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Quote from Benjamin Graham (1934)

The market is not a weighing machine, on which the value of each issue is recorded by an exact impersonal mechanism, in accordance with its specific qualities. Rather, should we say that the market is a voting machine, whereon countless individuals register choices which are the product partly of reason and partly of emotion.

Ignorance, Greed, Fear and Hope

Ignorance, Greed, Fear and Hope

In the book “Reminiscences of a Stock Operator,” Edwin Lefevre writes: 
The speculator’s deadly enemies are: Ignorance, Greed, Fear and Hope.

In today’s commentary we will take a look at “Hope” and see why it is one of the four deadly enemies of successful market timing. 
Each of us has a desire for success. That is why we use market timing in our investing. Not only to increase our gains in both bull and bear markets, but importantly to protect our capital against loss. 
But that same desire for success can stand in the way of our ability to recognize reality, even if it is right before our eyes. All of us have a survival instinct that typically causes us to focus on good news. Bad news is avoided, or at least put on the back burner. 
When we take a position in the market, whether bullish or bearish, we hope it will be successful. Hope can be such a powerful emotion, that when the same trading plan that told us to enter a position originally, reverses and tells us to exit immediately, our emotions may very well focus on the possibility that if we just hold on a bit longer, any loss may be erased.  (more…)

The 10 trading commandments

1.) Respect the price action but never defer to it.

Our eyes are valuable tools when trading, but if we deferred to the flickering ticks, stocks would be “better” up and “worse” down. That’s backward logic.

2.) Discipline trumps conviction.

No matter how strongly you feel on a given position, you must defer to the principles of discipline when trading. Always try to define your risk and never believe you’re smarter than the market.

3.) Opportunities are made up easier than losses.

It’s not necessary to play every day; it’s only necessary to have a high winning percentage on the trades you choose to make. Sometimes the ability not to trade is as important as trading ability.

4.) Emotion is the enemy when trading.

Emotional decisions have a way of coming back to haunt you. If you’re personally attached to a position, your decision-making process will be flawed. Take a deep breath before risking your hard-earned coin. See related link.

5.) Zig when others zag.

Sell hope, buy despair and take the other side of emotional disconnects. If you can’t find the sheep in the herd, chances are you’re it.

6.) Adapt your style to the market.

Different investment approaches are warranted at different junctures, and applying the right methodology is half the battle. Map a plan before stepping on the field so your time horizon and risk profile are in sync.

7.) Maximize your reward relative to your risk.

If you’re patient and pick your spots, edges will emerge that provide an advantageous risk/reward. There is usually one easy trade per session if you let it show itself.

8.) Perception is reality in the marketplace.

Identifying the prevalent psychology is necessary when assimilating the trading dynamic. It’s not what is, it’s what’s perceived to be that dictates the price action.

9.) When unsure, trade “in between.”

When in doubt, sit it out. Your risk profile should always be an extension of your thought process and when unsure, trade smaller until you establish a rhythm.

10.) Don’t let your bad trades turn into investments.

Rationalization has no place in trading. If you put on a position for a catalyst and it passes, take the risk off — win, lose or draw. Good traders know how to make money but great traders know how to take a loss.

There are obviously more rules but I’ve found these to be common threads through the years. Where you stand is a function of where you sit. So please understand that some of these guidelines may not apply to your particular approach.

As always, I share my process with hopes it adds value to yours. Find a style that works for you, always allow for a margin of error and trade to win, never trade “not to lose.”

And remember — any trader worth his or her salt has endured periods of pain but if we learn from those mistakes, they’ll morph into lessons. For if there wasn’t risk in this profession, it would be called “winning,” not “trading.”

The Education of a Speculator – Victor Niederhoffer (Great Quotes )

I always mark possible quotations when reading a book. This book is so full of them! Here are some random excerpts:

  • “Risk taking…is positively correlated with how well we feel about ourselves.” (page 113)
  • “One thing is for sure. Among the emotionally charged, you will not find one single long-term winner. Where are they? According to Bacon: “These quiet professionals are quite inconspicuous unless you look for them, because there are so many careless gamblers, crazy amateurs, jumping from one crackpot idea to another betting on hope and fear”. I show this passage to any trader in my office who is showing color or palpitation.” (206)
  • I find that Chinese handball has much to teach me about market practices. A limit order is a good tactic for Chinese trading, but a market order works best for handball trading. The direct market order against a quickly moving target frequently leads to a fast rebound against. The game is then over before it starts….I use limits orders. I don’t win fast, but the losses are a lot slower in coming.” (397)
  •  ”…chain smoking, temper tantrums, screaming…these expressions of emotion have within them the seeds of destruction. I enforce a ban against all jocularity and temper tantrums.” (207)
  • “Offering advice without expertise is aggressive ignorance.” (188)
  • “With the increasing specialization in modern times, born losers are commonplace.” (85)
  • “During the 10 years I traded for George Soros, I never heard him speak about a winning trade. To hear him talk, you’d think he had nothing but losers. Conversely, listening to the biggest losers, you’d think they had nothing but winners.” (95)
  • “Do not follow the mentally lazy habit of allowing a newspaper or a broker or a wise friend to do our security market thinking.” (114)
  • “The best opportunities come out of the clear blue.” (129)
  • “The exchange is a market ecosystem.” (353)
  • “Oracles, forecasts, and prophecies are a business. They should be evaluated with the same skepticism and savvy that would be applied to a used-car dealership.” (64)
  • “The only newspaper I read is the National Enquirer. I don’t own a television, don’t follow the news, don’t talk to anyone during the trading day, and don’t like to read books less than 100 years old.” (ix – preface)
  • “My resistance to conformity has been the bedrock of my speculative persona.” (110)
  • “…institutional learning, like the Harvard Colleges and Lincoln High Schools of Life – the kind that prepares most of us to become good soldiers, true believers, and conformists.” (110)
  • “An incapability of relying on oneself and faith in others are precisely the conditions that compel brutes to live in herds.” A quote from Niederhoffer’s intellectual hero, Francis Galton (136)

They are endless! If you are just to by one trading book, this is it. Enjoy!

Poker/Trading Similarities

pokertrading

  1. Actual winning/losing of a trade is unimportant.
  2. Each well executed trade, win or lose, is a victory.
  3. Each poorly executed trade is a defeat (even if you make money).
  4. Each move or action lacking discipline can eventually cost much more money than the original trade in the form of monetary/emotional loss.

My Trading Lessons for Traders

Read….When ever you are Free.

  • Prepare, be confident & be decisive

  • Follow my trading rules without exception

  • Plan every trade with profit exit, stop exit and risk/reward ranking

  • Trade only when you have time AND you have an edge

  • Formulate and write down a trading/investing plan

  • Exit a position at my stops and not “hope” it will recover tomorrow

  • Trade the market I actually see, not the one I think I will see

  • Focus more on what’s actually happening rather than what I wish would happen

  • Learn to prevent my skepticism and opinion over the economy from keeping me from making good trades

  • Have a plan every day to trade the market and to not let my opinions of the market interfere with my trading

  • Concentrate on rule based trade management and not the outcome of the specific trade

  • Follow price action as opposed to listening to the fundamental “experts”

  • Listen to the market signal rather than market noise

  • Don’t be afraid of making mistakes

  • To pay more attention to technical signals to determine purchase/sell points rather than emotion & personal reasoning

  • Have more confidence in my trade ideas and believe in myself more often

  • Do not have a bias but instead let the charts be the guide

  • Have the discipline and fortitude to stick to my trade plans

  • To improve my organization of stock lists and automation of stock alerts

  • Do not over-leverage

  • Select only the most favorable setups

  • Try not to over analyze every potential trade

  • Lose less when I am wrong

  • Spend less time reading words and more time reading charts

  • Stick with winners and sell the losers

  • Allocate 2-3 hours each day & 5 hours every weekend to finding attractive setups

  • Increase position size and be in the market more (more…)

  • Self-awareness

    1) the recognition that our thinking and our emotions are intertwined and both influence our perception and judgment that leads to our decisions and actions (this view also happens to be consistent what the leading brain scientists are now saying)

    2) much of our motivation – the intertwined thinking/emotion that drives our behavior – is actually subconscious, e.g. we assume we are trading the market but on other levels we are also trading our P&L and our feelings about our P&L  (and what our P&L represents to us) is just one example.

    3) when we understand (self-awareness) the underlying/subconscious motivation for our behavior we are in a better position to choose an alternative.

    Obviously, nothing can guarantee change or improvement (contrary to many claims made by pseudo “experts”), but at least an approach that emphasizes expansion of awareness puts the odds in your favor. (more…)

    Is Venting Emotion Good for Trading?

    ventingDoes venting emotion help a trader regain focus or does it exacerbate emotional and physical arousal and interfere with concentration and decision making? Research actually suggests that venting emotion after a traumatic event can lead to worse psychological outcomes. The key seems to be whether the venting allows for a reprocessing of the stressful events. If the venting leads to new ways to interpret what has happened–new perspectives–it can be helpful. If there is no such transformation of the stressful event, venting can simply amplify stress responses and reinforce them. Venting in a social manner to gain control can constitute good coping. But losing emotional control simply reinforces a sense of lost control.

    Do Stocks Fall Faster than They Rise?

    Think about it1) Markets fall faster than they rise — and options traders know this. Otherwise, arbitraging this difference would be a meal for a lifetime.

    2) Market participants perhaps anticipate that the realized volatility during a bear market is greater than a bull market. However, the problem with this analysis is one might expect to see an upward sloping volatility yield curve in out-of-the-money puts (during bull markets), and yet that does not usually occur based on my tests. Conversely, right now have a downward sloping yield curve in out of the money calls — which confirms the hypothesis that market participants anticipate slower price rises in the future. [Note to quants: I am not confusing delta, gamma and vega. I’m using options to predict terminal price at expiration.]

    3) For most humans, fear of loss is a stronger emotion/motivator than the pleasure of gain (greed). This is well documented in the psychology and behavioral finance literature. Hence, ceterus paribus, capital market participants (who have a net long position) will, as a group, pull their rip cord faster — to flee from risk — than they will embrace the possibility of profit.

    10 One Liner Rules for Traders

    Risk management- Plan your loss before planning your profit.
    Diversification- Be bullish, be bearish, be involved in various groups/markets.
    Proper Position Sizing- Trade small, trade safe.
    Effective Trading Plan- Make sure your plan works, and/or makes money.
    Cutting Losses Short- Enter a trade that offers a small loss.
    Letting Winners Run- Don’t kill your winners.
    Curbing Your Emotion- This is a bi product of trading small.

    Recommendation: Give your account the same foundation so you can participate in the activity above.
    Long: My rules
    Short: My emotion