Category: Best Of

1)      The market reacts positively to bad news. Negative headlines and terrible earnings reports are ignored. As the saying goes, reaction to news is more important than the news itself. Good reaction to bad news is the ultimate indicator of positive sentiment. Never underestimate the power of optimism in the market – it feeds on itself and creates positive feedback loop.

2)      Plethora of high-volume breakouts to major new highs, representing different industry groups. The so called “market of stocks” environment.

3)      Low correlation market, which produces both winners and losers. There are good ideas for both bulls and bears.

4)      Defensive sectors underperform. Capital leaves perceived safety and rotates into more economically sensitive sectors.

5)      High beta names outperform as the fear of missing out becomes higher than the fear of losing. Small caps, emerging markets, low priced stocks outperform.

6)      The financial blogosphere will be filled with skepticism. Six months of trend-less , volatile market that was dominated by mean-reversion could certainly condition even the most experienced market participants to be extremely cautious with new breakouts. The rule of thumb is that during pronounced uptrends, there will always be people who will complain that the market is overbought and warn for an impending correction. As Schopenhauer stated long time ago: ““Every truth passes through three stages before it is recognized: In the first it is ridiculed; in the second it is opposed; in the third it is regarded as self-evident.”

7)      There are so many breakouts that you are confused which ones to take. You feel like a kid in a candy store or like an adult in front of a cheese stand with 200 options to choose from. This is normal – the human brain is meant to operate in an environment of scarcity. To cope with a situation like this, we have invented shortcuts that mean different things for different people. Technical analysis is one form of a short cut.

8)      Breakouts stick and have a follow through.

9)      Most of the dips you buy, turn out profitable.

10)   Major market indexes are trading above their rising 50dma. The moving averages are typically lagging indicators, but they often play the role of a good point of reference.

11)   Market indexes are rising on increasing volume. The pullbacks are on lower volume

12)   People ask why such and such stock is up 15% today on now news. Sometimes the only news you need is the lack of bad news. Positive sentiment and money flow are powerful catalysts that could continue longer than most expect and have bigger impact than most are willing to comprehend.

13)   Your confidence increases substantially and you honestly believe that you are the best trader in the world. Don’t confuse brains with market uptrend. Overconfidence is the single biggest reason for investors’ demise. The second biggest reason is ignorance, but this is a topic of another conversation.

 

No matter the market environment you trade in, paying attention to risk management is of utmost importance. You don’t have to be right, you don’t have to be original, you don’t have to be first, but you have to take favorable risk to reward trades. If you don’t have a plan, you will become part of someone else’s plan.

I know 13 is an odd number, but this is all I could come up with at this point. Add yours in the comment section, if you will.

 

1. Stock prices run in cycles. Periods of re-pricing are usually quick and powerful and then they are followed by trendless consolidation.

2. Stocks are very highly correlated during drastic selloffs and during the initial stage of the recovery. In general, correlation is high during bear markets.

3. Bull markets are markets of stocks, where there are both winners and losers. When the market averages consolidate, there are stocks that will break out or down, revealing the intentions of institutional buyers.

4. In the first and last stage of a new bull market, the best performers are small cap, low float, low-priced stocks.

5. Try to trade in the direction of the trend. It is not only the path of least resistance, but also provides the best profit opportunities. Have a simple method to define the direction of the trend.

6. Traders’ attention (and market volume) is attracted by unusual price moves. Sudden price range expansion from a consolidaiton is often the beginning of a powerful new trend.

7. Opportunity cost matters a lot. Be in stocks that move. Stocks in a range are dead money.

8. Big winners are obvious only in hindsight. Many other stocks shared the same characteristics when they tried to break out. Some failed. Some had a followthrough. Being wrong is not a choice. Staying wrong is. You can only control your risk and how long you will ride your winners.

9. The overall market conditions will never be perfect and when they seem so, it is probably a good idea to decrease exposure and take profits. With that in mind, you don’t have to be in the market all the time. When you don’t see good setups, it just makes sense to watch from the sidelines.

10. Big institutions achieve outsized returns by riding strong trends for the long-term (long enough to make a difference). This is the only way for them. They can’t easily and often get in and out due to their size. Establishing small positions does not make sense for them as it would not make a difference for the bottom line. Big winners can make a difference when they are big positions. Big positions take time to accumulate and along the way institutions leave clear traces.

11. Small losses are often better than small gains. If I sell my position every time it shows me a small gain, I would never achieve a return high enough to make a difference and to cover the inevitable losses. Amateurs go bankrupt by not taking small losses. Professionals go bankrupt by taking small gains. It is absolutely true that a large number of consecutive gains could multiply returns substantially. The point is how big should be those gains. 4-5% is not going to help a lot. 15-20%  gains is something completely different.

12. Prices change when expectations change, but sometimes expectations change when prices change. In other words, there are different types of catalysts that move stocks. In long-term perspective (years), stocks move based on the underlying social trend and the stage of the economic and liquidity cycle. In medium-term perspective (months), stocks move based on expectations for earnings and sales growth. In short-term perspective (weeks and days), stocks move based on price action primarily.

13. If you understand the incentives of the major market participants, you will be able to predict their likely behavior. Technical analysis is a lot about understanding incentives and recognizing intentions.

14. Your first loss will often be your best loss. No one is right all the time and you don’t have to be. There are market participants that are immensely profitable by being right only 30% of the time. It is good to have conviction in your investment thesis, but discipline should always trump conviction.

15. Optimism and pessimism in the stock market are contagious. Investors psychology often loses its logic and become emotional. The news media and the most recent price action play a particularly important role in developing moods of mass optimism or pessimism.

16. Declining stocks often reverse their downtrends near the end of the year, as selling for income tax purposes subsides.

17. Fair value is an illusive concept and hard to calculate. While it is true that you don’t need to know the exact weight of a person to define if he is overweight, applying this philosophy is not going to help you in the stock market. Stocks constantly get overvalued and undervalued. This is the nature of the market. Warren Buffett says that price is what you pay, value is what you get.  I believe that value is what you think you get, price is what other people are willing to pay for it.  Just as beauty, value is in the eyes of the beholder. (there are universally accepted measures too, of course)

18. Liquidity is cyclical. It constantly expands and contracts. When it contracts, capital flows to perceived safety – U.S. Dollars and Treasuries.

19. Rising P/E is an indicator of rising expectations and confidence in the future of the stock. The P/E ratio reflects the enthusiastic optimism or the gloomy pessimism of investors.

20. When you calculate the time you need to drive from point A to point B, you should always take traffic into account.  Traffic is like the stock market. You might pretend that it doesn’t matter, but it will impact you anyway. It doesn’t matter how smart you are, how ingenious your idea is or how cheap your stock is – if the market does not agree with you, you will not get paid. Period.