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Four Keys to Understanding Uncertainty

  
  Education
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1) Uncertainty is always subjective. It is a state of mind that is derived from a mix of objective data, emotions and personal experience. To say that the market is always equally uncertain is to say that mood is always the same. It is not. It constantly changes.

If the perceived uncertainty is always the same, earnings reports would not have such huge impact on prices. We all know that this is not the case. In many cases, earnings reports provide new data that changes market expectations and therefore prices. Options premium is higher before earnings exactly because uncertainty is higher.

2) Uncertainty has become a synonym for bad mood in our everyday life.

The future is always uncertain, but our perceptions of the future vary. And perceptions define actions. Actions (supply and demand) define prices. Somehow uncertainty is used with a highly negative connotation in our everyday life. It is a game of words. Just like the weather people always say that there is a 30% chance of rain and never that there is 70% chance of sun.

3) Uncertainty is basically another word for market sentiment. High levels of perceived uncertainty (bad mood) and high levels of perceived certainty (good mood) have historically been good contrarian indicators, IF your investing horizon is long enough.

4) There are different types of uncertainty.

There is an economic uncertainty. Uncertainty leads to a decline in economic activity. Less people are hired. Old machines and software licences are used longer. Investments are cut. This is what it has been happening in Europe for 2 years.

Trading Wisdom from Market Wizards

  
  Education
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Michael Marcus

“The best trades are the ones in which you have all three things going for you: fundamentals, technicals, and market tone. First, the fundamentals should suggest that there is an imbalance of supply and demand, which could result in a major move. Second, the chart must show that the market is moving in the direction that hte fundamentals suggest. Third, when news comes out, the market should act in a way that reflects the right psychological tone. For example, a bull market should shrug off bearish news. If you can restrict your activity to only those types of trades, you have to make money, in any market, under any circumstances.”

“I think to be in the upper echelon of successful traders requires an innate skill, a gift. It’s just like being a great violinist. But to be a competent trader and make money is a skill you can learn.”

“Perhaps the most important rule is to hold on to your winners and cut your losers. Both are equally important. If you don’t stay with your winners, you are not going to be able to pay for the losers.”

Bruce Kovner

“The more a price pattern is observed by speculators, the more prone you are to have false signals. The more a market is the product of nonspeculative activity, the greater the significance of technical breakouts.”

On asking which is better, technical analysis or fundamental analysis, he answered, “That is like asking a doctor whether he would prefer treating a patient with diagnostics or with a chart monitoring his condition. You need both. But, if anything, the fundamentals are more important now. In the 1970s, it was a lot easier to make money using technical anaylsis alone. There were far fewer false breakouts. Nowadays, everybody is a chartist, and there are a huge number of technical trading systems. I think that change has made it much harder for the technical trader.”

Advice to novice traders: “First, I would say that risk management is the most important thing to be well understood. Undertrade, undertrade, undertrade is my second piece of advice. Whatever you think your position ought to be, cut it at least half.” “They personalize the market. A common mistake is to think of the market as a personal nemesis. The market, of course, is totally impersonal; it doesn’t care whether you make money or not. Whenever a trader says, “I wish,” or “I hope,” he is engaging in a destructive way of thinking because it takes attention away from the diagnostic process.”

Richard Dennis

“when you start, you ought to be as bad a trader as you are ever going to be.”

“I always say that you could publish trading rules in the newspaper and no one would follow them. The key is consistency and discipline. Almost anybody can make up a list of rules that are 80 percent as good as what we taught people. What they couldn’t do is give them the confidence to stick to those rules even when things are going bad.”

“my research on individual stocks shows that price fluctuations are closer to random than they are in commodities. Demonstrably, commodities are trending and, arguably, stocks are random.”

“There will come a day when easily discovered and lightly conceived trend-following systems no longer work. It is going to be harder to develop good systems.”

“The secret is being as short term or as long term as you can stand, depending on your trading style. It is the imtermediate term that picks up the vast majority of trend followers. The best strategy is to avoid the middle like the plague.” (more…)

Uncertainty

  
  Education
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1) Uncertainty is always subjective. It is a state of mind that is derived from a mix of objective data, emotions and personal experience. To say that the market is always equally uncertain is to say that mood is always the same. It is not. It constantly changes.

If the perceived uncertainty is always the same, earnings reports would not have such huge impact on prices. We all know that this is not the case. In many cases, earnings reports provide new data that changes market expectations and therefore prices. Options premium is higher before earnings exactly because uncertainty is higher.

2) Uncertainty has become a synonym for bad mood in our everyday life.

The future is always uncertain, but our perceptions of the future vary. And perceptions define actions. Actions (supply and demand) define prices. Somehow uncertainty is used with a highly negative connotation in our everyday life. It is a game of words. Just like the weather people always say that there is a 30% chance of rain and never that there is 70% chance of sun.

3) Uncertainty is basically another word for market sentiment. High levels of perceived uncertainty (bad mood) and high levels of perceived certainty (good mood) have historically been good contrarian indicators, IF your investing horizon is long enough.

4) There are different types of uncertainty.

There is an economic uncertainty. Uncertainty leads to a decline in economic activity. Less people are hired. Old machines and software licences are used longer. Investments are cut. This is what it has been happening in Europe for 2 years.

There is market uncertainty that impacts volatility. When correlation is close to 1.0 (another way to say that stocks move together disregarding of their individual characteristics), uncertainty is perceived as high. It leads to choppy environment that market timers prefer to sit out in order to preserve monetary and mental capital. Perceptions define reality.

Six Positive Trading Behaviors

  
  Education
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1) Fresh Ideas – I’ve yet to see a very successful trader utilize the common chart patterns and indicator functions on software (oscillators, trendline tools, etc.) as primary sources for trade ideas. Rather, they look at markets in fresh ways, interpreting shifts in supply and demand from the order book or from transacted volume; finding unique relationships among sectors and markets; uncovering historical trading patterns; etc. Looking at markets in creative ways helps provide them with a competitive edge.
2) Solid Execution – If they’re buying, they’re generally waiting for a pullback and taking advantage of weakness; if they’re selling, they patiently wait for a bounce to get a good price. On average, they don’t chase markets up or down, and they pick their price levels for entries and exits. They won’t lift a market offer if they feel there’s a reasonable opportunity to get filled on a bid.
3) Thoughtful Position Sizing – The successful traders aren’t trying to hit home runs, and they don’t double up after a losing period to try to make their money back. They trade smaller when they’re not seeing things well, and they become more aggressive when they see odds in their favor. They take reasonable levels of risk in each position to guard against scenarios in which one large loss can wipe out days worth of profits.
4) Maximizing Profits – The good traders don’t just come up with promising trade ideas; they have the conviction and fortitude to stick with those ideas. Many times, it’s leaving good trades early–not accumulating bad trades–that leads to mediocre trading results. Because successful traders understand their market edge and have demonstrated it through real trading, they have the confidence to let trades ride to their objectives.
5) Controlling Risk – The really fine traders are quick to acknowledge when they’re wrong, so that they can rapidly exit marginal trades and keep their powder dry for future opportunities. They have set amounts of money that they’re willing to risk and lose per day, week, or month and they stick with those limits. This slows them down during periods of poor performance so that they don’t accumulate losses unnecessarily and have time to review markets and figure things out afresh.
6) Self-Improvement – I’m continually impressed at how good traders sustain efforts to work on themselves–even when they’re making money. They realize that they can always get better, and they readily set goals for themselves to guide their development. In a very real sense, each trading day becomes an opportunity for honing skills and developing oneself.

Ten Times When A Trader Should do Nothing

  
  Education
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  1. When you are confused and don’t know what to do, do nothing.
  2. There are no set ups on your watch list, then don’t trade.
  3. You are a trend trader and there is no trend to trade.
  4. The market is extremely volatile due to headline risk.
  5. You want to make an option trade but the options are illiquid with a huge bid ask spread.
  6. If you are trying to trade supply and demand but the government keeps interfering with your market, pick a different market.
  7. Your stock reports earnings the next day and you expect a powerful move but it could easily go either way, wait until after earnings to trade.
  8. You are a momentum trader but their is not momentum, then wait.
  9. You play the long side only and the market is in a correction or a bear market, wait for a new trend to the upside.
  10. If you are not at your best mentally and emotionally then don’t trade until you are.

The Ten Trading Commandments

  
  Education
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Respect the price action but never defer to it.

The action (or “eyes”) is a valuable tool when trading but if you defer to the flickering ticks, stocks would be “better” up and “worse” down—and that’s a losing proposition. This is a particularly pertinent point as headlines of new highs serve as sexy sirens for those on the sidelines. 
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, above all, never believe that you’re smarter than the market. 
Opportunities are made up easier than losses. 
It’s not necessary to play every move, 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.
Emotion is the enemy when trading. 
Emotional decisions always have a way of coming back to haunt you. If you’re personally attached to a position, your decision making process will be flawed. It’s that simple. 
Zig when others Zag.

Sell hope, buy despair and take the other side of emotional disconnects in the context of controlled risk. If you can’t find the sheep in the herd, chances are that you’re it. 
Adapt your style to the market. (more…)

Trading Less Is Better

  
  Education
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I think the secret is cutting down the number of trades you make. The best trades are the ones in which you have all three things going for you: fundamentals, technicals, and market tone. First, the fundamentals should suggest that there is an imbalance of supply and demand, which could result in a major move. Second, the chart must show that the market is moving in the direction that the fundamentals suggest. Third, when news comes out, the market should act in a way that reflects the right psychological tone

The Anatomy of a Trend: 10 Guidelines

  
  Education
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  1. A trend begins with capital flowing into an asset based on a perceived increase in the future value of the asset.
  2. Trends are identified by higher highs and higher lows for several days in a row or the reverse lower highs and lower lows.
  3. Moving averages can also identify trends based on a moving average sloping up or sloping down visibly.
  4. A moving average can also act as support or resistance for a stock as it trends in one direction and bounces off a key moving average.
  5. Trends tend to persist because the owners of the asset have no reason to sell and tend to just let their position ride causing the trend to continue.
  6. Supply and demand causes trends when you have a lot of dollars chasing a limited asset.
  7. In stocks, up trends are caused by mutual fund managers building large positions in their favorite stocks.
  8. Down trends in stocks are caused when institutions start to unload a stock or investors cash in their mutual fund shares during bear markets and managers have to raise cash by selling their holdings.
  9. Capital is always looking for great returns so they chase stocks with the biggest earnings expectations planning on the stock price following.
  10. Trends tend to persist until acted on by an opposing force. Sometimes this is as simple as running out of buyers or sellers of the asset.

The money is in the big trends, look for them, find them, and ride them until they end.

“The trend is your friend until the end when it bends” -Ed Seykota

Three Keys to Trading Success

  
  Education
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The successful trader is creative. I think it’s fair to say that his approach is a short-term trend-following method. His way of evaluating the market trend, however, is unique. He is definitely not just looking at the same old 14-period oscillator that comes pre-programmed in most charting applications. Similarly, he has clear stop points and price targets, but these are defined in a unique way, based upon the market conditions he’s observing. This “out-of-the-box” thinking style is common to successful traders, I’ve found. They look at markets in unique ways that help them capture shifts in supply and demand. to find a way of trading that you can make your own. You’re more likely to stick with a method that fits with how you think (and that fits with your skills) than if it’s something you’ve blindly copied from others. Our trader believes in his method, and that gives him the brass ones to hang in there during relatively lean periods.

2) The successful trader is always seeking improvement. If our trader is already successful, why does he need to talk with Henry? He knew that, by sharing his ideas, he would learn a great deal about the strengths and weaknesses of his trading. Sure enough, Henry found that the average size of the trader’s losers was larger than it needed to be. A simple modification of stop-loss rules improved the system’s performance meaningfully. Similarly, by putting a filter on the system–only taking trades if certain conditions were met–the average profit per trade went up significantly. That could aid position sizing. The trader knew he had something good, but good wasn’t good enough. He wanted better.

3) The successful trader is persistent. One thing I want to stress: the trader’s methods were very sound–and Henry found ways to make them better–but they were not perfect. Out of about sixty months analyzed, fourteen were losers. The drawdowns were not hellacious, but there were periods of flat performance and drawdown. What that means is that a successful trader needs to have the confidence to ride out these periods of poorer performance to get to the periods of success. That is one reason why it’s so important

Why Trend Followers Mint Money ?

  
  Education
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The reason trend traders make money in the long term is because due to supply and demand and the flow of capital equities, currencies, commodities, and future contracts tend to trend in one direction or the other in different time frames, trend traders and trend followers are there to capitalize on those trends by letting the market action determine their buy and sell decisions seeking to be on the right side of the market’s trend the majority of the time.
Here is why it works:

  1. Bear markets have no supports, they keep falling until a new support level is found.
  2. Bull markets have no resistance, they keep keep going up until a new resistance level is found.
  3. The world’s capital is always flowing and seeking to find returns; this flow causes trends to emerge.
  4. Monster stocks can double due to earnings growth expectations.
  5. Currencies can plunge based on fear of a nations solvency.
  6. Commodities can run to absurd levels based on supply expectations.
  7. Fear can bring markets down far below what any one thinks is rational.
  8. Greed can inflate markets up far above any reasonable valuations.
  9. Trend traders are not predicting price action they are simply following it. They let reality guide them not opinions.
  10. Markets tend to trend and systems that are able to capture trends and minimize losses in choppy environments are robust in the long term.
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