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Book Review: Market Indicators

  
  Education
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MARKETINDICATORS

Every one one us has limited bandwidth for analysis of data. We pick and choose a few ideas that seem to work for us, and then stick with them. That is often best, because good investors settle into investment methods that are consistent with their character. But every now and then it is good to open things up and try to see whether the investment methods can be improved.

For those that use market indicators, this is the sort of book that will make one say, “What if? What if I combine this market indicator with what I am doing now in my investing?” In most cases, the answer will be “Um, that doesn’t seem to fit.” But one good idea can pay for a book and then some. All investment strategies have weaknesses, but often the weaknesses of one method can be complemented by another. My favorite example is that as a value investor, I am almost always early. I buy and sell too soon, and leave profits on the table. Adding a momentum overlay can aid the value investor by delaying purchases of seemingly cheap stocks when the price is falling rapidly, and delaying sales of seemingly cheap stocks when the price is rising rapidly.

Looking outside your current circle of competence (more…)

Great Quotes of Mark Douglas

  
  Education
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“I know it may sound strange to many readers, but there is an inverse relationship between analysis and trading results. More analysis or being able to make distinctions in the market’s behavior will not produce better trading results. There are many traders who find themselves caught in this exasperating loop, thinking that more or better analysis is going to give them the confidence they need to do what needs to be done to achieve success. It’s what I call a trading paradox that most traders find difficult, if not impossible to reconcile, until they realize you can’t use analysis to overcome fear of being wrong or losing money. It just doesn’t work!”
-Mark Douglas

“There is a random distribution between wins and losses for any given set of variables that defines an edge. In other words, based on the past performance of your edge, you may know that out of the next 20 trades, 12 will be winners and 8 will be losers. What you don’t know is the sequence of wins and losses or how much money the market is going to make available on the winning trades. This truth makes trading a probability or numbers game. When you really believe that trading is simply a probability game, concepts like “right” and “wrong” or “win” and “lose” no longer have the same significance. As a result, your expectations will be in harmony with the possibilities.”
-Mark Douglas (more…)

4 Types of Traders

  
  Education
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The first type of profitable discretionary trader is the one who has a natural feel for the market.  When you talk to one of these traders and ask them about their trading at some point you’ll hear them say something about ‘feeling the market was this way or that….’. These are traders who over the years have acquired a lot of implicit knowledge of the market and its participants. They understand what moves markets and they also have the required self-trust to act on their ideas and to protect themselves when they are wrong.  Their personalities allow them to have the self-trust to know their limits and believe in their capabilities. We could call them a ‘natural born trader’; and there are very few of them. Although Jesse Livermore eventually blew-out, he’s an example of this rare type of natural trader.

 The second type of profitable trader – or more accurately temporarily profitable – is the lucky trader; the trader who’s P&L is currently in an up swing but they’ll soon be negative. Often these traders either got lucky with a number of trades and can not replicate it, or they learned the habit of holding onto losing trades and they got lucky when those positions came back. This accounts for the largest number of “profitable traders” – but for these traders the money often leaves faster than it arrived. (more…)

Durbin, All About Derivatives

  
  Education
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All About Derivatives (McGraw-Hill, 2011, a fully revised second edition) is a curious book, and I don’t say that unkindly. It’s just odd that in a book in the “All About” series, touted as “the easy way to get started,” you find such a lengthy discussion of options pricing. But then Michael Durbin is, among other things, a financial technology consultant specializing in high-frequency trading of financial derivatives, and he has helped numerous Wall Street firms develop derivative pricing and trading systems.

The structure of this book is straightforward. After an overview chapter, the author devotes a chapter each to forwards, futures, swaps, options, and credit derivatives. He then looks at using derivatives to manage risk, pricing the various derivatives, hedging a derivatives position, and derivatives and the 2008 financial meltdown. In three appendices he investigates interest, swap conventions, and binominal option pricing.

Even though this book would be a fine introduction to the subject of derivatives, it often goes beyond the elementary. For instance, Durbin points out the subtle pricing differences between warrants and options. Moreover, the book is laced with interesting tidbits. I didn’t know, for example, that Enron issued a series of credit-sensitive notes in 1998 that offered a coupon rate inversely tied to its credit rating. (more…)

When To Quit

  
  Education
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Whether you are following your own trading system, or following an advisory, newsletter or some other service, if you don’t have an exit plan for discontinuing it, you should.

Why? Studies have shown that when people are under stress, many times they make poor decisions. Certainly if you were losing money with your systems you would be stressed. Consequently, you might make a knee jerk reaction to the losses, or you may stick your head in the sand and avoid a decision all together. Both scenarios can be dangerous. So, the time when you are losing is a bad time to determine when to exit.

Ideally, you already determined when to stop trading when you first decided to trade the system. If not, it is not too late. Just determine the metric(s) that are most important to you. They could include such things as:

• Maximum drawdown

• Consecutive losers in a row

• Amount lost in a week/month/year

• Overall profit after X months

• Overall winning percentage dips below XX %

• Significant break in your personal equity trendline, or equity moving average

• New highs, or breaking of another “good” metric (yes, some people try to quit at the top)

• Anything that can be measured and monitored

The exact condition you select probably is not as important as writing it down and sticking to it. That is the key. It needs to be solid, definitive and written down. Ideally, you’ll also tell your spouse or a friend, too, since it is harder to back out when you make the proclamation public. 

I’ve heard that one money management firm’s exit criteria is 1.5 times the maximum drawdown, and a 24 month commitment. Those aren’t bad, but the best one is the one that you feel comfortable with – one you can stick with.

You’ll definitely worry less about your system’s performance if you write down and follow your exit plan – today!

THE MASTERS ON MASTERY

  
Education, Life

Success in this game depends less on strength of body than strength of mind and character.
-Arnold Palmer

It’s great to win, but it’s also great fun to be in the thick of any truly well and hard fought contest against opponents you respect, whatever the outcome.
-Jack Nicklaus

You must work very hard to become a natural golfer.
-Gary Player

I never prayed that I would make a putt. I prayed that I would react well if I missed.
-Chi Chi Rodriguez

Golf is a game that is played on a five-inch course – the distance between your ears.
Bobby Jones (more…)

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