Using what you know

“Good trading is 10% technology and 90% psychology. People defeat themselves. It doesn’t matter how often you repeat basic trading principles when almost no one will practice them”

Maoxian

Everybody knows the four cardinal rules of trading, but so few people follow them — 1) Trade with the trend. 2) Cut losses short. 3) Let profits run. 4) Manage risk.

Maoxian

There is a big difference between knowing something and applying it.

Mark Boucher on using RS

One of the most important lessons that a successful stock investor needs to learn is that there are times when the market presents plentiful low-risk opportunities and there are times when making money in the markets is quite difficult and far less certain. Adjusting one’s strategy for different market environments is key. You can trade aggressively in a terrific market environment and make triple digit annual gains with easy. But trading just as aggressively in a very difficult market environment could result in huge drowdown of capital. Remember that a 50% drowdown erases 100% gain just to get back.

Over the years one of the most common stories I have seen is for smart investor to begin investing very  aggressively during stock market run-up, when the opportunities are plentiful. The smart investor will have a strategy that exploits the good environment quite well – an he’ll typically make huge gains of about 500%-1000% of his money in one to three-year period. But when the market environment changes, this investor refuses to change with it and in the following one to two-year period, the investor losses most or all of his trading capital. Foxhound Funds levereged 300% gain in 1999, but a total of 100% loss of everything by April 2000.

Clearly learning to understand when one can be aggressive, and to understand when to be defensive is important to investors, desiring to maximize gains wit minimum risk.

Hedge Fund Manager says Goodbye!

Andrew Lahde, manager of a small California hedge fund, Lahde Capital, burst into the spotlight last year after his one-year-old fund returned 866 percent betting against the subprime collapse.

Last month, he did the unthinkable — he shut things down, claiming dealing with his bank counterparties had become too risky. Today, Lahde passed along his “goodbye” letter, a rollicking missive on everything from greed to economic philosophy.

Recently, on the front page of Section C of the Wall Street Journal, a hedge fund manager who was also closing up shop (a $300 million fund), was quoted as saying, “What I have learned about the hedge fund business is that I hate it.” I could not agree more with that statement. I was in this game for the money. The low hanging fruit, i.e. idiots whose parents paid for prep school, Yale, and then the Harvard MBA, was there for the taking. These people who were (often) truly not worthy of the education they received (or supposedly received) rose to the top of companies such as AIG, Bear Stearns and Lehman Brothers and all levels of our government. All of this behavior supporting the Aristocracy, only ended up making it easier for me to find people stupid enough to take the other side of my trades. God bless America.

I will no longer manage money for other people or institutions. I have enough of my own wealth to manage. Some people, who think they have arrived at a reasonable estimate of my net worth, might be surprised that I would call it quits with such a small war chest. That is fine; I am content with my rewards. Moreover, I will let others try to amass nine, ten or eleven figure net worths. Meanwhile, their lives suck. Appointments back to back, booked solid for the next three months, they look forward to their two week vacation in January during which they will likely be glued to their Blackberries or other such devices. What is the point? They will all be forgotten in fifty years anyway. Steve Balmer, Steven Cohen, and Larry Ellison will all be forgotten. I do not understand the legacy thing. Nearly everyone will be forgotten. Give up on leaving your mark. Throw the Blackberry away and enjoy life.

I have no interest in any deals in which anyone would like me to participate. I truly do not have a strong opinion about any market right now, other than to say that things will continue to get worse for some time, probably years. I am content sitting on the sidelines and waiting. After all, sitting and waiting is how we made money from the subprime debacle. I now have time to repair my health, which was destroyed by the stress I layered onto myself over the past two years, as well as my entire life — where I had to compete for spaces in universities and graduate schools, jobs and assets under management — with those who had all the advantages (rich parents) that I did not. May meritocracy be part of a new form of government, which needs to be established.

Brian Shannon on Bear Market

Let me repeat the mantra that using P/E, cash flow and other fundamentals can be harmful as crucial trading determinants in a downward market. During downtrend, hope tempts market participants to look at these traditional measures of valuation to justify establishing a long position. But only price pays and the message of declining prices says do not buy. In a bearish environment, these valuation tools will drop much lower than most people expect, then revert back outside the mean. Price is the only objective measurement of value, and as perceptions change, prices and valuations change.

Another temptation is to get long a declining stock because you feel the stock is “down too much”. This thinking is based on the hope that sellers will “come to their senses” and recognize the value. They won’t. Logic and reason get thrown out of the window when participants act on emotion. Recognize that a stock in a downtrend will bring about those emotions at quick to sell at first signs of trouble. A stock is never down too much when there is a simple absence of demand.”

Nicolas Darvas

Chairman Maoxian managed to find some great links with Nicolas Darvas interviews:

(1959 Interview):

“Since he has to do trading from wherever he is dancing he ignores tips, financial stories and brokers’ letters, and has never been in a broker’s office. Basically, his approach is that of a chartist: he watches price and volume … When a stock makes a good advance on strong volume, he begins watching it, buys when he feels that informed buyers are getting in. For example, when he was playing in Calcutta, he noticed E. L. Bruce moving up in the stock tables. Suddenly, on 35,000 shares it moved from 16 to 50. He bought in at 51, though he knew nothing about the company, and ‘I didn’t care what they made.’ (They make hardwood flooring.) He sold out at 171 six weeks later.

Darvas places his buy orders for levels that he considers breakout points on the upside. At the same time, he places a stop-loss sell order just below his buy order, so that if the stock does not move straight up after he buys, he will be sold out and his loss cut. ‘I have no ego in the stock market,’ he says. ‘If I make a mistake I admit it immediately and get out fast.’ Darvas thinks his system is the height of conservatism … If he has a big profit in a stock, he puts the stop-loss order just below the level at which a sliding stock should meet support. He bought Universal Controls at 18, sold it at 83 on the way down after it had hit 102.

Darvas trained for the market just as methodically as he had studied his dancing, read some 200 books on the market and the great speculators, spent eight hours a day until saturated. Two of the books he rereads almost every week: Humphrey Neill’s Tape Reading and Market Tactics and G. M. Loeb’s The Battle for Investment Survival. He still spends about two hours a day on his stock tables.”

That line, “[He] buys when he feels that informed buyers are getting in,” made me chuckle. It should read “He buys when he suspects that uninformed fools are piling in.”

An Interview With Nicolas Darvas in 1974:

“Don’t forget I too went through a period of learning from 1953 to 1958 where I lost a substantial amount of capital before I worked out what worked and then was lucky enough to time it in the 1958-1960 bull market.”