Trading Tips

A Few Bits of Trading and Market Wisdom

At the beginning of the year, Barry Ritholtz published a list of Market Truisms and Axioms from Arthur Huprich. The full list is well worth reviewing, especially if you’re a stock market trader or investor. Here are the ones that I thought the most worthwhile.

 – There is nothing new on Wall Street. There can’t be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again, mostly due to human nature.

 – Understanding mass psychology is just as important as understanding fundamentals and economics.

 – Learn to take losses quickly, don’t expect to be right all the time, and learn from your mistakes.

 – When trading, remain objective. Don’t have a preconceived idea or prejudice. Said another way, “the great names in Trading all have the same trait: An ability to shift on a dime when the shifting time comes.”

 – Wishful thinking can be detrimental to your financial wealth.

– Technical analysis is a windsock, not a crystal ball. It is a skill that improves with experience and study. Always be a student, there is always someone smarter than you!

Trading Tips

Picking a Good Business School

The question of business schools (meaning MBA programs) comes up on a fairly regular basis on the trading forums. Colleges tend to see an upswing in applications during weak economic periods like this one, as people look to both improve their credentials and ride out a poor job environment. No doubt there are loads of people pondering that very thing right now.

Of course the question among traders tends to be whether an MBA does anything for them in terms of trading and going after professional trading jobs, and secondarily which schools are best.

Will an MBA Help Me?
To address the first part of the question, there are a lot of variables involved. It used to be that to get a professional trading or markets position you had to come through the training program of one of the big banks (read Liar’s Poker). In order to get into those programs you had to be recruited out of college or from an MBA program, though some were able to get in there from the back office side of the bank. That meant you needed to come out of a top program – one which had good placement ties with those Wall Street firms.

Things have changed some in recent years, though. The old training programs aren’t what they used to be and there are fewer of those big firms doing the recruiting. The financial industry has splintered with the development of new trading operations like hedge funds. That’s changed the way recruitment is going for students nowadays. An MBA, however, is still considered a mandatory (or at least strongly preferred), but these aren’t the go-go years of the past.

I personally have an MBA from the University of Maryland with a concentration in Finance. My undergraduate degree was also in finance. I can honestly say that little of what I was taught plays a part in my day-to-day duties or my trading. That isn’t to say the theoretical education hasn’t been of value. One just needs to realize that you aren’t going to learn how to trade or be a professional market analyst in a college or university business school program. They are intended to prepare students for the job market by giving them a knowledge base, not a specialty.

Which Business School Should I Pick?
Your test scores and other qualifications are going to go a long way toward determining what schools will be on your short list. Putting that aside and focusing on what’s going to happen coming out of the program you choose, however, I can offer a couple of suggestions.

First of all, do you know where you want to end up geographically? If so, you should look at the schools that are strong in that region. For example, Harvard and Wharton are big name schools that place people all over the world. If, however, you know that you want to end up in Southern California you will want to look very seriously at schools like UCLA because they have a wider, deeper set of connections and alumni base in the region. That increases not only immediate job prospects, but also future prospects through networking.

Secondly, look to see if the school does a good job placing students at the companies you want to target. Some schools are going to be better than others with certain firms because of different connections and associations. That, of course, means you have to do your homework on your prospective future employers.

High Profile Doesn’t Necessarily Mean High Value
My last bit of advice is that you shouldn’t just go with the biggest name school you can get into. Consider the value proposition. The name on your degree will tend to mean less the further you get away from graduation and into your profession. Think about how much you are going to have to spend for that piece of paper. If you look to the business school rankings you can start to see what the different programs offer you, and which represent the best value. That’s how I ended up at Maryland – by finding it listed just outside the top 25 and noted as one of the best values.

The Basics

The Trade that Hurts the Most

Way back in the day I was a newbie trader. I know, it’s hard to believe, but it’s true. 🙂

One of the first trades I ever made that was actually based on my own market analysis (as opposed to getting trading ideas from other people) was taking a short position on the NIKKEI 225. This was back somewhere in 1990 when the NIKKEI was trading north of 30,000. I was very bearish, quite sure the Japanese market was in for a major tumble.

NIKKEI 225 Monthly Chart from the early 1990sThis chart shows roughly where I got short. I can’t honestly remember the exact level, but it was somewhere in there.

Now back then futures wasn’t part of the equation for trading the NIKKEI, at least not for me. I was a stock market player only in those days. That meant working through an instrument available on an exchange. In this case, it was a put warrant. The basic idea of the put warrant is similar to an ultra-short ETF these days. It rose in value if the associated market, the NIKKEI in this case, fell. The difference, however, is that the warrants had a defined life – generally three years from issuance.

I bought that NIKKEI put warrant somewhere in the $5 range. The market pretty much went in my direction straight away. Some point later on – I can’t recall how many months – I saw the price in the $9s and decided to take my profits. It was my first meaningful gain on a trade, so I was quite please with myself,….

…at least until I looked back at the price chart later. 🙁

After I closed out the put warrant trade I pretty much forgot about it. I was in college and not really doing a great deal of market watching. Eventually, though, just out of curiousity, I checked the prices. I knew the NIKKEI had kept tumpling in the interim, so naturally I expected to see those warrants have gone higher. When I saw $25, though, I’m pretty sure I moaned aloud.

I’ve made more trades over the years than I can even estimate. I don’t remember too many of them any more, but that’s one which will stick with me until I die. It’s the first “got the analysis right, but didn’t trade it right” experience I had. I hate those!

Guest Posts Trading Tips

One Trader’s Path – Guest Post

One of my list members answered the call to contribute some thoughts on trading and trader development to share with others through a guest post. He’s asked to remain anonymous. I think it provides a fantastic perspective on what it really takes to become a successful trader – hard work and experience.

It took me many years and thousands of hours of market watching to develop my proprietary trading methodology. The baggage from my old “learnings” was so heavy that I was unable to trade successfully until I got rid of it. Then I stopped trading for about two years to get rid of bad habits.

There is always a price to pay for education. For some it may be losing several accounts, for others it may be hiring a good mentor to teach them; for me it was the school of hard knocks and even living at the border of impoverished conditions in order to study the market, back-testing and forward-testing several trading strategies until I finally developed a proprietary trading methodology that gives accurate entry/exit signals with levels for stop loss and profit targets. It was back tested with 5 years of data, forward tested in a virtual account successfully for six month and I am currently forward testing it in a live account.

Success comes with knowledge. Knowledge comes with experience. Experience comes with time and hard work.

I believe that one needs one good trading methodology to enter a world that no one ever really sees until you are there yourself. I am determined to enter this world this year and I will be happy to take many with me, if they so choose. I am taking baby steps toward that world and it is a great feeling.

I definitely don’t know everything. In fact I know very little and I am finding out the longer I live the less I know. I do make mistakes like everyone else; but I learned to quickly correct them with no ego involvement. Hesitation has little reward in life and none in trading.

News & Updates

Looking forward to the new year

Welcome to 2009!

If last year wasn’t a great one for you, then I hope this one brings you a turn for the better.  And if 2008 was pretty good, I hope that continues. 🙂

I’m not going to make any predictions about where the markets are going. That’s the pattern of the season, but it really isn’t worth much in the end. The one thing I will say, though, is that I don’t expect the markets to get easier to trade in 2009.

Last year was a clear trending year with the major question throughout it being “How far?”. This year there are going to be a lot of cross-currents which could make for very choppy action. Traders right now seem to be asking “When will the transition end?”, meaning when does the shift from negative to positive happen. Transitions tend to be uneven at best, and things almost always take longer than people expect, so there could be a lot of back and forth in the markets for a while.

On the plus side, while volatility as measured by the likes of the VIX is probably not going to be as high, it likely will stay high enough to keep things interesting for traders.

For my own part, I’m liking the way 2009 is setting up. In many ways it’s been a difficult last two years since I left full-time volleyball coaching to return to the ranks of the professional market analysts. I’ve been dissatisfied with the way certain things in my life have gone during that span, but in the last couple of months I’ve seen things really start to turn in a good direction. I’m very much looking forward to the new year.

In terms of trading resolutions, I want to get more active in the markets than I’ve been. I’ll soon be shifting out of the stock market and back into forex in terms of my professional work. Though I do plan to keep trading stocks and the mini S&Ps, especially the latter, being focused on forex will allow me to get back to trading that market in a way I haven’t done much of in a while.

So what about you? What are your trading resolutions for 2009?

The Basics

Efficient Markets: Should you even bother trading?

The question of whether the markets are efficient was broached again by a fellow blogger recently. The idea is that if the markets are efficient, then it’s not really worth attempting to trade them (meaning stock market investors should stick to index funds). This is all based on the Efficient Market Hypothesis (EMH).

There’s a bit of confusion in the public about what market efficiency really means. It does not mean that the price in the market reflects the value of the asset in question (like a company in the case of a stock). It means that current price reflects the array of potential future outcomes. Basically, the theory says that every idea of what could happen in the future is incorporated into the current price.

The EMH basically contends that it’s impossible to outperform the market on a consistent basis because the information upon which one would make investment/trading decisions is already factored into the market. There are three forms off efficiency, as defined by the academics:

Weak: Historical prices cannot be used the determine future prices, meaning Technical Analysis is useless. The contention is that there are no patterns to price behavior.

Semi-Strong: Prices adjust to publicly available new information so quickly that no excess returns can be made with that information.  This basically rules out fundamental analysis.

Strong: Excess returns cannot be achieved by employing any information. This rules out even insider trading as providing an edge.

There aren’t many folks who accept the strong form of analysis because it’s pretty clear that insider trading can indeed produce excess returns (if you can get away with it). The other two, however, have been widely accepted as legitimate in academic circles.

Here’s my view.

The more actively traded a market is, the more it tends toward efficiency – especially in relatively low volatility and quiet news environments. Those are times when information can be distributed most efficiently and participants are most likely to act rationally. As you get into less actively traded markets, and as you start adding pressure to a market efficiency becomes less and less the case. Information distribution becomes less efficient and participants act increasingly less rationally.

I still chuckle when I think about an article on Bloomberg in August of 2007 where a quant trader (we used to call them rocket scientists) was complaining about what was happening in the markets to cause his systems to go haywire. He said something to the effect of “If people would just act rationally, everything would be fine.” Ha!

I rejected EMH as soon as I learned it as a young undergraduate finance student, even arguing it with my professors. When I started working I was vindicated in my views when I found out the the Johnson Redbook weekly retail sales figures (no longer published) were reported to the traders in the futures pit 15 minutes before they were reported to the public. That’s a great example of a violation of the information dissemintation part of the EMH. Plus, I saw the way traders reacted to things like Non-Farm Payrolls releases to see how irrational traders became when fear and greed take over.

But I’m not the only one in this camp. Benoit Mandelbrot provides a great discussion of how all the classical financial theories develop and how they have largely been proven less than solid over the years. Among the evidence is studies which show that low P/E stocks tend to produce excess profits and that there are in fact price patterns in the markets. These suggest that market analysis can indeed be used to produce market outperformance.

That said, it’s also worth reading Nassim Taleb on the subject of randomness in trading performance (and life). He is not really an EMH proponent, but he does have strong views about how even the likes of Warren Buffett can be explained in that light.

Trading Tips

Revisiting the impact of these markets on traders and investors

The other day I asked the question “How have these markets impacted your trading?” (if you haven’t already left your thoughts, please feel free to do so). I was very interested to see the number of responses which were variations on the “I’ve kept to the sidelines” theme. It seems like the volatility of the markets has driven quite a few traders away. The question is whether that’s a temporary thing until the volatility drops back down, or whether it’s a more permanent development.

From the perspective of a trading educator, I like to hear that traders who are struggling with the markets have pulled back and are using the opportunity to become more knowledgeable about things, leaving their money out of harm’s way. That’s a very intelligent and rational way to go about things. I don’t recall who it was, but one of the traders interviewed in Market Wizards said something to the effect of “When you don’t understand what’s going on, get out.” And of course if the volatility means you would have to take more risk than you should to make a trade, then you shouldn’t make the trade (which of course also brings back the question of capitalization levels).

Of course not all those who have pulled their money out of the markets are traders who will return when conditions are better. Many are people who feel burned. It’s like the exodus after the Crash in 1987 and the bear market at the start of this decade. Both drove investors out for years. This chart highlights that very well:

The Normalized Average True Range (N-ATR) below the monthly S&P 500 plot tells us how much volatility there is from month to month. We can see that it dropped off very significantly in the years after the ’87 Crash, and then again after the Tech Bubble burst. Given how volatile the markets have been of late, as the N-ATR line shows, I wouldn’t be surprised to see another period of relatively quiet trading once we get past this period of uncertainty about the markets and the global economy.

With that in mind, it’s worth looking at your trading strategies and evaluating them as to how they may respond to changing circumstances. That’s something you should be doing periodically anyway.