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The erroneous notion of trading

January 31, 2012 By 2 Comments

While starting out as a trader, you have likely read most of the classic books on trading, technical analysis, money management, or psychology. You might have even executed a few trades with meager success. From a theoretical experience you are not a newbie but from a practical standpoint you still are.

Being a trader is commonly associated with an erroneous picture of freedom. You may be drawn to the flexibility of lifestyle, not having a boss, and having geographic independence. That’s like saying you want to become a racing driver because of the high salaries and traveling around the world. But to be a good racing driver you need to love racing. Not everyone loves racing. Similarly, to be a good trader you need to love markets. Showing “passion” may be overrated for this business, but strong interest coupled with the right approach does correlate with performance. Committing to doing something brings with it the duty to do what is required.

Someone who ponders about making $1 million per year with no boss, and getting out of a job which he hates, is definitely looking at trading for the wrong reasons. Trading doesn’t work like that as it is not a consistent income. Furthermore, it is not a steady progression like most careers. Success (if it comes) is rather unpredictable, comparable to the evolution of an entrepreneur. You can have great periods and you can have dead periods. A great method can suddenly stop working after years of success, and you may have disasters where you lose a lot of money.

If not pursued earnestly, trading can offer excitement for the time being and serve as a big dream of a glorious life in riches. In reality, chances of prosperity in this case are as likely as with playing the lottery.

Those who claim they wish to be traders but are secretly unwilling to do the work, will never get there. As a mentor, I am honest and blunt to aspiring traders, just as the professor is to an aspiring medical doctor. They won’t be told that due to the hard work in their profession of healing it would be better done in a country where there are less medical regulations with worse tools and technology than you find in the West. If you kill a few poor patients along the way, it would not matter because you are unlikely to be sued or prevented from working further. That is not the discipline you want to see in someone. Becoming an independent trader must not be taken lightheartedly either. Education is of utmost importance in this business, and working with a competent trader can be easier than being self-taught. Those who are relentless in figuring out a methodology are more likely to succeed. If you find investigation, research, problem solving, and frequent setbacks tedious, you would be well advised to do something else.

Regardless of assistance, you should be fairly comfortable with experimenting on your own because even a personal mentor can only go as far as showing you the path. A strategy still has to be based on your very own decisions to be able to trade with confidence. Start with a $10,000 account and trade part-time outside your normal working hours. Set maximum drawdown goals by losing not more than $3,000, for instance. The point of this is not to make money, but to learn trading with real money without taking excessive financial risks. If by the end of year one, you managed to make a profit without losing 30% of your starting capital at any point, then you have some potential. Take your time and put more emphasis on gradual growth with a sound strategy than sudden wealth.

What remains to be said about the brutal reality is that the vast majority of retail traders fail even to break even over their trading careers; let alone make a living from it. Those that do, tend to have an unusual aptitude and passion for markets and trading. Therefore you are generally better advised to keep your job until you have figured out a time-tested strategy. Not being able to watch the market during regular trading hours is not an excuse.

Filed Under: Trader Education Tagged With: , ,

S&P 500 Trend Update (Week 4)

January 29, 2012 By 1 Comment

Last week merely extended the uptrend channel we are currently in, but it is noteworthy that the SPY has finally been able to fill the gap open since July 28, 2011 (shortly before the massive sell-off last summer).

Imminent danger is not seen as of Friday’s closing, but the current formation could pose an opportunity for bears to profit from a minor reaction.

Support is currently seen at 129.50 whereas a more significant support zone is at around 126.50 according to historical price action in the daily time frame. Should these areas break, the market might be in for more trouble. Nothing is signaling this yet, so the trend trader is better advised to use a bounce off the aforementioned barriers as an opportunity to commit to new long positions.

The primary direction is still to the upside. Reactions are therefore most likely short-lived, so betting on them need to be undertaken with greater attention.

Filed Under: Market Commentary

AAII Investor Sentiment Survey (Week 4)

January 28, 2012 By Leave a Comment

Investors extend their bullish sentiment by another week. It is interesting to note that optimism has not been as high for almost an entire year (the last time investors sticked to the 50% mark was the week ending February 10, 2011).

This week’s special question asked AAII members what factors are causing them to be bullish, neutral or bearish. Respondents credited signs of an improving economy followed by better corporate earnings as the primary reasons for their optimism. Bearish respondents most frequently cited Europe’s sovereign debt problems, followed by the economy, the federal deficit and Washington politics.

The specific results of this week’s survey are as follows:

  • Bullish: 48.4%, +1.2
  • Neutral: 32.7%,+3.5
  • Bearish: 18.9%, -4.7
Filed Under: Sentiment Survey

Five reasons why Interactive Brokers triumphs

January 25, 2012 By Leave a Comment

Interactive Brokers is by far my favorite broker. I have been trading with them ever since I started out in this business, and never miss to recommend them to anyone who asks for my broker. You can claim that IB is mainstream among active traders. Here are their strengths:

#1: Access to Worldwide Markets

Whether you want to place your trade directly on international exchanges, diversify your cash deposits among various currencies, deal with bonds, options, futures all at once, this is the one which gives you access to everything. Under normal conditions, your order is submitted to the exchange instantly and gets filled promptly (depending on market liquidity). For example, I once traded the Nikkei 225 Mini futures a few times on the Osaka Securities Exchange and bought German equities through XETRA without a single issue.

#2: Quality of Market Data

Besides gaining access to exchanges you would otherwise never reach, you can subscribe to their real-time market data feeds. I subscribe to the “US Securities & Commodities Non-Professional Bundle” which includes market data for stock, options, and futures products on: AMEX, CBOT, NYSE, NASDAQ, and OPRAE. Altogether, this costs you a mere $10 per month (given that your monthly commission is below $30). Even during volatile markets, I have not experienced any delay with its feed. Other providers such as eSignal had lagged several seconds during very volatile times.

#3: Extremely Low Cost

Trading up to 200 U.S. shares (including ETFs) costs just $1 in commission. That’s it, simple. One trade for futures contracts of the E-mini S&P 500 is charged with $2.01 per lot. IB encourages you to trade a few times per month, hence it enforces an activity fee of $10. If you create less than $10 in commission, you would pay the difference. Do not let this influence your trading decisions, as transactions with other retail brokers can easily cost you more per month if you are active.

#4: Mobile App

A few months ago, IB introduced an iPhone and iPad app called mobileTWS. It allows clients to trade while on the go and is already fully equipped with the most essential tools such as order management, portfolio and account values, market data, or charting.

#5: API for 3rd Party Platforms

Every relevant 3rd party application can make use of Trader Workstation’s (TWS) API. It makes possible to feed your favorite charting platform with IB’s real-time data. NinjaTrader or MultiCharts come to mind. The API even opens doors to automated trading systems that execute orders automatically on TWS.

For active and experienced retail traders, IB is a very compelling proposition due to the low hurdles for accessing and trading on international markets. The TWS trading platform is extensive and due to its complexity, you want to approach it with attention. Check every detail before submitting an order. In any case you need support, a representative is at your disposal via online chat or support ticket which are both attended to in a timely manner.

Filed Under: Uncategorized Tagged With:

AAII Investor Sentiment Survey (Week 3)

January 23, 2012 By Leave a Comment

While the bullish sentiment retreated sightly, the S&P 500 is continuing its way higher. Financial markets worldwide appear to be leaving the preceding years of crises behind and looking ahead with renewed optimism.

Yesterday, the Investment Company Institute (ICI) said domestic stock funds experienced their first week of net inflows since last August. Even Mark Hulbert’s Stock Newsletter Sentiment Index (HSNSI) is showing that market timers expect stock prices to rise.

As you know, stocks have started the year off on the right foot. In fact, the S&P 500 is enjoying its best early January performance since 1987, according to Bloomberg. The index is also extending a 17% rebound that started in early October.

Here is the sentiment’s survey result for the week ending January 18:

  • Bullish: 47.2%, -1.9
  • Neutral: 29.2%, -4.5
  • Bearish: 23.6%, +6.4
Filed Under: Sentiment Survey

Little hope for the little trader

January 21, 2012 By 2 Comments

Traders that are new to the industry are too easily scammed into dubious trading products or subscriptions. So-called trading gurus permeate our society to exploit the starry-eyed eagerness of a trader trying to learn. It is marketers and their never-ending sales pitches like, “You need this system. This one will make you the star trader you’ve always dreamed of. The new and improved version is guaranteed to double your money instantly or you get your money back.”

Gossip tabloids exploit readers that crave sensational news. Did you hear the latest on Brad Pitt? The National Enquirer tells me so. What will your car salesman, who needs to achieve his quota for the month in order to pay for his new house, tell you? “You look successful. This car will represent you perfectly in your next business meeting.” You try on clothes in a fashion boutique and ask the salesgirl whether it suits you, “Fits perfectly.” Whatever you try on, it always fits perfectly. These people just want to sell you stuff! The sooner you understand it, the better. What will a politician tell his supporters? “If you want change, then vote for me. I will deliver change for you, my friend.”

We live in a capitalistic world where people will always inevitably seek to exploit the ignorance of others. The original intentions may be good, but trading products are often marketed in a way as to guarantee positive performance. A guru is under no obligation to disclose his profit and loss column to you or anyone.

It is pathetic to hear traders complain how gurus are out to extract money from them. It is up to them to separate the wheat from the chaff and some unfortunately are horrible at separating fact from fiction until it is too late. Usually money is lost as a penalty for not being properly informed. There is a learning curve involved in this business of trading and struggling traders are repeatedly seeking a quick solution to their problem that typically requires months or mostly years to reach proficiency.

Just because a trader can show proof that he can make money does not insinuate that he is also a good teacher, and vice versa. The very best thing to do is apply common sense while learning as much as you can (ideally with the help of a trusted mentor). Every trader is individual in his personality, so you need to find out what strategy, time frame, market, or position size suits you best. A mentor can only provide advice. You have to continuously test and improve while risking the least amount of money. This will increase your chances of emerging financially unscathed and start a profitable trading journey.

Filed Under: Mentoring Tagged With: ,

Behavioral biases favor trend following

January 16, 2012 By 2 Comments

Commodity Trading Advisors (CTA) that utilize trend following through managed futures accounts have long known that there is no Holy Grail in investing.

When following trends, they know that anything can happen, so they have completely abandoned strategies involving fundamental analysis or buy-and-hold fallacies. Many successful trend followers and CTAs have developed trend following systems based on multiple time frames with the objective to harness the trend that herding generates in the market. In order to do that, their primary focus lies in managing risk so that the return would somehow take care of itself. Whenever they engage themselves in a trade, the potential loss is always known upfront.

In perhaps no other industry, subjective misjudgments become so blatantly obvious as in the trading business. Trend following tries to circumvent this. Behavioral finance has documented some of the investor biases explaining the rationale for trend following:

  • Anchoring bias: Tendency to rely too heavily on one piece of information, specifically the recent price history to estimate “fair-value”.
  • Bandwagon effect and feedback trading: Tendency for traders to act as a group and jump on the bandwagon of a rising price trend (herding).
  • Confirmation bias: People tend to look for information supporting their beliefs and consider recent price moves to be representative of future prices. This leads investors to over-allocate funds to markets having already risen and under-allocate to fallen markets. This behavior favors trend continuation.
  • Overreaction: Market participants overreact to new information, creating larger- than-warranted effects on market price and stronger trends.

The trend following industry prefers to analyze trends on a meta-level according to the Dow Theory: Higher highs and higher lows for an uptrend, or lower lows and lower highs for a downtrend.

Practitioners understand that the crowd is always collectively smarter and therefore do not bother to predict or outsmart the market with discretionary analytical methods. Instead, their goal is to participate in the crowd’s wisdom and follow the path as it is given to them without judgment.

Filed Under: Psychology Tagged With: , ,

AAII Investor Sentiment Survey (Week 2)

January 14, 2012 By Leave a Comment

Bullish sentiment remains at elevated levels of around 50%, but it does not necessarily mean that the S&P 500 cannot go further higher. It happened often enough in the past that markets could continue its rally, while the mood cooled down at the same time. What remains striking is the fact that markets tend to reverse when bullish sentiment reaches 50% (top) or 25% (bottom).

  • Bullish: 49.1%, +0.3
  • Neutral: 33.7%, -0.3
  • Bearish: 17.2%, ±0.0
Filed Under: Sentiment Survey
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