a sound strategy too long when it's not working is going to wipe out your trading account. The best you can do is decide how much of your trading capital you will risk on the strategy up front, and if you lose that predetermined stake, move on. Trading is challenging and unless you are prepared, there are forces that put the odds against you. With the right mindset and proper risk control, however, you can move the odds in your favor, and achieve consistent profitability.


Reprint from the Prudent Trader archives

Tuesday, August 26, 2014

Index Pivot Points - 3 Time Frames

There are several different methods for calculating pivot points, the most common of which is the five point system; two support and two resistance levels.  The calculation utilize today's high, low, and close and offsets the data by one day on the chart.


If you are chomping at the bit to go short, why not wait until a pivot in your time frame gives way. What's your time frame of reference?

Thursday, August 21, 2014

Risk Aversion: The Trader's Handicap

Whatever failures I have known, whatever errors I have committed, whatever follies I have witnessed in private and public life have been the consequence of action without thought.
Bernard Baruch

You have often heard the sage advice, "Cut your losses short, let your winners run." Do you have trouble following it? Based on experience, you may think letting your winners run is easier said than done. It is not a good idea to let a losing trade mount losses to the point that the entire position is wiped out, but it's often not easy to hit upon a winning trade, and then, just sit back and let it ride. There's a strong temptation to take profits. You also are aware of the old cliché, "No one ever got hurt taking a profit?" Why you can not just let this winning trade run just a little longer. An analysis of your trade diary entries shows that if you could have held out a little longer, you would have made substantially more profits. Many traders hate to lose, and when they see a winning trade materialize, they want to lock in the profits and insure a win. Whatever you call it, it is still risk aversion. For some strange reason we are quite willing to gamble with losses, but when it comes to wins, we will take a sure thing over a gamble any day. Risk aversion is surely a weakness of many traders. If it can be beaten, traders can make significantly greater profits.

Why is risk aversion a problem? Why not just take small profits across a series of trades? It all depends on how successful your methods are. If you have methods that works 90% of the time, then you can take small profits and come out profitably overall. Unfortunately, most traders have a track record that is much lower than 90%. Obviously then for your economic survival, you must make larger profits on your winning trades. 

The sting of several losing trades can impact your pride and your ego. Losing even greater amounts of money by letting a winning trade turn into a losing trade is even harder to accept. Your conscience often tells you, "Sell now before it is too late." There isn't a simple solution to this problem. Profits can be hard to come by in the trading world; it's hard for many to risk losing a profit once they see they can lock it in by selling early. It may be hard to swallow, but winning traders tend to be those kinds of people who actually enjoy risk. They are happy to see they have hit upon a winning set of circumstances and they can't wait to see what happens. They want to push the limits and see if they can squeeze out as much profit as possible. If you aren't a natural born risk taker, it may be difficult for you to hold out and avoid selling early. If you are the kind of person who feels uneasy while a position is in motion, you may have to make an extra effort to let your profits run. One strategy is to sell off increments of the position as it rises in value so that you can ease some of the psychological pressure gradually. By taking a little bit of profits at a time, you can feel an ever-increasing sense of safety.

It is essential that you trade with money you can afford to lose. The reason most traders are risk averse is that they are trading with money they need for basic living expenses. Thus, they are risking their safety and security, and this puts added pressure on them to perform. It isn't surprising that under these circumstances, one has trouble taking risks once a position starts to increase in value. You can come up with all the rationalizations you want, but if you trade with money you deeply care about, you'll have trouble risking it, and "to make money, you must risk money." You must manage risk, and that's hard to do if you don't have a large trading account. An large trading account allows the trader to risk as little as 1, 2, or3% on a single trade and still make a substantial profit. Risk aversion is a handicap. It's hard to beat it, but many do. If you are one of the few lucky ones, you will realize substantial profits and trade consistently and profitably.


Reprint from 2005 PrudentTrader Newsletter

Tuesday, August 19, 2014

Zweig Breadth Thrust

A "Breadth Thrust" occurs when, during a 10-day period, the Breadth Thrust indicator rises from below 40% to above 61.5%. A "Thrust" indicates that the stock market has rapidly changed from an oversold condition to one of strength, but has not yet become overbought. According to Dr. Zweig, there have only been fourteen Breadth Thrusts since 1945. The average gain following these fourteen Thrusts was 24.6% in an average time-frame of eleven months. Dr. Zweig also points out that most bull markets begin with a Breadth Thrust.
According to RSInvestor Market Research the Zweig Breadth Thrust  triggers very infrequently. The idea behind the indicator is that stocks turn up sharply from oversold, but are not yet overbought. Dr. Zweig found that anytime the value goes from below 40 to above 60.5 within 10 days, the likelihood of a new bull market is quite high.  It doesn't happen very often, (only 15 times since 1945) but when it does, he claims that the average return over the next 11 months is 24.6%.
The calculation are as follows:
  • Find the number of advancing stocks
  • Find the number of declining stocks
  • Calculate the 10-day, exponential moving average (MA) of each
  • Zweig Breadth Thrust = (MA of Advancing) / (MA of Advancing + MA of Declining)
Chart from Last Night


Not quite, However, see that second dip below 40? That could trigger another count. In that case we have another day or two to make it. Stay Tuned!

Friday, August 15, 2014

The Right Mindset

I think anything is possible
if you have the mindset
and the will and desire
to do it and put the time in.
Roger Clemens

Trading requires cultivating the right mindset. You must be relaxed, logical, perceptive, and ready to tackle anything the market throws at you. Unfortunately, this sounds much easier than it actually is. Trading is a difficult profession with unique issues that other professionals do not deal with. If you can identify these issues, address them, and halt their influence, you can cultivate the mindset of a winning trader.

Why is trading more difficult than other occupations? In many professions, a group of scholars have clearly defined foolproof ways to gain success. And the leaders of a particular profession argue that if one follows these well-proven pearls of wisdom, success will surely follow. In most professions, these claims are somewhat supported, but when it comes to trading not so. Many so-called trading gurus claim to have discovered the Holy Grail, but oftentimes these claims only offer false hope to those seeking easy money. Think for a moment, I read an advertisement recently claiming 900% in 5 years. That is 180% per year. Take $10,000 at 180% per year and using the rule of 72 your money doubles approximately every 3 months. That means in 5 years your $10,000 is equal to $1,721,036, why are you working? Why are you promoting and selling this system? Think!

Seasoned traders warn, for example, "Do not trust anything you read or anything you hear." The general consensus is that most of the information out there about how to trade is suspect, and that the only way you'll ever separate the truth from the fiction is to try it all out and find out for yourself just what works and what does not. Seasoned traders also warn, "There are no universal rules for traders to follow." Conventional wisdom is only correct when it is correct. History only repeats itself when it does. Lack of consistency in the rules of the market and in how the market behaves can be disheartening. Many seasoned traders warn, "Trading is a profession where you should go in assuming you'll lose more money than you'll make." Considering this advice, it is no wonder that novice traders have difficulty cultivating the right mindset. Trading consistently seems difficult if not impossible.

The good news -> It is still possible to overcome these limitations. First, it's vital to remember that there are indeed actual traders who have studied the markets over years, made efforts to build up trading skills, and became profitable. You can't turn a $5,000 online investor account into a fortune, but with the proper trading plan, the proper attitude, and with a few simple trading rules designed by you and for you, you can become a very successful trader. Again, it's just a matter of having realistic expectations, the proper training and mentorship, and the necessary experience to trade under a variety of market conditions.

Second, the right attitude is also essential. Once you face the fact that trading is not easy money, or that you won't become rich overnight, you'll be able to prepare yourself mentally. It is merely accepting a few disconcerting facts about trading. If you know that you need a sufficient amount of capital to survive the learning curve and the draw downs, you'll manage risk properly in order to have as much trading capital as possible to invest. If you expect more losing trades than winners, you won't be disappointed when you face losing trade upon losing trade. When you know that your seemingly foolproof trading strategy is bound to fail when the market conditions change, you won't be very upset when it does indeed start to fail. By facing the cold, hard facts about the pitfalls of trading, you'll neutralize them.

Trading is a challenging profession, but there are many traders who have met the challenge and have the winning track record to show for it. By meeting the challenge through hard work and dedication, you can also be a member of this small, elite group of winning traders.


Reprint from Prudent Trader August 2005

Wednesday, August 13, 2014

Investor Scorecard

The theory behind this idea was to run a series of back tests against various instruments, looking only for, or at expectancy.  Not the amount of profit, just that fact that a profit was produced.
I ran the backtests against 6 criteria:
  • Relative Strength as measured against the Total Stock Market.
  • Relative Strength as measured against a fixed return of 10% per annum.
  • Linear regression slope of the moving average of $ weighted Advancing minus declining volume.
  • Relative position of my Dollar weighted buying power.
  • Linear regression slope of the moving average of the A/D line of the sector or index (as opposed to the NYSE or NASDAQ A/D line).
  • Finally a Linear regression slope of the moving average of the McClellan Summation index, again calculated on the sector or index.
The plus and minus signs below describe the state of that indicator, positive or negative.  A composite score of all the tests is calculated and printed. The last four columns are an estimate of the Hurst Cycles. The scorecard is run against Morningstar sectors and industry groups, and 19 indexes.  A modified version against selected ETFs by asset class.

This is run weekly for members. If you would like to compare today’s run against the 19 indexes values on April 16 of this year, click HERE! 

Friday, August 8, 2014

Becoming A Highly Motivated Trader

Our greatest weakness lies in giving up. The most certain way to succeed is always to try just one more time.Thomas A. Edison

Are you a relatively new to trading?  Are you frustrated and ready to give up? You have read many of the trading books, followed all the trading "gurus," and worked tirelessly. Yet, despite all your efforts, your account is lagging badly. 

Save heart, your experience is common. When you start out, new traders are excited. They dream of success, the recognition that huge profits will bring. Some indeed achieve early success, but many soon discover that achieving success consistently can be elusive. Many people are drawn to trading, but few can trade profitability. The winning trader is a special breed, a person who is highly motivated, but at the same time is realistic and able to persist in the face of adversity, this describes, I am quit sure, most many of you.


It's easy to get yourself "psyched up" when you first start out: You merely convince yourself, "All I have to do is apply myself and I'll achieve high profitability." This is a good positive attitude, but the "power of positive thinking" doesn't usually go very far in terms of achieving trading success. It makes you feel good, but then you find that hard work and persistence does not necessarily pay off. You need sound trading strategies you need to expose yourself to a variety of market conditions, and you must hone your trading skills. Successful trading requires talent, and there's no way to develop one's talents without extensive practice. Just think of your favorite sports hero, how often and for how long have they trained and practiced to develop their talent?


While a positive attitude is very good, a healthy skepticism is paramount. When it comes to trading, you can't believe anything your read or hear. The only time you actually know that you've stumbled upon a profitable trading strategy is when it, indeed, produces a profit. Just convincing yourself you can master the markets with sheer determination and willpower will not get you very far. You must accept the fact that, in the end, trading is like a game, a game of probabilities. Obviously you must take it seriously on one hand, but you must also learn to enjoy the process. Experienced traders take the game seriously, they acknowledge that real money is on the line and it is likely that real losses can wipe out one's account. They address this issue utilizing money and risk management (money management on your total account and risk management on individual trades). No trading strategy is foolproof.


Realize that despite all your efforts, it is quite possible that some unforeseen adverse event can go against your trade, or that current market conditions may just not be conducive to your trading plan. That's where a happy-go-lucky attitude comes in. I believe it's important to view trading like a sport. If you score the winning point, fine. But if you miss it, don't get too bogged down. Just pick yourself up and try again. Eventually, with enough practice and experience, you will move into the realm of the seasoned professional. It is not going to happen over night. It will take time and practice. And that's where the motivation comes in. It is easy to stay motivated for a short time, if you think the payoff will be large and relatively immediate. Trading is a profession where you can go through long periods with little progress. Over the years, a great deal of money will be spent on commissions, losses, apparatus, and instructional materials. 

The would-be professional trader isn't fazed by it all. He or she views the money spent on trading as similar to what any professional spends on college tuition. He or she believes that eventually, his or her time and effort will pay off. The winning trader is highly motivated. He or she admits that trading is a challenge and that success is far from assured. Despite this harsh reality, the winning trader persists until he or she achieves consistent profitability.


Tuesday, August 5, 2014

S&P + Morningstar Sector Watch

For members, I maintain rankings of Fidelity Select Funds by relative strength. The performance over the last 25 years or so has been exemplary with risk adjusted annual returns in excess of 12% and 13% (depending upon the number of funds rotated). The problem with this method is the draw downs can be quite severe at times, and I am aware of the public's propensity to panic at bottoms. Attempting to utilize a market timing technique based upon a major market average actually worsened performance; reducing the returns with even larger draw downs. 

Reason: markets top and bottom Sector by sector.  A sell signal may have occurred on a major average but our sector long position did not top, even advanced for awhile longer. That gain was lost due to the major average sell. A buy signal and buying the top ranked found that they had already moved a bit. Conclusion follow sectors and not the major averages.

Sector Watch: I have found over the years that stocks in an Overweight position surprises tend to the positive side. Those with underweight the reverse. If you are a bull look to buy the over weights, a bear look to short the under weights.