Category: Market Insights

Charts in this post are powered by MarketSmith.

The two biggest errors in bull markets are usually errors of omission. Not buying a stock because it is up too much too fast or not buying a stock because you sold it at a lower price recently.

If you bought something at 10 and sold it at 14, the odds are that you are not going to buy it back at 20. Even if the new setup looks incredible, it will be like chasing to most. This is why momentum investing is a contrarian approach and it continues to work. It seems easy only in hindsight, but it is never so when you have to apply it in real time.

People need time to adjust to new prices. When a stock goes from 40 to 160, it seems extremely expensive to everyone. It takes spending a considerable amount of time in that new price range, for people’s mental model to change. This is why many momentum stocks build new bases after a considerable recent run.

The typical momentum stock goes through 3 distinct stages:
1. Price leads – expectations for a brighter future attract buyers and a company price appreciates very quickly mainly because of a P/E expansion. The market is willing to pay a higher price for the expected earnings. FOMO (fear of missing out), short squeezes, and the overall market sentiment also have a big impact. An optimistic market might be willing to pay several times higher price than a pessimistic market for the same earnings growth.
2. Price spends some time in a range while earnings growth catches up with the market expectations. The market made a bet for a brighter future in stage one and now the company needs to prove the market right by delivering strong earnings growth. If a company fails to meet the market’s high expectations, its stock might quickly decline 50% or more.
3. Price growth and earnings growth go hand in hand.

NVDA might be a typical example. It had a huge run in 2016-2017. It seemed expensive all the way from 40 to 200. Then, it spent 6 months in a range and now it is setting up again near its all-time highs. $300 is very possible scenario by the end of 2018.

Disclaimer: everything on this website is for informational and educational purposes only. The ideas presented are not recommendations to buy or sell stocks. The material presented here might not take into account your specific investment objectives. I may or I may not own some of the securities mentioned. Consult your investment advisor before acting on any of the information provided here.

Traders who are considered successful are often asked the question – “What Trading books do you recommend?”. I am often stunned to hear some of them saying that there are no good trading books.

The reasoning that there are no useful trading books is ridiculous. It comes from people who don’t have the patience, the time, or the skills to create a good book – it takes hundreds of hours of dedicated deep work. The difference between writing and reading a book is the difference between growing and eating an apple.

“If it is that good why are you sharing it” is the silliest argument. Writing a book about any subject makes you think long and deeply about it. It encourages and requires you to experiment, read, compare, study, write. At the end of the process, you learn a lot more about yourself and about the subject.

The statement that “no trader will share a working method” doesn’t hold water. It is one thing to read about a subject and completely different to be able to practice it properly. Watching a Bruce Lee movie doesn’t make you a martial arts expert. Knowing what it takes to get in a great shape (proper diet and exercise), doesn’t mean that it is easy to achieve it.

If you are too lazy to learn from other people’s perspectives, nothing is going to change your mind.

I ran a search on Google for the expression “mistakes are”. The results:

In his first book, Michael Batnick outlines the big investing and trading mistakes of some of the most successful investors and brightest minds that are known to humankind. Most mistakes revolve around the same themes:
– being overleveraged and building too big positions in assets that were illiquid or suddenly became illiquid;
– venturing outside of expert zone when having to manage a much bigger amount of capital;
– overconfidence and hubris;
– normal mistakes that cannot really be prevented; they are part of the investing process;
– fear of missing out.

I enjoyed reading Michael’s book . It is not a how-to book. It is an interesting dive into market history and psychology. Here are some of the more interesting insights I found:

1. Leverage made Livermore his fortune, leverage destroyed him. He knew everything one can possibly know about market psychology and price action but it seems he never learned how to control risk – it was a constant all or nothing betting for him. No wonder he went broke 4 times.

2. Ben Graham understood that no approach works all the time. There are time and place for everything. Markets evolve and some concepts stop working. A margin of safety doesn’t matter during periods of forced liquidation, especially when you are leveraged to the hill.

3. “A high IQ guarantees you nothing! This is one of the hardest things for newer investors to come to grips with, that markets don’t compensate you just for being smart.” and “Intelligence in investing is not absolute; it’s relative. In other words, it doesn’t just matter how smart you are, it matters how smart your competition is.”

4. “Putting too much money into something you don’t fully understand is a good way to lose a lot of money. But what’s more damaging than losing money is the psychological scar tissue that remains after the money vanishes.”

5. “Once something belongs to us, objective thinking flies out the window.”

6. “Professional win points. Amateurs lose points”, therefore professionals should play to win and amateurs should play not to lose (try to make fewer mistakes).

7. “Bad things tend to happen when we compare our portfolios with others, especially if they possess a lesser IQ and extracted a higher return.”

8. On the dangers on concentrated bets: “A single stock leveled one of the most successful funds of all time, you should think twice before putting yourself in the same type of situation.”

9. “The most disciplined investors are intimately aware of how they’ll behave in different market environments, so they hold a portfolio that is suited to their personality. They don’t kill themselves trying to build a perfect portfolio because they know that it doesn’t exist.”

10. “The average intra‐year decline for US stocks is 14%, so a little wind in the bushes is to be expected.2 But saber‐toothed tigers, or backbreaking bear markets, are few and far between. Corrections occur all the time, but rarely do they turn into something worse, so selling every time stocks fall a little and waiting for the dust to settle is a great way to buy high and sell low.”

Source: Batnick, Michael. Big Mistakes: The Best Investors and Their Worst Investments (Bloomberg). Wiley. Kindle Edition.