1. TANSTAAFL: There ain’t no such thing as a free lunch.
2. Incentives matter; incentives affect behavior.
3. Economic thinking is thinking on the margin.
4. The only way to create wealth is to move resources from a lower-valued to a higher-valued use. Corollary: Both sides gain from exchange.
5. Information is valuable and costly, and most information that’s valuable is inherently decentralized.
6. Every action has unintended consequences; you can never do only one thing.
7. The value of a good or a service is subjective.
8. Creating jobs is not the same as creating wealth.
9. The only way to increase a nation’s real income is to increase its real output.
10. Competition is a hardy weed, not a delicate flower.
Archives of “corollary” tag
rssTwo Corollaries
Corollary 1
If most of the money that is lost in the markets is lost by traders who thought they knew which way the market was supposed to go, then most of the opportunity that is missed in the markets is missed by those who couldn’t possibly believe the market would go that expected distance — but in the opposite direction.
Corollary 2
If most of the money that is lost in the markets is lost by traders who thought they knew which way the market was supposed to go, then most of the money to be made in the markets is made at the places where most traders are proven wrong and stopped out.
Dormeier, Investing with Volume Analysis
In addition to his “real” job managing money, Buff Pelz Dormeier develops technical indicators. He shares some of the fruits of his—and his noteworthy predecessors’—labor in Investing with Volume Analysis: Identify, Follow, and Profit from Trends (FT Press, 2011).
When I started reading this book I suspected that it would be like so many others: long on generalities and short on actionable ideas. The first hundred pages or so do indeed deal with general relationships between price and volume, and some of the material is familiar. But even the familiar material is often presented in an unusual way. Here’s one example.
Newton’s second law of motion, reinterpreted to apply to financial markets, analyzes “how much volume (force) is required to move a security (the object) a given distance (price change) at a given speed (acceleration/momentum). … Richard Wyckoff referred to this principle as the law of effort versus result, which asserts that the effort must be in proportion to the results.” (p. 47) As a corollary of this law, “if more volume (force) is required to produce less price change (acceleration), then the stock is becoming overly bought or sold.” (p. 85)
In apparent contradiction to Wyckoff’s law of effort is the rule of trend volume, according to which “more volume substantiates a stronger trend.” (p. 85) Can these two principles be reconciled? Dormeier suggests that they can, once we bring the notions of strong hands and weak hands into the equation. His discussion is too detailed to summarize here, but it is premised on how strong hands and weak hands play the game. As he writes, “Strong hands buy out of an expectation of capital appreciation. Weak hands buy out of greed and the fear of missing out on an opportunity. Weak hands sell from the fear of losing capital. Strong hands sell to reinvest in better opportunities (which does not have to be other equities).” (p. 87)
Dormeier really hits his stride when he turns “general volume principles into indicators with numerical values.” (p. 113) These indicators have a dual mandate—to lead price and to confirm price. But they don’t all work the same way; they are “tools, each of which is designed to explain a distinct piece of the volume puzzle.” (p. 117) (more…)
13 Trading Rules
- Let winners run. While momentum is in phase, the market can run much further than might be expected.
- Corollary to that rule: Do not exit winners without reason!
- Be quick to admit when wrong and get flat.
- Sometimes a time stop is the right solution. If a position is entered, but the anticipated scenario does not develop then get out.
- Remember: if one thing isn’t happening the other thing probably is. Historically, this has never been good for me…
- Be careful of correlations. Several positions can often equal one large position bearing unacceptable risk. Please think.
- I am responsible for risk management, money management, trade management, doing the analytical work and putting on every trade that comes.
- I am not responsible for the outcome of any one trade. Markets are highly random. I do not have a crystal ball. I am not as smart as I think I am.
- Risk management is the first and last responsibility. I can make almost any mistake and be ok as long as I do not violate my risk management parameters.
- Opportunity comes every day. Do not neglect the work. Must do analysis every day.
- Opportunity comes every day. Get out of poor positions. Move on.
- I am a better countertrend trader than a trend trader. Sometimes the crowd is right, and they will run me over at those times if I’m not quick to admit I’m wrong.
- If you’re going to do something stupid, at least do it on smaller size.
MURPHY’S LAWS FOR TRADERS
1. It is morally wrong to allow a sucker to keep his money 
2. Everyone has a trading strategy that won’t work
3. For every expert who says prices are going up, there is one who says they are going down
4. If you can drink it, don’t trade it
5. The market is not logical; it is psychological
6. The successful speculator is one who dies before his time comes
7. If you drop a dead cat far enough, it will bounce
8. The market goes your way the day after your stop was hit
ITS COROLLARY
9. The big move begins the day after your option expires
10. He who sells uncovered options goes broke
11. If you feel like doubling up a profitable position, slam your dialing finger in the drawer until the feeling goes away
12. The perfect strategy works every time until you start using it
13. If your strategy seems to be working well, you haven’t been using it long enough
14. The guy who owns the horse when it dies is the loser
15. When it comes to luck or skill, you can’t beat luck (more…)
Cut your losses and let your winners ride
This quote is the perfect corollary to Livermore’s. Just as he preached “sitting”, letting your winners ride is the same idea. If you have on a position and it’s working, let it make you money. Don’t cut it prematurely for the sake of booking a small profit. Don’t get scared and exit on the first reaction, when all of your trading rules dictate staying in. If it’s a winner, and it’s working, then let it ride. Winners are good—embrace them.
The important flip side is how to treat losing trades. The first lesson is that losers have to be cut at some point. Otherwise, a losing trade can keep eating away at your P&L, undoing the profits from any winning positions. If you cut losses at a pre-defined level, then they stop—and presumably your wins can be larger than your losses.
The math behind this is compelling. If you assume that your average winner make 1.6x what your average loser loses, then you only need to be right 40% of the time in order to make money consistently. By keeping the leash short on your losses, then you can let the math of statistical expectation work in your favor. Cut losses and let your winners ride.
There is another aspect to this. A loser isn’t just a trade where you get stopped out at a pre-defined loss limit. Imagine a trade that isn’t making money and has just been languishing on your books—this is also a loser. Cut it, free up financial and mental capital and move on.
Learn from Rafael Nadal
As I was watching Rafael Nadal put away Novak Djokovich this Monday night to win his first US Open, I couldn’t help but compare the qualities he has leveraged in improving his game to that of an aspiring trader. Nadal has literally willed himself into becoming the best tennis player in the world, amazingly enough, at a time when the best player possibly in history (Federer) is still in his prime. I was at the US Open earlier this week and marveled at how easy Federer positioned himself for each shot, and the best word I could use to describe him is efficient. Nadal however, can be best described as a machine that doesn’t quit. As I broke his game down, I realized that so many of the qualities he possesses have a corollary in the trading world.
- Expand your playbook: When Nadal burst onto the scene, he was a dominant clay court specialist. Despite the incredible success early in his career on clay, his game needed improvement if he wanted to duplicate his success in other venues. He worked very hard to not only improve his serve, but also his net game to the point each of these areas are now pluses, on top of being the top baseliner in the game. He eventually won Wimbledon which is an incredible accomplishment for a player groomed as a baseliner. With the US Open under his belt, he is also one of the few to accomplish a career grand slam. A trader should not get too comfortable with only one setup, as the market will eventually change and render that setup less effective. Traders should constantly look to expand their playbook in order to have options in adapting to the markets. Being great at one play is very important, and should not be minimized, but traders should be willing to stretch themselves in order to improve as a trader.
- Eliminate Mistakes: As I was watching the final set on Monday night, they mentioned that Nadal hadn’t made a single unforced error in the final set yet. I think he ended up with a single error in the last set when it was all said and done. This is flat out ridiculous. Nadal was playing someone who was at the top of their game and slugging it out toe to toe for many 20 plus shot rallies. This is probably one of the biggest reasons he is at the top right now. He doesn’t give away points; he makes the other player earn it. As a trader, you must eliminate needless mistakes. It is hard enough to take money consistently from the markets, let alone if you are struggling with mistakes. Common mistakes could include, trading sub par setups, letting stops slide, or not sizing a position properly. Make sure your trading methodology is clearly defined, and then trade it well.
- Plays every single point: Another amazing quality Nadal has is the unwillingness to give up on a point. I’ve seen Nadal up 40-Love, standing 3 feet behind the baseline when his opponent hits a drop shot. This is a scenario where many players would concede the shot, content to be up 40-15 on the next point. I don’t think I have ever seen Nadal concede the shot. He hustle’s for every ball, which forces his opponents into more errors as they try to hit perfect shots. As a trader, you certainly don’t want to overtrade, but your job as a trader is to take advantage of opportunity when it is presented. You can’t do this if you are not at your desk waiting for each opportunity. Beyond just being there, you must be prepared, whether that entails pouring over charts before the markets open or running through potential market moving news events. It takes a high level of concentration to be able to sit and watch the markets for hours on end, especially when it is dull and lifeless, but all it takes is one single opportunity to make a traders day.
- He is in excellent shape: Nadal may be in the best shape on tour. He slugs away for hours on end, and may hit the most balls overall on tour. If you think about it, his game is predicated on prolonged rallies which he usually wins. You must be in excellent shape in order to withstand 4 or 5 hours matches several times in a 2 week period. While a trader doesn’t have to be in the same physical shape as a world class athlete, being in good shape helps a trader remain balanced through the day and traders should definitely be well rested. One of a traders most important qualities is the ability to stay focused. Remaining focused is much easier when a trader isn’t dealing with ups and downs of a high sugar diet or dealing with only a few hours of sleep. While a trader can certainly deal with being tired once in a while, they will surely have frequent concentration lapses if they are in a constant battle with their diet and rest schedule.
Traders who are not happy with their performance should take a hard look at themselves and ask are they working hard enough. Nadal could have been content to win a few French Opens and hang around long enough in other tournament to get some decent payouts, but he kept working at improving his game. He has managed to become the best player in the world, and is already on his way to becoming one of the all time greats. When someone is this successful, it is never simply from talent alone. The Michael Jordan and Tiger Woods of this world do happen to be talented, but they also outwork their peers and are never satisfied.
Traders should constantly be looking for ways improve their game as the markets are one opponent that is also constantly evolving. It’s also worth noting, that a traders biggest adversary is themselves, much like any athlete who performs in a non team sport. It is not that easy to have lasting success in this field, but the ones who do have certainly adapted by constantly improving themselves.