What’s Widely Considered As Safe Is Often Risky

Has it ever occurred to you that bubbles always happen in a new asset class that people don’t yet understand and have no idea how to value? Cryptocurrencies, Internet Stocks in the late 90s, Japanese debt, real estate and stocks in the 80s, gold in the late 1970s, Dutch tulips, etc.

Bubbles (trends) can last a lot longer than most can possibly imagine. They can be both wealth creators and wealth destroyers.

Recognising something is a potential bubble is not hard. Convincing yourself to participate in it is a lot more difficult.

Every bubble goes through three stages: first, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident by most people. Fear of missing out kicks in in stage three.

Every bubble needs sceptics and naysayers. Otherwise, there won’t be anyone left to buy. By the time most people feel it is safe to enter a trend, that trend is usually close to an end.

Here’s George Soros, explaining bubbles in a way more sophisticated manner:

First, financial markets, far from accurately reflecting all the available knowledge, always provide a distorted view of reality. The degree of distortion may vary from time to time. Sometimes it’s quite insignificant, at other times, it is quite pronounced. When there is a significant divergence between market prices and the underlying reality, there is a lack of equilibrium conditions.

I have developed a rudimentary theory of bubbles along these lines. Every bubble has two components: an underlying trend that prevails in reality and a misconception relating to that trend. When a positive feedback develops between the trend and the misconception, a boom-bust process is set in motion. The process is liable to be tested by negative feedback along the way, and if it is strong enough to survive these tests, both the trend and the misconception will be reinforced. Eventually, market expectations become so far removed from reality that people are forced to recognise that a misconception is involved. A twilight period ensues during which doubts grow and more and more people lose faith, but the prevailing trend is sustained by inertia. As Chuck Prince, former head of Citigroup, said, ‘As long as the music is playing, you’ve got to get up and dance. We are still dancing.’ Eventually, a tipping point is reached when the trend is reversed; it then becomes self-reinforcing in the opposite direction.

Typically bubbles have an asymmetric shape. The boom is long and slow to start. It accelerates gradually until it flattens out again during the twilight period. The bust is short and steep because it involves the forced liquidation of unsound positions.

How To Become The Best Trader You Can Be

We have all heard the phrase “practice makes perfect”. The truth is that not all practice makes perfect. There are people who think they have ten years of experience when in fact they haven’t learned anything new after their first year.

Dr Anders Ericsson has spent 20 years studying world-class performers in various fields. Thanks to his work, we now know a lot more about how to become drastically better at anything we want to.

Ericson claims there are two types of practice – deliberate practice and good enough practice.

“Good enough” is how most of us approach any new skill. As soon as we reach a certain level of basic proficiency, we stop improving and never move beyond it.

According to Dr Ericsson, deliberate practice is the foundation of incredible skills. It has four components:

Setting goals – some say it is better to have a system than having a concrete goal. The creator of the Dilbert comics, Scott Adams says “eating healthy is a system, losing 10 pounds is a goal.” The truth is that being able to measure your improvement and achieving a set of micro-goals can be a system. People become experts by developing a series of micro skills and connecting them together. For example, an aspiring trader can work one month only on cutting his losses quickly, then another month on picking only certain setups that meet a checklist of criteria, then another month on letting his winners run, then another month on recognising the current market environment and the best setups for that environment. Every month, our trader can be laser-focused on acquiring one new skill. After a year of relentless work, he will acquire all micro skills that great traders possess.

Focus – deliberate practice requires all your attention. This means no watching movies, using social media, listening to podcasts, talking on the phone, texting, reading or snap-chatting while learning a new skill. You have to be 100% focused and immersed in one thing.

FeedbackHaving an experienced coach, who can objectively assess your improvement, correct your mistakes, highlight what you are doing right and what you are doing wrong, is an incredible plus and absolutely needed if you want to be an elite performer. Why do you think every single one of the best-ranked tennis players has a coach?
Here’s what Serena Williams says about the contribution of her coach:

No matter what, no matter what stage you’re at, you can get better, and you can’t always do that yourself. You need another set of eyes, another voice. That’s what Patrick gives me.

Here’s what Paul Annacone – the guy who coached Pete Sampras and Roger Federer says:

It is all dependent on what the players want and need. A lot of it is about figuring out your environment. There are different layers, different levels in coaching a younger player or adolescent as they develop versus the adult. I argue it becomes more complicated with the older, more accomplished players.
No matter how good you are as a player, you need to be directed, managed. You need a trusted pair of eyes because your own eyes can’t see if everything is on course. Those players have immense skills, but one of their biggest strengths is often that they are incredibly stubborn and a good coach can go in and handle that mentality.

The best hedge funds and trading firms have coaches that help their traders become the best traders they can be. Most individual traders don’t have access to those coaches, but they can find good mentors who can accelerate their learning curve and make them at least a little better.

Discomfortdeliberate practice should push you outside of your comfort zone. Never stop learning new skills, never stop improving and experimenting, figure out a system to adapt to the constantly changing market conditions.

Check out my newest book: Top 10 Trading Setups – How to find them, when to trade them, how to make money with them.

The 10 Secrets of Trend Following

The other day I posted a chart of a stock that I rode for a 50% gain in 2016. It went up another 75% after I sold. I had good reasons to sell at the time – the stock was extremely overbought on a weekly time frame and, more importantly, it had a major reversal after a strong upside move. The strongest stocks can stay overbought for a long time and they tend to have multiple 20-25% pullbacks along the way. This is why it is not easy to hold them. They can also correct through time and go through long periods of treading water. It is hard to sit on them during those periods when you watch so many other stocks trending.

Anyway, I was surprised by the strong response to my tweet and I decided to expand on my view of trend following:
  1. Trend following is easy only in hindsight. No one has a clue how long a trend can last and what profits it can deliver. No one can sell at the top consistently.

2. You have to be willing to give up 20%-25% of the gains in order to catch a complete move in a strong momentum name.

3. Holding strong stocks in a bull market can make you a lot of money but it can chop you into pieces during range bound and corrective markets.

4. There are different time frames in trend following – some use monthly, weekly, daily, hourly, 30 min or even a 5 min chart. Figure out what game you want to play in the market. Do you want to catch a dozen 50% to 100% multi-week gainers in a year or do you want to capture hundreds of short-term 5% to 20% gainers in a year? The former requires less time in front of a computer but it comes at a steep price – you have to be content with being wrong very often (more than 60% of the time) and you have to be able to stomach deep drawdowns in your portfolio. The latter approach is also known as swing trading. Its success rate varies between 40% and 80% depending on the market environment. There is not just one type of swing trading- there is buying breakouts, dips, buying in anticipation of a move, mean reversion, etc. You can learn more about my approach to swing trading in my books Top 10 Trading Setups and The 5 Secrets to Highly Profitable Swing Trading or you can watch me do it on marketwisdom.com.

5. The best time to enter a long-term trend is right after a major market correction. The second best time is after an earnings-related breakout.

6. Pay attention to industry-related moves. When an entire industry starts to break out or break down, there’s usually a strong catalyst that is likely to sustain trends for multiple months.

7. It is far easier to find a trend than to ride it long enough to make a difference in your returns.

8. Figuring out when and how to sell can be as much an art as a science. Sometimes, being a contrarian means staying with a trend.

9. It is ok to take partial profits on strength. It is ok to add to your position once it sets up properly again.

10. There is trend following on the short side as well but very few do it. Most momentum stocks give up 50% to 80% of their upside moves. Catching a top is very hard and personally, I don’t know how to do it consistently. Shorting ex-momentum stocks after they set up below their 50 or 200-day moving averages offers a lot better success rate and risk/reward.

Fred Wilson On What It Takes To Be A Great Angel Investor

Fred Wilson is a seasoned venture capitalist with one of the best track records in the industry. He started Union Square Ventures in 2005 by raising $125 million for early stage investments in Internet companies. By 2017, he has managed to distribute $1.6 billion to his investors and he is not done. Fred recently gave a speech at MIT. Here are a few quotes that stand out for me:

On working with entrepreneurs:

Working with entrepreneurs is a challenging endeavor. It is also an incredibly rewarding endeavor.  I think of it as parenting or teaching a very willful and talented child. It is not for the faint of heart but if you do it well, if you do it right, you can have a tremendous impact on both the entrepreneur and the world. It is these dreamers, these hackers, these unsatisfied souls who end up making things and companies that push us forward and change our lives, mostly for the better.

On early stage investing:

Seeds and early series A investments are the way that you can make a hundred times your money in the venture business. I am not aware of another legal means to do that.

Enthusiasm and appreciation are crucial in VC investing:

A VC’s most important role is that of a cheerleader. I know that seems like nothing. How hard is it to be a cheerleader? But it is everything. And very few VCs do it.

You need a cheerleader in your life:

Joanne is the secret to my success. She understood that being supportive was important. She believed in me from day one. She pushed me and she knew who I can be before I did.

Good judgment comes from experience and experience often comes from bad judgment.

F*cking up royally is good for you if you take the time to learn from it. I am who I am because of Flatiron. This is where my belief system comes from, my instincts and my insights.

The best time to invest:

The best time to invest in something is when nobody believes in it besides you. You have to totally believe in it and you have to know why.

The entrepreneurs are VC’s customers:

The entrepreneurs are VC’s customers. This is something I learned for myself. I grew up in the business and it was always: “Our customers are our investors. We got to make our investors happy. We have to do a nice annual meeting. We have to write a nice letter”. This was something that resonated in the culture of Euclid Partners (his first VC firm). That’s wrong. Our customers are the entrepreneurs and the companies that they build. Our investors are our shareholders.

VCs are service providers to entrepreneurs. We ride on their coattails. Even though venture capital requires a sophisticated understanding of finance, markets, technology, markets, strategy, it is ultimately a people business. And learning how to be a successful VC is learning how to work with people. A particular breed of people, who are at the same time charismatic, brilliant, frustrated, anxious, and fragile. And our job is to meet them right there where they are and support them with all our might.

What is he looking for in an entrepreneur?

1. Charisma – entrepreneurs have to be able to convince people to suspend disbelief. They have to convince investors, people to join their team, customers, the skeptical world at large. It’s not salesmanship. It is something more than that. I really think of it as charisma. That is necessary but not sufficient.

2.Technical expertise – knowing how to make something, not outsourcing the making to somebody else is really important. It doesn’t mean that you have to build it, but you need to be technical enough to understand what is involved in the making of it.

3. Integrity – is this person going to be honest, is he going to be a good partner, can we work together?

What does it take to be a great angel investor

1.Build a broad-based portfolio. Lot’s of investments because most of them are not going to work out. You need a lot of diversification. More than a typical venture firm will need.

2. Build networks with other angel investors. The more other angel investors you know, the better because you want to syndicate your investments with other people. You want to have many people you can call to try to get in into the deals that you want to do.

3. You will have to help the entrepreneur to get to VC firms. I watch my wife do this all the time. She is tireless in helping the founder she works with to get their series A or even series B round because she knows that her investment is not going to work if she can’t get the follow-up capital.

How to get into the venture business

The conventional wisdom and the advice I often give are “go work in a bunch of startups”. Spend your 20s and 30s working in startups and then, spend your 40s, 50s, and 60s working in venture capital. This is generally a good advice. Most of the people I know who have done that are very good, but this is not the path I took. So, it is a little disingenuous for me to say that. Actually, none of the very best VCs from my generation took that path.

The Truth About Passive Investing

Some say that there is no such thing as a pure passive investing, just fifty shades of active investing. Even indexing is considered a form of active investing, because of the frequency of rebalancing.

Others point out that passive investing has nothing to do with the frequency of transactions and everything to do with the ability to impact the direction of a company you are investing in. The latter definition makes every form of public investing passive (with the exception of activist investing).

No matter the definition of passive investing you believe in, we can probably all agree that indexing has provided a cost-efficient way to invest in the growth of the world economy.

S&P 500 annual return (ex. dividends)

There’s nothing wrong in indexing (buying the S&P 500 for example), but you need to understand what exactly are you buying and decide for yourself if you can do better.

The S&P 500 goes through frequent rebalancing. It replaced ten stocks in the first three months of 2017. Some of the changes are due to acquisitions; others are due to poor stock performance. First Solar is one of the stocks that was recently replaced.

The S&P 500 is essentially a slow trend-following program run by a committee of people. The rebalancing is not based on strict technical rules. A group of people sits and decides which stocks to add and drop based on market capitalization, liquidity, domicile, float, sector classification, financial viability, length of time spent as a public company and the stock exchange it has been listed on.

The selection criteria have produced some odd timing. For example, AMD was recently added to the index, after a 500% move in the past year and a half. Do you think you can find a better entry spot?

While its timing has been often poor, over time the S&P 500 has managed to capture most long-term winners. It has kept the long-term winners and dropped the losers, many of which eventually went out of business.