“Trade what you see” is a common mantra among short-term traders who formulate their trade ideas from charts. But do we process information from charts in accurate and non-biased ways?
An interesting set of studies reported in the 2003 Journal of Behavioral Finance suggest that perceptual biases in what we see can skew our trading and investment decisions.
Specifically, when investors see a chart that has a salient high point, they are more likely to want to buy that stock. When the chart depicts a salient low point, they are more apt to sell. In the words of the authors, “expectations about future prices assimilated to extreme past prices.”
The authors found that, when a chart contained a highly noticeable high point, traders listed more favorable features of the stock; when the chart depicted a salient low, more negative aspects of the stock were emphasized. Their analyses suggest that charts affect investors by providing them with enhanced access to either positive or negative information about the stock. In other words, our processing of the chart creates a selective bias in retrieval, leading us to view shares in artificially positive or negative ways.
It isn’t too far from the authors’ finding to a broader psychological hypothesis that *any* highly salient feature of a trading situation may skew information retrieval, perception, and action. For instance, the salient information may be a recent large gain or loss; a dramatic market move; or a piece of news. Trading what we see might be dangerous for the same reason that it is dangerous to trade what we hear or what we feel.
When one facet of a situation becomes highly salient to us, we overweight it in our perception and information processing. Our ability to view the entire situation in perspective is compromised. What is most obvious in a chart–or in our minds–may not be an accurate reflection of underlying supply and demand in a marketplace.
Archives of “investment decisions” tag
rssVictor Sperandeo -Quotes
The key to investment success is emotional discipline. Making money has nothing to do with intelligence. To be a successful investor, you have to be able to admit mistakes. I trained a guy to trade who had a 188 IQ. He was on “Jeopardy” once and answered every question correctly. That same person never made a dime in trading during 5 years!
-Victor Sperandeo
Most people lose money because of lack of emotional discipline
-the ability to keep their emotions removed from investment decisions. Dieting provides an apt analogy. Most people have the necessary knowledge to lose weight—that is they know that in order to lose weight you have to exercise and cut your intake of fats. However, despite this widespread knowledge, the vast majority of people who attempt to lose weight are unsuccessful. Why? Because they lack the emotional discipline.
-Victor Sperandeo
In my opinion, the greatest misconception about the market is the idea that if you buy and hold stocks for long periods of time, you’ll always make money. Let me give you some specific examples. Anyone who bought the stock market at any time between the 1896 low and the 1932 low would have lost money. In other words, there’s a 36 year period in which a buy-and-hold strategy would have lost money. As a more modern example, anyone who bought the market at any time between the 1962 low and the 1974 low would have lost money.
-Victor Sperandeo
-Victor Sperandeo
Once a price move exceeds its median historical age, any method you use to analyze the market, whether it be fundamental or technical, is likely to be far more accurate. For example, if a chartist interprets a particular pattern as a top formation, but the market is only up 10% from the last low, the odds are high that the projection will be incorrect. However, if the market is up 25% to 30%, then the same type of formation should be given a great deal more weight.
-Victor Sperandeo
To use a life insurance analogy, most people who become involved in the stock market don’t know the difference between a 20 year old and an 80 year old. Investing in the market without knowing what stage it is in is like selling life insurance to 20 year olds and 80 year olds at the same premium.
Advantages of Technical Analysis
- Technical analysis is a bit of a misnomer since it is really not that technical. A better name for the use of charts to make investment decisions might be risk/reward analysis or even market psychology. Sure, there are some complex mathematical concepts involved with some of its more esoteric indicators. But at its core, technical analysis is simply a method of determining if a stock or the market as a whole is worth buying or selling. Once we identify this we are way ahead of the game with regard to assembling a winning portfolio.
- Simply stated, technical analysis is the study of data generated from the market and from the actions of people in the market. Such data includes price levels that have served as turning points in the past, the amounts of stock being bought and sold each day (volume), and the rate of change of price movements (momentum) over a given span of time. (more…)
Market Timing
“Market timing is the art of making investment decisions using indicators and strategies to observe and determine the direction of prices. Many believe that market timing involves predicting the future, when in reality, the goal of market timing is to participate in periods of price strength and avoid periods of price weakness.? |
Profitability -Market Timing
How often you are right on a trade is only half of the equation. The other half is how much do you make when you’re right and how much you lose when you’re wrong. You can remember that with this formula: Probability (odds of it going up or down) x Magnitude (how much it goes up or down) = Profitability. “Market timing is the art of making investment decisions using indicators and strategies to observe and determine the direction of prices. Many believe that market timing involves predicting the future, when in reality, the goal of market timing is to participate in periods of price strength and avoid periods of price weakness.? |
The Darvas System in a Nutshell
I truly admire author and trader Darrin Donnelly for bringing the system thatNicolas Darvas used to make over $2 million in the stock market into modern times by really setting more precise metrics for the Darvas system. He uses moving averages we have today to look at possible price supports in addition to the price boxes that Darvas used. Below is a concise summary of the Darvas system in an up trending market.
While O’Neil is a brilliant trader who has helped thousands make better investment decisions, I feel that there are some aspects of the CAN SLIM system that, frankly, aren’t all that important in picking winning stocks.
Therefore, we offer a new, easy-to-remember acronym for the Darvas System:
D – Direction of the Market
A – Accelerated Earnings and Sales
R – Relative Price Strength (and Return on Equity)
V – Volume Increasing
A – Aggressive Growth Group
S – Sound Base Pattern
To further explain:
D – Direction of the Market
Is the market, as a whole, in an uptrend? It is highly unlikely that a stock will have huge gains when the overall market is in a downtrend, so make sure the direction of the market is moving upward.
A – Accelerated Earnings and Sales
Is the company seeing increases in earnings and sales this quarter compared to the same quarter last year?
Normally, you want to see stocks with at least 40% increases in earning AND sales in the most recent quarter compared to the same quarter last year. And remember, the higher the increase in earnings and sales, the better. If you have a choice between a stock with a 50% increase and one with a 90% increase, definitely go with the 90% increase stock.
R – Relative Price Strength (and Return on Equity)
Is the stock outperforming most other stocks in terms of its price increase?
Darvas wanted to see stocks that had at least doubled over the past year before he’d consider buying. If a stock has already increased a great deal over the past year, most investors are fearful of a steep decline, but many studies have shown that Darvas was right in his assessment; if a stock had already made a powerful move, it proved that it had the ability to move in such a fashion and therefore, was likely to do it again.
Another important characteristic of ideal Darvas stocks is a high Return on Equity. Fund managers love to see a high ROE. Some put a higher value on ROE than they do earnings and sales. (more…)
7 Psychological habits
1. Overconfidence and optimism
Most of us are way too confident about our ability to foresee the future, and overwhelmingly too optimistic in our forecasts.
This finding holds across all disciplines, for both professionals and non-professionals, with the exceptions of weather forecasters and horse handicappers.
Lesson: Learn not to trust your gut.
2. Hindsight
We consistently exaggerate our prior beliefs about events.
Market forecasters spend a lot of time telling us why the market behaved the way it did. They’re great at telling us we need an umbrella after it starts raining as well, but it doesn’t improve our returns. We’re all useless at remembering what we used to believe.
Lesson: Keep a diary, revisit your thinking constantly.
3. Loss aversion
We hurt more when we sell at a loss than we feel happy when we (more…)
Emotion, Stress & Trading
I was recently asked by a member to share my thoughts on how I manage the high stress levels and how you keep emotion out of the mix. I will get to the the stress handling in a second, but let me start by addressing “keeping emotion” out of it.
While many traders say they can keep emotion out of their trading, I believe when it comes right down to it they’re being disingenuous. Unless those same traders really employ a completely robotic trading system which requires absolutely no supervision or control, that simply cannot be true. This is one of those things that I’ve seen many traders say to impress others, but in reality it just isn’t possible or even realistic.
When you have real money on the line and have also invested your own time and energy beyond that, emotion will play a significant role in every decision. After all, none of us are trading robots! We all have feelings and egos and therefore our trading and investment decisions will be impacted from those even in subtle ways that you may not even realize. The key is to learn how to use those emotions to your advantage. For some of you, trading completely contrary to your logical fears is an excellent way to make big money in the markets. Just look at all of the people who went short hoping for Hindenberg Omen type crash in August and who’ve been fighting it every step of the way!
As far as coping with stress, we all have to develop our own methods. But, this is what I’ve learned over time. For me, stress comes primarily from three things:
Not having a plan and being out of position in a challenging market
From not staying on top of my work and not sticking to my rigorous routine (usually from unforeseen events like technology issues or personal issues that all of us experience from time to time)
Stress and pressure I place on myself in hitting my daily, weekly, and monthly goals especially when I’m not performing up to my expectations
So, how do I cope with these? Here are a few thoughts… (more…)
My Favorite Quotes from “The Big Short”
I just finished reading “The Big Short”by Michael Lewis and I definitively recommend it so anyone who is even remotely interested in a career in the investment world.
Here are some of my favorite passages in the book:
On bank stocks’ book value:
He concluded that there was effectively no way for an accountant assigned to audit a giant Wall Street firm to figure out whether it was making money or losing money. They were giant black boxes, whose hidden gears were in constant motion.
Regarding the value added by sell-side analysts:
You can be positive and wrong on the sell side. But if you are negative and wrong, you get fired
On Manipulation of the masses:
How do you make poor people feel wealthy when wages are stagnant? You give them cheap loans
On Recognizing when a credit driven bubble is about to burst: (more…)
Five Timeless Rules of Investing Learned From Jesse Livermore
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“My greatest discovery was that a man must study general conditions, to size them up so as to be able to anticipate probabilities.” What did Livermore mean by “general conditions”? He meant the macroeconomic environment and geopolitics. Are they favorable or not favorable to buying stocks? Today, the Fed is raising rates and squeezing the money supply (the monetary base declined last month for the first time in years; a year ago, it was going up 10%.) The war in the Middle East is heating up. These general conditions are not conducive to a bull market, except for gold!
2. Learn from wise old men who have experience in the markets. In Reminiscences of a Stock Operator , the author talks about “the Old Turkey,” a “very wise old codger” who counseled Jesse Livermore on making good investment decisions and avoiding mistakes. How can you do this? The best way is to read histories of the great investors such as Warren Buffett, Peter Lynch, John Templeton and J. Paul Getty.
3. Learn your strengths and weaknesses. “We’ve all got a weak spot. What’s yours?” asks the Old Turkey. A good question that we must all answer. “Study mistakes,” he counsels. You don’t learn from your successes, only from your mistakes!
4. Always save some of your gains. “I was again living pretty well, but always saving something, to increase the stake that I was to take back to Wall Street.” Unfortunately, Livermore made the mistake of not living up to his own advice. He leveraged himself too much, and often went bankrupt. By taking some of your gains and investing the funds in alternative investments, such as real estate, art and collectibles, or gold coins, you protect yourself in case you are wrong.
This reminds me of something that happened to me many years ago. I had made a $2 million profit on a penny stock and my wife sat me down and insisted I pay off the mortgage, which was sizeable. I told her I preferred to reinvest the profits in more penny stocks, but she insisted, and I finally agreed with her and paid off the mortgage. It was the best decision “I” ever made! Had I invested the profits in more penny stocks, I would have lost my shirt, because the penny stocks went into a major bear market soon after.
5. Beware the charismatic financial guru! “It cost me millions to learn that another dangerous enemy to a trader is his susceptibility to the urgings of a magnetic personality when plausibly expressed by a brilliant mind.” Oh, how true. I well remember the times I invested in several tax shelters that eventually went bust, because I was thoroughly convinced by a smooth talking salesman who seemed brilliant at the time.