Category: Best Of

I am being asked all the time, what do I think about this and that stock. I don’t have an opinion about every stock. I might have the occasional insight into the merits of one business or another, but I never let my subjective perspective dictate my buy and sell decisions. Not in public markets, where liquidity and momentum have created their own world; where perception is the reality.

When conviction and biases trump discipline, nothing good happens in the financial world and if does, it is due to non-repeatable luck and not a skill. (apparently if you are a value investor, this doesn’t apply to you – you have a different market philosophy and that is ok; there is room for everyone)

If you honestly believe that you don’t know what will happen next when you open a new position, then:

1. You will find a method that has positive expectancy in the current market environment. After years of adding and cutting, complicating and refining, the basics of my approach could be summed up to: buying breakouts near 52-week highs from proper technical bases in healthy markets. It is not the perfect approach for every market environment, but it is consistently profitable.

2. You would never venture to use a method you don’t understand and just buy random stocks based on tips or rumors. There will be no fear of missing out, because you realize that you don’t have an edge outside of your market approach.

3. You will not hesitate to take your signals – because you don’t know which ones will be successful

4. You will always have a predefined stop – because you could be and occasionally, you will be wrong. It is Ok to be wrong. It is not Ok to stay wrong.

5. You will risk equal percentage of your capital on each signal (idea), because there is no way to know in advance which ones will be the big winners. They are obvious only in hindsight.

6. You will have an exit plan – rules to protect profits and keep you in a position until a trend persists

Everything you need to know about successful trading and investing is on the web, gratis. There are no secrets. The rules of the game are known for each of the major market approaches – momentum, value and statistical arbitrage. Most people simply lack the discipline to follow the rules. There is a huge empathy gap between knowing something and actually applying it. It is just like the difference between knowing how to get in shape and doing it. It takes strong will and a desire to make it; it takes discipline.

Other than using a market method with proven positive expectancy, the only edge I have is discipline and it is more than enough. Diligently doing my homework and following my rules.

At Stocktoberfest, I had the honor to present alongside Howard Lindzon and share how I think about the stock market. There are two major cornerstones to our approach – simple is good and “a glass half full” attitude.

The most important thing to remember is that stock market is an opportunity machine. Times change, gas prices change, fashion changes, presidents change, but there are always companies that find a way to monetize on an undergoing social and business trend and make their investors rich.

One company’s rising costs are another company’s rising revenues and the market usually does a pretty good job of identifying the winners and the losers.

Albert Einstein liked to say that “Any fool can make things bigger, more complex, and more violent. It takes a touch of genius-and a lot of courage-to move in the opposite direction”. No truer words have ever been said when it comes to investing. You could make your investing life as complicated as you want it to be, but the degree of complexity is not positively correlated with market returns.

Most people put the odds against themselves as they fish for stocks in the wrong pond. Guess what? 1 out of 3 publicly traded stocks lose 75% of tgeir IPO price. All of them come from the 52-week low list.

All major stock market winners come from the 52-week high list and better yet – the all-time high list; hence we focus our equity selection efforts there.

Market is a discounting mechanism that looks 6 to 12 months ahead into the future. This is why prices will often change before fundamentals change. By no means, I try to convey the message that the market is always flawless. It is not and there are short periods of time when it acts like a bipolar schizophrenic, but for the most part it is a leading indicator and I want to put the odds in my favor by paying attention to price action.

Prices don’t change when fundamentals change. Prices change when expectations and perceptions change and they could change for various reasons. From a trend follower’s perspective, the main indicator that signals change in expectations is price.

Anybody could buy a stock as the ETrade baby commercials has long tried to convince us. Most people’s investing problems come from not being able to sit on their hands when they are right. Very few hold their winners long enough to make a difference in their returns.

Price is not the only reason we buy, but price is the only reason to sell. It is good to have conviction in your picks, but discipline should always prevail. Sooner or later, all trends end and when they do, it is not pretty. I have accepted that I won’t be right every time and I have learned to live with it. Being wrong is not a choice. Staying wrong is.

1) Not Having a Method – if you don’t stand for something, you stand for nothing. If you don’t know where you’re going, you will get to nowhere. Define yourself and go a step further – follow your own plan, because if you don’t have a plan, you will become part of someone else’s plan:

If you don’t understand why you are in a trade, you won’t understand when it is the right time to sell, which means you will only sell when the price action scares you. Most of the time when price action scares you, it is a buying opportunity, not a sell indicator. – Martin Taylor

2) Trading too big – you will exit because of fear, not because your thesis was proven incorrect. Define an amount you could afford to lose, a price level where your thesis will be invalidated and based on that data come up with the right position size for you. For example, if you risk $1000 per idea and your stop is $2 below/above your entry, you could only afford 500 shares. ($1000:2)

Traders focus almost entirely on where to enter a trade. In reality, the entry size is often more important than the entry price because if the size is too large, a trader will be more likely to exit a good trade on a meaningless adverse price move. The larger the position, the greater the danger that trading decisions will be driven by fear rather than by judgment and experience. – Steve Clark

3) Overtrading – How frequently we open new positions is defined by our market approach. In any case, less is more, no matter what your time frame of operation is.   Don’t get me wrong, you need more than one idea, just because it could go bust for various unforseen reasons no matter the homework you’ve done. But taking any signal and spreading your energy and capital in too many directions is rarely a wise move. Stick to what you know, stick to what is working and don’t chase rumors and ideas you have zero edge at.

Sometimes the best trade is not to take any new trades at all and stick to what you already have. I know how tempting it is, especially in a bull market, when everything is breaking out all over the place. You feel like a kid in a candy store and don’t know where to go. Pick one or two spots and just go there. Don’t try to get them all. You can’t. You won’t. (unless you’re a computer)

The major reason behind mistakes N2 and N3 is usually overconfidence. It is essential to have some confidence in order to follow your plan and take your signals, but above the reasonable level, it turns against you. Overconfidence is the single biggest reason why experienced traders and investors lose money. The moment you start to believe that your success is due to your genius and not due to your carefully thought out and tested market approach, you have already lost.

4) Watching your stocks too closely – granted if you are an intraday trader, this is part of your job, but for longer time frames of operation, watching too closely is detrimental. Give your trading ideas some room to breath and don’t watch every tick.

Staring at the screen all day is counterproductive. He believes that watching every tick will lead to both selling good positions prematurely and overtrading. He advises traders to find something else (preferably productive) to occupy part of their time to avoid the pitfalls of watching the market too closely. – Jack Schwager about Steve Clark

Watching your stocks too closely could certainly have negative consequences on performance. You end up overtrading. You buy new, lousy setups you don’t need and close positions that are doing perfectly well, just because of a small tick against your position. Being too close to the market is like being on a diet and spending your time at the finest cake bakery. It is hard not to nibble on something.

In the words of Warren Buffett, if you spend enough time in a barbershop, sooner or later you will decide that you need a haircut. (even if you are bald).

Paraphrasing Soros – You go to work every day thinking that you have to do something. As a result, you often do stupid things out of boredome, when you would be better off just sitting on your hands. I go to work only when there is something to do, only when it is worth doing so. As a result, I have learned to distinguish the important from the ordinary days and I know when to put the extra effort.

If you are a swing trader or an investor, find something worthwhile to do instead of starring at your stocks all day. Writing, reading, exercising, competitive eating…whatever floats your boat.

It is not the lack of knowledge that hurdles most market participants. It is its application in the real world. Everyone knows what needs to be done in order to lose weight, but how many have the discipline to actually follow their own plan.

All quotes are from: Schwager, Jack D. (2012-04-25). Hedge Fund Market Wizards. John Wiley and Sons. Kindle Edition.