The reason I bring this up was to share with you two reactions I got when describing these recent trades and cash holdings. I had two separate conversations in July — one with a well known Trader, the other with a Fund Manager (known in the industry, but not a household name) — about our posture prior to yesterday’s drop.
The two responses were polar opposites, 180 degree apart.
The trader respected the discipline of honoring stop losses. Good traders know that opportunistic speculation is a process. Ignore any one single outcome, focus on the methodology that can consistently avoid catastrophic losses, manage risk, preserve capital. A good process can be replicated, a random spin of the wheel cannot.
The fund manager, who was having a decent year being long high vol names (at least before Wednesday), was having none of it. “Stops are for losers” is a quote I shall long remember (and email him after he blows up). Apparently, real men have the courage of their convictions.
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Rather than fight our foibles, people should admit this error stream is real, and repair the errors of our ways as soon as we discover them. I have noticed over the years the difficulty some people have in cutting losses, admitting an error, and moving on. Way back in 2005, I wrote a piece advising investors that they should Expect to Be Wrong (originally published 04/05/05). I noted that “I am rather frequently — and on occasion, quite spectacularly — wrong.” However, if we expect to be wrong, then there will be no ego tied up in admitting the error, honoring the stop loss, and selling out the loser — and preserving the capital.
This is a recipe for investing disaster. We humans make 6 billion errors per day, at the very least. The biggest one is not acknowledging this simple truism.
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The reason I bring this up was to share with you two reactions I got when describing these recent trades and cash holdings. I had two separate conversations in July — one with a well known Trader, the other with a Fund Manager (known in the industry, but not a household name) — about our posture prior to yesterday’s drop.5 Lessons From Legendary Traders: Michael Marcus
Lesson #1: Each Trader has A Distinct Style
“You also have to follow your own light. Because I have so many friends who are talented traders, I often have to remind myself that if I try to trade their way, or on their ideas, I am going to lose. Every trader has strengths and weaknesses. Some are good holders of winners, but may hold their losers a little too long. Others may cut their winners a little short, but are quick to take their losses. As long as you stick to your own style, you get the good and the bad in your own approach. When you try to incorporate someone else’s style, you often wind up with the worst of both styles. I’ve done that a lot.”
This is a very important point: You have to find out your strength and weaknesses and develop a trading style that suits your personality best. If you are good at holding winners – trade trend-following systems. If you are comfortable with several consecutive small losses and several big wins – trade chart patterns. If you are highly disciplined and not too aggressive – you could focus only on high-quality trades which come rarely. Let your personality choose your trading style.
Lesson #2: Always Use Stops
“Always use stops. I mean actually put them in, because that commits you to get out at a certain point”
This one’s a no-brainer, but worth mentioning. Many beginners tend to discard stop losses after seeing several trades touching their stop loss and then continuing in their direction. Very wrong approach. Putting stop loss is crucial for your trading success and performance. If you stop loss is placed in logical place (A.K.A: Support or Resistance level), you should have no reason not to respect it – if price touched it, the basis for your position has voided and staying in the position is highly risky. Also, always have an emergency stop in case of sudden news or catastrophe. (more…)
Trade Your Plan
“When you see a position that is going against you and the market is dropping, and you are losing money on a trade, but your stop loss hasn’t been hit yet, how do you stay with the position? What is your secret? Do you pullback and look at the big picture or do you simple assume its all noise as long as it doesn’t hit that lower low? This is my biggest problem with tracking your trades and most of the time you are right in holding on.” … Because we thought our answer to his question may be beneficial to other traders as well, we wanted to share our reply to his e-mail, which was… “The key point you stated is ‘but your stop loss hasn’t been hit yet.’ When we put on a trade, it’s like entering into a contract, so we try to stay the course and simply follow the plan. Over the years, we’ve found it’s best to stick with our original analysis because we usually plan a trade at night, or in the pre-market, without the stress of live trading. During the trading session, in the heat of the moment, there is so much pressure that we have to fight the voice in our heads telling us to sell the position when everything around is crumbling. It basically comes down to planning the trade and trading the plan…easier said than done, right? Sometimes, if you have a feeling things are going bad, and you’re an active trader, you can maybe sell 1/4 or 1/3 of the position to ease your mind. However, you must have the discipline to get back in once the coast is clear. Try to lay out a plan, write it on paper, and stick to it. The one thing every trader must accept, in order to be successful, is a loss. You must be fully prepared to lose what you’re risking. Once you accept losses as part of the trading game, the pressure to be right is not so intense. By the way, we at ASR are no different; we fight the same urges to sell that most traders do. It’s a constant battle, that’s for sure!” |
Overtrading: A Common Mistake
Over trading is one of the biggest causes why traders never make it in the financial markets. With a click of a button, a trader can place a trade anytime he wants. It takes tremendous discipline to hold yourself back from over trading. There are many reasons why one may choose to over trade.
1. Traders without a plan
Traders without a plan are my favorite type of traders because they will always lose. Without a plan, how would one know when to take a trade and when not to? Having a trading plan is a necessity. I can not trade if I do not have a plan for the day. I feel lost without one.
2. Revenge trading
Many new traders become tilted after a loss or a string of losses. This causes them to revenge trade just to break even. This often leads to reckless trading forcing a trade when opportunity is low.
3. Chasing the markets
Alot of new traders feel more pain when they have missed a move than an actual loss. This is why new traders love to chase the markets. If price has moved away from your projected entry point, let it go. There are plenty of more opportunities. Chasing is one of the worst habits a trader can have. Not only does it offer you low rewards, it also gives you a horrible entry and alters your stop loss placement. Always think about the risk before the profits.
When you have a plan to follow, it is easy to filter out bad trades from good one. This keeps you discipline and selective in your trades. I personally do not like trading more than 5 round trips a day. Patience is a virtue. There are always good high probability trading opportunities everyday. Just sit tight and don’t jump the gun.
One way to control a loss is by reducing your size. The problem with gamblers is that they will often double up their stake so they can get even quicker. This usually leads to a greater loss and devastation. Having the strength to grind your way back from a loss is important in trading. Whenever I am having a losing streak, I will trade small and gradually recover. This also gives me the confidence I need after a string of losses.
Being prepared
Make a list of everything that can go wrong and determine how you will respond to that situation. That will be the key to your success – knowing how to respond to the unexpected.”
Ask 3 essential questions:
1. Why am I taking this particular trade? ( is it part of carefully prepared plan, or is it an emotional reaction; what is the catalyst behind the move and does it have the potential to sent the stock’s price higher; are there other better trading alternatives for my money)
2. What if a am wrong? (figure out where and when I will exit, before I initiate the trade; where is my stop loss and does it makes sense to be put there; how much am I risking? How am I going to protect my capital against “unexpected” gaps)
3. What if I am right? (how am I going to protect my profits; where I would exit and why)
Remember that good trading is all about managing risk. If you are entering a position without knowing where you are getting out when you’re wrong, then you’re sunk before you begin.
Trading: The Difference Between Playing Offense & Defense
The sooner traders learn to carefully manage risk the better off they will be. So many new traders come in with only the thoughts of profits dancing in their heads. This is equivalent to a football team only focusing on scoring points and not planning their defense.In trading you must play both sides of the ball. You have to be able to score points against the market and not allow the market to score back those points on you.
Your entries are your offense and your exits are your defense.
Letting a winner run is your offense, cutting your loser short is your defense.
Your automatic buy stop is your offense and your automatic stop loss is your defense.
Buying a monster stock is an offensive move, planning on how you will exit with your profits is your defensive move.
Identifying a trend is your offensive play creating a trading plan on how to trade it is your defensive play.
Your choice on what to trade is playing offense, choosing your position size is playing defense.
Your watch list is playing offense choosing how much capital to risk on any one trade is playing defense.
In trading your wins are not permanent and your profits can be taken back, when you score you have to next ensure that you are not scored on. The goal of keeping your profits has to be far above the desire for making quick money with big risk.
Lessons From The Wizards
One of the first books I read in this business oh-so many years ago was Stock Market Wizards. It had a profound impact on my thinking about trading, psychology, risk, capital preservation, etc.
Sometime ago, I came across a good discussion of the lessons from the book at Simply Options Trading. What follows is my edited adaptation of those rules he derived from Stock Market Wizards:
- All successful traders use methods that suit their personality; You are neither Waren Buffett nor George Soros nor Jesse Livermore; Don’t assume you can trade like them.
What the market does is beyond your control; Your reaction to the market, however, is not beyond your control. Indeed, its the ONLY thing you can control.
To be a winner, you have to be willing to take a loss; (The Stop-Loss Breakdown)
HOPE is not a word in the winning Trader’s vocabulary;
When you are on a losing streak — and you will eventually find yourself on one — reduce your position size;
Don’t underestimate the time it takes to succeed as a trader — it takes 10 years to become very good at anything; (There Are No Shortcuts)
Trading is a vocation — not a hobby (more…)
Quantifying Low/Risk High/Reward Trades
Q: How can do you quantify odds of 10-1 in your favor before you make a trade? Is it your profit goal is 10x more than your stop loss? 10 indicators that look good and one that does not look good? Can you share with the group how you get to 10-1 odds? It may not be an easy answer, but I wonder if you could expand.
Think of it this way. After I’ve performed my analysis of all of the things I look at (fundamentals, technicals, sentiment) and list them out at the price I’m considering making a specific trade, they must without any measure of doubt be highly tilted in my favor. In other words, it must fit my definition of what I consider to be a low/risk high/reward setup. For every negative I can find that argues against a specific trade, I need more than just a few positives to offset it.
What results from this analysis is that the total number of trades I make is lower than most, but the percentage of average winning trade is higher as well as my win/loss average. (more…)
My 10 Favorite Nicolas Darvas Quotes
My favorite Nicolas Darvas quotes from the book on the subject of:
Discipline:
“I knew now that I had to keep rigidly to the system I had carved out for myself.”
Risk/Reward:
“I was successful in taking larger profits than losses in proportion to the amounts invested.”
Exiting profitable trades:
“I decided to let my stop-loss decide.”(Speaking on when to exit an up trending stock)
Bear Markets
“I also learned to stay out of bear markets unless my individual stocks remain in their boxes or advance.”
Technical Analysis versus Predictions
“I believe in analysis and not forecasting.”
Trading Psychology
“I became over-confident, and that is the most dangerous state of mind anyone can develop in the stock market.”
Risk Management
“I decided never again to risk more money than I could afford to lose without ruining myself.”
Fundamental Analysis
“All a company report and balance sheet can tell you is the past and the present. They cannot tell future.”
Trend Following
“I made up my mind to buy high and sell higher.”
The Market tells its own story best
I accepted everything for what it was-not what I wanted it to be.”
Four Trading Fears
“Ninety-five percent of the trading errors you are likely to make—causing the money to just evaporate before your eyes—will stem from your attitudes about being wrong, losing money, missing out, and leaving money on the table. What I call the four primary trading fears.” -Mark Douglas (Trading int he Zone)
As Mark Douglas points out in his great book about trading psychology is that the majority of traders lose because of wrong thinking, misplaced emotions, and wanting to be right. We know fear and greed drive the market prices far more than fundamentals do. However fear makes traders do the wrong things at the wrong time. Here are four great examples of fear over ruling sound trading strategies.
Here are more thoughts about these four fears:
The fear of being wrong: Traders fear being wrong so much they will hold a small loss until it becomes a huge loss. Even adding to the loss in the hopes of it coming back and getting to even. Don’t do this, holding on to a loser after it hits your predetermined stop loss is like being a reverse trend trader. Do not be afraid of being wrong small be afraid of being wrong BIG.
The fear of losing money: New traders hate to lose money, they do not quite understand yet that they will lose 40%-60% of the time in the long term. We should come to expect the small losses and wait for the big wins patiently. Many times traders fear this so much that they have a hard time taking an entry out of fear of losing. If you can’t handle the losses as part of the business, you can’t trade.
The fear of missing out: The opposite of the fear of losing money is the fear of losing potential profits. This causes traders to watch a stock go up and up, miss the primary trend, then not being able to take it any more and get in late just in time for the trend to reverse and lose money. Trade at your systems proper entry point do not chase a stock because you are afraid to miss out on some profits.
The fear of leaving money on the table: When your trailing stop is hit get out of the trade. If your rules tell you to get out after a parabolic run up and stall then exit. You must be disciplined on taking money off the table while it is there. Being greedy for that last few dollars when your system says to sell could lead to major losses of paper profits. Let your winners run but when the runner gets to tired to continue: bank your profits.