Category: Best Of

Here are 10 lessons I learned in 2015. Some are new, some I had to relearn:

1. I am most creative and work better after a workout – after a run or some other aerobic exercise.

2. My best swing trade ideas are usually profitable almost immediately after I enter them. Those stocks that don’t follow through and go sideways, end up costing me money on average. Such realization helps me to cut my losers quickly and to add to my winners.

3. No market approach works all the time. I knew that before, but 2015 cemented it in my mind. I even wrote a whole chapter on it in my book “The 5 Secrets to Highly Profitable swing trading.

4. Drawdowns are inevitable, but their size could be managed.

5. Market timing is even more important than equity selection in a range-bound choppy market like 2015. There are times to be extremely aggressive and leveraged in the market. There are times to play defense and stay mostly on the sidelines.

6. Money is always going somewhere.There are always trends, but not all of them are easy to ride.

7. Revenge trading usually does not work. It is better to take some break from the market.

8. Never say never. Never turn a trade into an investment.

9. One good trade a day could allow you a comfortable life, but you might need to have 2-3 small losses before you get to that trade. Be prepared. Have a list of stocks in play.

10. Being aware of where the general market is in its price cycle is extremely important.

What are your market lessons for 2015?

The odds of an investor experiencing a big market crash during his/her life are 100%.

A well-diversified portfolio might save you from losing money in any 10-year period, but it might also “save” you from achieving high returns over time. Diversification won’t save you from experiencing big drawdowns during market panics when correlations go to 1.00 and all assets move together up and down regardless of underlying fundamentals.

Paul Tudor Jones says that “once in a hundred years events” have started to occur every five years. Obviously, his comment is more of an anecdote than a statistical fact, but it is also a reflection of a timeless market truth – the obvious rarely happens, the unexpected constantly occurs.

The stock market is not a place, where for one party to win, another has to lose. It is a place, driven by cycles – periods when almost everyone is a winner followed by periods when almost everyone is a loser.

Everyone could make a lot of money during market rallies when liquidity and performance chasing lift all boats and trump all bad news. Not everyone keeps that money when the inevitable correction comes.

They say that the definition of insanity is doing the same thing over and over again and expecting different results. Well, if you do the same things over and over in financial markets, you are guaranteed to get different results. Markets change; luckily in a relatively cyclical manner; unluckily the duration of each cycle is unpredictable.

Patterns repeat all the time because human mindset hasn’t changed for thousands of years. Since 1980, the S & P 500 has had an average intra-year decline of 14.2%. In 27 of last 35 years, stocks still finished positive for the year.

Corrections come a lot slower than anyone expects, but once they happen they escalate faster than most could imagine.

All corrections feel the same. At the beginning, people don’t believe them, then as prices continue lower and weakness spreads to more sectors, fear escalates and it leads to forced liquidation. Forced liquidation means selling, because you have to, not because you want to. Smart investors dream to be on the other side of forced liquidation. It is easier said than done, but there’s method to the madness.

Each correction is preceded by distribution and weakening market breadth. Stocks top individually but tend to bottom as a group. At the lowest point of a correction, the fear of losing is substantially higher than the fear of missing out.

The typical correction has distinct stages that vary in duration and require different tactical approach:

1) Quick and wide-spread leg lower that ends with a momentum low.

2) Oversold bounce.

3) Choppy period, that whipsaws both bulls and bears.

4) A Retest of the momentum lows with breadth divergence.

5) A Recovery

The history of U.S. stock markets has been a perpetual long-term uptrend interrupted occasionally, but very consistently by shocks. Most of those shocks take the form of short-term drawdowns that come and go. Some corrections turn into bear markets that last more than a year. They say that almost everyone loses money in bear markets – both bulls and bears. Bulls because they stubbornly hold on to positions in favorite companies and some stocks never recover from deep drawdowns. Bears because they get squeezed during the violent rallies that happen under declining 200-day moving averages. Bear markets should be respected, but they should not be feared. They require a different approach than what most are get used to in bull markets.

I wrote this book mainly to serve as my own guidance, to organize my thoughts and learn more in the process.
Keep in mind that everyone has his own agenda and bias, including me. The following pages present the perspective of a trader, who believes in active portfolio management and stock picking. The thought process and observations that I share here might not be suitable for everyone.

By reading this guideline, you will become better educated in the following subjects:

How to protect capital during market corrections

When to raise cash, take profits and sell long holdings

When and how to hedge

How to remain calm and protect your confidence during corrections

How to make money on the short side during market corrections

How to survive extremely choppy periods during market corrections

How to be flexible and prosper during long bear markets

How to recognize market bottoms

How to make money during market recoveries

How to use social media during corrections

A list of a hundred worthy people to follow on social media

The book is available on Amazon.

1. Distribution in the stock market is non-linear. A small number of stocks account for the majority of profits. For each big winner that remains in market’s folklore, there are many more stocks that do poorly. From the book The Ivy Portfolio, by Meb Faber:

“The Russell 3000 index measures the performance of the largest 3000 U.S. companies, 98% of the investable U.S. equity market.  40% of the stocks had a negative return over their lifetime, 20% of stocks lost nearly all of their value, 10% of stocks recorded huge wins over 500%.  80% of the gains are a function of 20% of the stocks.”

2. It is psychologically impossible to ride a stock for a thousand percent return, because of the huge drawdowns it goes through. Here’s Michael Batnick on one of the best-performing stocks of all times, Disney ($DIS), which is up 128,000% since its IPO.

The hypothetical investor who captured the entire 128,000% return over the last nearly sixty years would have experienced plenty of discomfort along the way. Disney has seen eight separate drawdowns of at least thirty percent. To be clear, what this means is that on eight different occasions, Disney would hit new all-time highs and then fall by at least thirty percent. A few more data points worth mentioning:

1)  Disney has been in a 20% drawdown 55% of the time.
2) After gaining 270% in the seven years following its IPO, Disney would decline 80% in under two years.
3) Disney has been in a 50% drawdown 25% of the time.

These sobering numbers come from one of the greatest companies of all-time. What does the rest of the stock market look like?

What is the alternative to trying to pick individual stock market winners? Owning an index?

1. Indexes also go through deep 50% drawdowns. Between 2000 nd 2002, Nasdaq Composite went down 80%. The average annual drawdown of the S & P 500 since 1980 has been 14%.

2. Yes, indexes always come back eventually, because they are getting rebalanced every year. Indexing is not as passive as many people think. And yes, some stocks never come back.

3. Overall, indexes have smaller drawdowns than stocks and they tend to come back (those who bought Japan in 1990 are still waiting), but everything comes for a price. The return they provide is lot smaller than what a basket of high-growth stocks could achieve in a bull market.

4. We don’t have to own a stock forever in order to make money in it. Trading and investing, both require having an exit strategy:

in 2006… Wynn Casino stock was $69. Today’s it’s $69. In between…$160, $18 and $220 …buy and hold FTW

— Howard Lindzon (@howardlindzon) Sep. 10 at 09:24 PM

5. Psychologically, it is a lot easier to catch ten 50% to 100% gainers in a bull market than one 1000%. It is even easier to catch a hundred 10-20% gainers that ten 50% to 100%. And by easier, I mean that we don’t have to go through big drawdowns in order to catch them.