Month: May 2017

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.

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.

Feedback – Having 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.

Discomfort – deliberate 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.