Sunday, January 30, 2011

Trading thoughts.....

As I look over the last few posts that I have made on this blog I am struck by the contradictions in the posts. As the title of this blog states, these are the "mental meanderings" of this poster. Since my interest in economics and markets is an attempt to make money for myself, perhaps for clarity's sake I should explain how I have learned to let the markets, equity markets in particular, give me money.
From the beginning about fifteen years ago, I was fascinated by the way prices move. Somewhere there, someone advised me to make my own charts. So I watched 20 min. delayed prices, reloading the pages every 2 minutes or 5 minutes and using graph paper, constructed charts. Mostly commodities at that time. It didn't take long before I began to develop "a feel" for the price action. At the same time that I was doing this I was reading everything I could find on trading. I came across an old book called "Reminiscenses of a Stock Operator", the story of Jesse Livermore. I loved the story, but it took many years before I really understood it.
My initial efforts at trading led to quick losses. I had started in the futures markets, so it is no surprise that I lost quickly. Being the stubborn sort, and not inclined to let those losses stand, I decided that if I had done the opposite trades I would have made money instead of losing. Those initial trades were the result of a Ken Roberts "course" in trading. A little reading later and I saw that I was trying to pick tops and bottoms using his methods. A low probability strategy. So my first lesson to be learned was, "the trend is your friend".
Since those initial efforts were chart oriented in nature, I began to study technical analysis. For the uninformed, technical analysis is the study of price movement and volume as an indicator of future price moves. At that time we were in the middle of the big bear markets in commodities. Later, I read a book on the Turtle Traders, who were traders that some wealthy individuals brought in "off the streets" and taught them to trade using trend following techniques. In that book they talked about how anyone could be a succesful trader if you followed rules strictly. Most of the turtle traders went on to become very successful. I noticed for many years later that I had a bias to the short side. As if I had been imprinted in my trading infancy to sell short in those long bear markets.
I read stuff by Curtis Arnold and Alex Elder on chart reading and the psychological aspects of the market that those patterns represented. I paid attention to my own emotions and how I felt about winning and losing. I was trading stocks by this time, having learned the disadvantages of the leverage in the futures markets. Also a big psychologic lesson. Trading too big makes a trader like a poker player who is sitting in on a high stakes poker game that he has never been in before. He is the scared money. Fear and apprehension makes for poor decisions. So I learned the value of money management. Keeping the bets small. Much harder to do than it sounds, particularly when you start to develop some skill at chart reading. You see a pattern start to unfold, price start to move like you anticipated, and you want to make alot of money quickly. You put on a big trade, and then it turns out that you are wrong. Not only are you wrong but you've got a big bet on. This leads to the temptation to let the bet ride, particularly as the losses mount. You tell yourself that you'll wait until the price moves in your favor and then you will close out the trade. But when the price then moves in your favor, you don't sell because you HOPE that you can be made whole. In the end the price moves against you so much that you take a big loss. This has the effect of making you afraid to trade. I remember taking those "big" losses in the gold market when I first started. I didn't even look at a gold chart for years. Same thing in stocks. Those big losses caused me to not look at those stocks and subsequently miss some big moves that later happened. So I began to learn money management. It was in "Reminiscenses" that I finally made sense of Livermores money management rules. He bought in 1/3's. Buy a one third position as the market starts to move the way you thought, wait for it to show you by the price and volume that it is a valid move, then buy another 1/3. Repeat this for the last 1/3. And then sit. By doing it this way, you are sure that you are trading with a trend. The price is continuing on a trend while you are putting on your full position. And when you finally have a full positon on, you have been making profits all along. I always keep my average price figured. Sometimes the trend will change and it is pretty easy to get out at break even. Sometimes the trend continues, and then the hard part is to let it continue. As the profits build, pullbacks happen and can cause alot of anguish about letting some paper profits get away. The hardest part about trading well is sitting tight on a profitable position. It is human nature to want to take a quick and easy profit. I still tend to take profits too early, but have gotten alot better over time. This leads to the second rule of good trading. "Cut your losses, and let your profits run". This can be done over any time frame. In other words, the markets act similar in price action whether I am thinking in a time frame of a single day or a year. In fact, when looking at a chart it is hard to tell the time frame of a chart if it is not written on the chart. Five minute bars will look the same as weekly bars.( Patterns will form on both. Or not. Sometimes there are no patterns discernable.) The point being that one can trade over a short time frame, or "invest" over a longer time frame using these same rules. And it really doesn't matter which markets either. Stocks, bonds, commodities. All they really are is money. That is what you are trading. Money.
Another hurdle I had to get over was worrying about all the money my broker was making off my trades. One of the common excuses I have heard others make is that they stick with a losing position because it will cost them a commission to get out. That is silly. Why let an adverse move in price cost you hundreds of dollars to avoid paying a $10 commission? I'll tell you why, because a trader hates to admit when he is wrong! And that same trader will not get back into that same stock when it starts going in the direction that he had initially thought it would if he took a previous loss. It is pride and ego. I found that I had to quit worrying about what someone might think if they knew how often I got in and out of a stock. Sometimes it takes a few trys to get a good position pricewise. In other words, I need that stock to be showing me a profit right away. If it doesn't, my timing must be wrong. Now of course you have to be adequately capitalized to be able to trade frequently. Commissions have to remain a very small percentage of the size of each trade. This is one of the psychological hurdles to starting in trading. Having a big enough account so that the commisions don't drive you to distraction.
The above paragraph also brings to mind another point. And that is that if you tell all of your friends what your bets are, you will dread them asking you how it turned out. If you dumped the position because it just wasn't "acting right", that is hard to explain to most people. And then a stock can make a big move, but you can find no high probability entry point. That is the point of technical analysis after all. To find those times when the odds of a price move are higher than other times. Sometimes you just shouldn't be in the market. But most lay people don't understand trading, so I have found that I am better off not talking about the trades I have on due to the internal conflicts that I cause myself. If I make predictions I lock myself into a mindset about the future. I can still have that mindset, but from a tactical point of view I have to let the market action dictate my bets. So I reserve the right to change my mind if the facts have changed. There are a couple of good rules in there also...."Neither a tip giver, nor a tip taker be".
Over the years when I have had periods of losses I have noticed that if I close out my positions and wait awhile I can usually come back and be profitable. There is nothing like being out of the markets to give some perspective on those markets. I am reminded of one of the "Market Wizard" interviews, when asked what his secret was, he threw the chart book on the floor and got up on the desk to look down at the chart. The point being, keep the "big picture" in mind. Always look at the big picture. Being out of the markets let me do that much better. I have tended to think of a herd of cattle. If I am in the middle of the herd it is very hard to tell which way we are all going.And if the herd panics I can get trampled quickly. But if I get outside the herd it is easy to see which way the herd is moving. Also to see how big the herd is, and to see hazards the herd may encounter. In trading, my best and quickest profits have come when I could be correct about when the herd was wrong. Either the herd has to buy to get right with the market, or they have to sell to get right. When a herd panics is best. Losses cause traders to act impulsively. It is those times that markets are not efficient... It is hard to be outside of the herd/market, but gives good perspective. The hard part is being patient and waiting for the right moment. Herds can move in the "wrong" direction for extended periods.
These are just some thoughts today. It is very possible to make consistent profits trading. I hope that some who may read this will find it helpful.

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