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- The Japanese Government’s Bet Against Tesla
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- ‘Smart Beta’ Investing Lets the Yardstick Pick the Stocks
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- Why Government Pension Funds Became Addicted to Risk
- Supreme Court rebukes Obama on recess appointments
- ‘Dark Pools’ Face New SEC Probe
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- Achieving Greater Long-Term Wealth Through Index Funds (AAII)
- 5 Reasons Why Excessively Low Rates May be Harmful to the Economy
- Ruling Risks New Argentine Default as Monday Deadline Approaches
- Top Shiite Cleric Tells Iraq Leaders to Pick New Premier
- Li Ka-Shing Says Widening Inequality Keeping Him Awake at Night
- Emerging Markets Show Biggest Premium Since ’12 With ETFs
- Calm Ain’t Bad, Necessarily
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- Narrative Fallacy
- The State of the Nation’s Housing
- The Race to Dominate Digital Health Heats Up
- Single Variable Market Analysis is for Losers
- Big asset managers and other brokerage firms are giving the Heisman to Barclays and re-routing trades elsewhere
- Twitter goes nuts on huge Barclays upgrade
- Where have all the traders gone? Three factors behind the extraordinary drop-off in equity volume.
1. Markets tend to return to the mean over time
When stocks go too far in one direction, they come back. Euphoria and pessimism can cloud people’s heads. It’s easy to get caught up in the heat of the moment and lose perspective.
2. Excesses in one direction will lead to an opposite excess in the other direction
Think of the market baseline as attached to a rubber string. Any action to far in one direction not only brings you back to the baseline, but leads to an overshoot in the opposite direction.
3. There are no new eras — excesses are never permanent
Whatever the latest hot sector is, it eventually overheats, mean reverts, and then overshoots. Look at how far the emerging markets and BRIC nations ran over the past 6 years, only to get cut in half.
As the fever builds, a chorus of “this time it’s different” will be heard, even if those exact words are never used. And of course, it — Human Nature — never is different.
4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways
Regardless of how hot a sector is, don’t expect a plateau to work off the excesses. Profits are locked in by selling, and that invariably leads to a significant correction — eventually. comes.
5. The public buys the most at the top and the least at the bottom
That’s why contrarian-minded investors can make good money if they follow the sentiment indicators and have good timing.
Watch Investors Intelligence (measuring the mood of more than 100 investment newsletter writers) and the American Association of Individual Investors survey.
6. Fear and greed are stronger than long-term resolve
Investors can be their own worst enemy, particularly when emotions take hold. Gains “make us exuberant; they enhance well-being and promote optimism,” says Santa Clara University finance professor Meir Statman. His studies of investor behavior show that “Losses bring sadness, disgust, fear, regret. Fear increases the sense of risk and some react by shunning stocks.”
7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names
Hence, why breadth and volume are so important. Think of it as strength in numbers. Broad momentum is hard to stop, Farrell observes. Watch for when momentum channels into a small number of stocks (“Nifty 50” stocks).
8. Bear markets have three stages — sharp down, reflexive rebound and a drawn-out fundamental downtrend
I would suggest that as of August 2008, we are on our third reflexive rebound — the Januuary rate cuts, the Bear Stearns low in March, and now the Fannie/Freddie rescue lows of July.
Even with these sporadic rallies end, we have yet to see the long drawn out fundamental portion of the Bear Market.
9. When all the experts and forecasts agree — something else is going to happen
As Stovall, the S&P investment strategist, puts it: “If everybody’s optimistic, who is left to buy? If everybody’s pessimistic, who’s left to sell?”
Going against the herd as Farrell repeatedly suggests can be very profitable, especially for patient buyers who raise cash from frothy markets and reinvest it when sentiment is darkest.
10. Bull markets are more fun than bear markets
Especially if you are long only or mandated to be full invested. Those with more flexible charters might squeek out a smile or two here and there.
- Ignore the news, only price pays. How many times can I say it, the price you buy something and sell something is all that matters. Everything else is just noise. So many times over the past five years I’ve heard every reason in the book prices should drop, but they haven’t. I don’t know if all the bad news is truly priced in, I do know ignoring the scary headlines and following price has made you more money than listening to the constant fear mongers.
- No one is as good as they seem. I laugh when I hear how someone has 30 winners in a row, a 90% win rate, etc. I’m just as guilty sometimes. Make some calls on Twitter and if they work, you point it out. If you are lucky enough to find someone who points out their mistakes and what they learned from those mistakes, follow them immediately. The bottom line is trading is extremely hard and never easy, if someone makes it sound easy all the time – they are lying.
- There is no holy grail to trading. As much as we’d all like, there is no black box to trading. Markets are always changing, the participants are getting smarter, and you had better be able to adapt in a hurry or you’ll lose. I like to say ‘adapt or die’ is a golden motto for investing. What worked last year probably won’t work this year. As soon as everyone noticed last month how strong Tuesday had been, Tuesday stopped going up. It is as simple as that. This isn’t an easy game, so don’t expect the results to bring with it tons of easy money, and don’t waste your time looking for a holy grail – there isn’t one.
- Sentiment needs to be a part of your methodology. I don’t care how you use it, but use sentiment in your trading decisions. Whether it be put/call ratios, investor sentiment polls, short interest, or anecdotal sentiment – this could be the difference between a good year and a great year. Think about it, if everyone loves something, the odds of it going up are slim. The flipside is if everyone hates something, the odds of a strong rally are much higher. Coming into this year everyone ‘knew’ that interest rates had to go up, as the Fed was slowing QE. If they couldn’t keep rates low when they tried, how could they keep them low once they stopped trying? Well, everyone already knew this and the most hated asset coming into 2014 is now one of the strongest performers. To quote the great Humphrey B. Neill, “When everybody thinks alike, everyone is likely to be wrong.”
- Being smart doesn’t make you a good trader, it probably hurts. I’ve seen a lot of very smart guys fail at trading. When you consider how many degrees and awards the team at Long-Term Capital Management had and they blew up, that makes it clear being the smartest guys in the room doesn’t equal making money. Mark Douglas best sums it up:
“Trading is probably the hardest thing you’ll ever attempt to be successful at. That’s not because it requires intellect, quite the contrary! But because the more you think you know, the less successful you’ll be.”
I love that quote. Don’t worry about why something is happening, just make sure you are in on it.
- Trends really are your friend. I know, this is a common investing rule and I’m supposed to share the top secret things I’ve learned. The only problem is it isn’t as easy as it looks to stay in a trend. Look at what’s happened since late ’12, we’ve had one of the better trending markets ever. None the less, we’ve heard everything from new highs in margin debt will bring a crash, to Cyprus in turmoil will bring world markets crashing down, to the recent ‘we look just like 1929’ charts everyone was worried about back in February. Through it all, none of it mattered. The upward trend that has been in place for years has prevailed. The SPX has been above its 200-day moving average for nearly 400 days. This sounds like a lot I know, but the all-time record is 525 days. So could this bull market stick around a lot longer than people think? I have no clue, but I wouldn’t bet against it either.
- There’s no wrong way to make money. If you like premium selling and it works for you, do it over and over. If you like swing trading, do it. Day trading? Do that. If you are lucky enough to find one thing you are good at, do it and perfect it. It is very hard to be a good swing trader and a good day trader. Not saying you can’t, but it is hard enough to be good at one thing – let alone two. It could take years to find you true trading niche, but once you do, perfect it. Don’t look for the next shiny new strategy all the time, find what works for you and stick with it.
- If a trade isn’t working, get out. Now, I’m not talking about limiting losses, but that is extremely important as well. I’m talking about the mental drain certain trades can do to you. Over the years, I’ve found there are some trades you are just more mentally invested. Maybe you were told it wouldn’t work, or it is a stock you’ve lost on before so you just want to get even. Whatever the reason, once that trade starts to go against you, it is all you can think about. In other words, this one modest loser is messing with you so much, that you aren’t looking for new opportunities. This would happen with me when I’d sell premium. The stock would be close to the strike I sold and I’d just watch it all day – every tick. We’ve all been there, but once one trade starts taking up most of your mental health – it is time to cut it and move on.
- Losing streaks happen. We aren’t perfect. Doug Kass called the 2009 bottom to the day, but how many times has he been wrong since then? Trust me, I’ve been wrong many, many times also. Losing is part of the game. If you don’t like to lose – don’t trade. No one likes having four losers in a row, but the key is to learn from your mistakes. Keep a trading journal and try to be as honest as you can be, you’ll learn so much this way. The past seven years I’ve had three kids. Trust me, the worst I ever traded was that first year with each of them. But each year got a little better actually. Took me a while to learn, but a lack of sleep didn’t help my trading. I now have a rule if I was up most of the night, I don’t trade the next day. Might miss one or two opportunities, but I’m sure I’m up overall on the sleep deprived losers I’d be throwing out there.
- The market doesn’t owe you anything. Lastly, know that Mr. Market doesn’t care about you. All he wants to do is take your money. There’s a reason 90% of option traders don’t last that first year, it isn’t easy. Trading is one of the most rewarding, yet frustrating endeavors you could ever do. Put the time in and the results will come, but don’t expect to be a master trader overnight.
Courtesy: Ryan Detrick