6 Trading Insights from Mark Douglas

1. The four trading fears

95% of the trading errors you are likely to make will stem from your attitudes about being wrong, losing money, missing out, and leaving money on the table – the four trading fears

2. The proverbial empathy gap

You may already have some awareness of much of what you need to know to be a consistently successful trader. But being aware of something doesn’t automatically make it a functional part of who you are. Awareness is not necessarily a belief. You can’t assume that learning about something new and agreeing with it is the same as believing it at a level where you can act on it.

3. The market doesn’t generate happy or painful information

From the markets perspective, it’s all simply information. It may seem as if the market is causing you to feel the way you do at any given moment, but that’s not the case. It’s your own mental framework that determines how you perceive the information, how you feel, and, as a result, whether or not you are in the most conducive state of mind to spontaneously enter the flow and take advantage of whatever the market is offering.

4. The flaws of fundamental analysis

Fundamental analysis creates what I call a “reality gap” between “what should be” and “what is.” The reality gap makes it extremely difficult to make anything but very long-term predictions that can be difficult to exploit, even if they are correct.

5. A good trader is a confident trader

I’ve worked with countless traders who would spend hours doing market analysis and planning trades for the next day Then, instead of putting on the trades they planned, they did something else. The trades they did put on were usually ideas from friends or tips from brokers. I probably don’t have to tell you that the trades they originally planned, but didn’t act on, were usually the big winners of the day. This is a classic example of how we become susceptible to unstructured, random trading—because we want to avoid responsibility.

6. Anything could happen to any stock

The best traders have evolved to the point where they believe, without a shred of doubt or internal conflict, that “anything can happen.” They don’t just suspect that anything can happen or give lip service to the idea. Their belief in uncertainty is so powerful that it actually prevents their minds from associating the “now moment” situation and circumstance with the outcomes of their most recent trades. They have learned, usually quite painfully, that they don’t know in advance which edges are going to work and which ones aren’t. They have stopped trying to predict outcomes. They have found that by taking every edge, they correspondingly increase their sample size of trades, which in turn gives whatever edge they use ample opportunity to play itself out in their favor, just like the casinos.

Source: “Trading in the zone”

Is Cash Really A Position?

Josh Brown, who I tremendously respect, made an interesting comment on Twitter about going to cash in times of turmoil:

In this case, he does not refer to hedge funds or individual trading accounts, but to people’s retirement savings.

I can see why he would suggest that most investors should not go to cash and should continue the course of dollar-cost averaging each month:

First, past history shows that many investors are not very good at timing the market. Here’s Joel Greenblatt in the book Hedge Fund Market Wizards by Jack Schwager:

The single best-performing mutual fund for the entire decade was up 18 percent a year, on average, during a period when the market was flat, yet the average investor in that fund lost 8 percent. That is because every time the fund did well, people piled in, and every time it underperformed, people redeemed. The timing of the money flows was so bad that investors, on average, turned a fund that was making 18 percent a year into a losing investment. I think that says it all. Institutions make the same mistakes as smaller investors.

Second, achieving average returns would be a great success for many investors.

And third, many investors are likely to be reluctant to buy at higher prices. Psychologically, it is difficult to buy an asset at $200 if you sold it at $170. In life as in markets, if you want to achieve bigger than average results, you often have to do things that are psychologically challenging for the majority of people. If it was easy, everyone would do it and the potential reward would be much smaller.

These are all good arguments, but constantly staying 100% invested and diversified is not the perfect solution for many.

1. Some don’t invest in well-diversified ETFs and own individual stocks in their 401k in order to achieve higher returns.
2. Those that are well diversified geographically and in terms of market cap and non-correlated assets, also go through deep drawdowns because correlations often go to 1.00 during deep market correction. It doesn’t matter if you own Apple or Snapple. Your portfolio is getting hit during market panic. When your portfolio goes through a deep drawdown, you are very likely to panic and sell near the lows. What happens when you sell near the lows? You lose your confidence and you don’t take advantage of the recovery.

3. If you manage to minimize drawdowns during deep market corrections, you will be able to grow your capital faster and be in a better psychological position take advantage of much lower panic prices.

If you are an investor that prefers to ride some trends in a long-term perspective, you need to learn how to hedge. One simple way to hedge long-term holdings is to buy some short-term protection (put options or put spreads) when your stocks start to show signs of distribution and close below their 50dma.

If you are a trader, it is very simple. You diligently take your losses and make sure that they are small, so the size of your winners can overshadow them. As George Soros was famously quoted by Druckenmiller – “it is not important whether you are right or wrong, but how much money do you make when you are right and how much money do you lose when you are wrong”.

Is market timing possible? I believe it is. It is not an exact science, but there’s a process to the madness. There are some clear signs in the market that hint when it makes sense to raise cash, hedge and go net short – distribution days in major stock indexes, price action in market leaders, changes in market breadth, changes in trading results, etc. I wrote about them in more detail in my book Crash – How to Protect and Grow  Capital during Corrections.

To answer Josh’s question about “when do you get back”

There are a few things we will be watching ranked in terms of importance:

1. Stocks setting up on the long side are starting to break out and following
through. These are the next market leaders that we want to own
2. Multiple days of heavy buying in the major indexes: up 1.5% on bigger
than the average 50-day volume; the signal is much stronger if indexes
finish near the high of their daily range. Sustainable bottoms are formed by
heavy buying, not heavy selling.
3. A retest of the momentum low with a smaller number of stocks making
new 20-day lows or larger number of stocks trading above their 20-day
moving averages – with other words, a retest with some form of market
breadth divergence. Retests are not always necessary for a bottom to form.
They matter from a psychological perspective because they flush out the last
remaining weak hands in the market, which makes the recovery smoother
and faster.
4. The major indexes close back above their 200-day moving averages and
stay there. They start to move higher.
We could gradually increase our long market exposure depending on how
many of those points are met: 25% when point 1 is met; 50% when 1 & 2,

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10 Market Lessons I Learned in 2015

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?

8 Misconceptions about Financial Markets

  1. “You are not as bright as you think you are. The human brain is not built to trade stocks.” – Never mind that the human brain is also not built to drive a car, play tennis or ride a bicycle. Those are all skills that could be learned.

  2. “This stock is already down 50% and it is a solid business. There is no way it can go below this level. If it does, the market is broken.” – just before the same stock drops another 30% and you panic and sell. If you don’t know why you are in stock, you won’t know when to exit, which means you will only sell when the price action scares you. Never say never and always have an exit plan.

  3. “There is no way this piece of crap stock could go any higher. It has already tripled in the past year” – just before it doubles again and squeeze all short-sellers.

  4. “This highly successful hedge fund billionaire is super-bearish. It is time to go 200% long and show him who’s smarter. “ – pick carefully your contrarian indicators. Some popular hedge fund managers are rich for a reason. They will not be right every time, no one is, but odds are that they know what they are doing.

  5. “Despite recent evidence of the opposite, Oprah’s, Hillary’s and Icahn’s tweets don’t move markets. They are an utter waste of time, garbage signals that mean nothing, but hey look at Fibonacci extensions of the moon cycle. I can’t believe more people are not paying attention to them.” – Technical  and sentiment indicators work when enough people believe and act on them. None of them have 100% success rate. The success rate of all varies substantially depending on the market cycle.

  6. “Look, stock picking is too hard. Read my 1000 posts on why you are a terrible stock picker and why you should let me invest your money in a well-diversified equity index for 1% annual fee.”

  7. “This company missed estimates”. – Really!? Imagine if I try to guess the exact score of Superbowl and if I don’t end up being right to blame the teams that they missed my guess.

  8. “All VCs are greedy pigs because they keep great companies private for too long and don’t leave any profits for public investors.” – Never mind that many of those VCs took huge risks and have dedicated staff that actually helped those companies to become great. Never mind that probably 6 out of 10 of their investments will end up being zeros or that it it’ll take 7 to 10 years of waiting to see a payback.



The Best Performing Stock for the Past 34 Years Will Surprise You

For most people, their house is their biggest investment. Some have done a lot better than others depending on the price they paid and the region they chose to live in. What very few realize is that investing in home improvement stores would have been a lot more lucrative. In fact, the best performing stock for the past 34 years is a home improvement store.

Today, Home Depot closed at new all-time highs near $126 per share. $5000 invested in its stock on its IPO day in 1981 is worth about $25 Million today. Very few stocks have managed to average 28% annual returns over the course of so many years.


Of course, I write this with the benefit of hindsight. Finding stocks with great potential is a lot easier than holding them through the inevitable drawdowns they go through. For example, Home Depot had a 71% pullback during the bear market of early 2000s. Then, it had another 50% correction in 2007-2008. It takes a lot of conviction to hold a stock through such big setbacks. I would venture to say that the total number of individuals who bought Home Depot on its IPO day and are still holding it, is probably very close to zero.

Don’t forget that for each Home Depot that recovers from a 70% drawdown, there are 20 other story stocks that either never come back to new highs or they take decades to do so. A simple trend following system that would sell Home Depot every time it closes below its 20-month moving average and buys it back when it makes new 52-week highs would have achieved three results:

  1. Catch all of the upside.
  2. Eliminate most of the scary corrections and limit drawdowns.
  3. Allow to invest your capital in other stocks during periods when HD was not trending up.