Saturday, May 17, 2008

Certainty

Ever since I began trading I have encountered many statements seemingly made with great certainty. I have heard people say that a specific stock price is going to jump up on the earnings announcement. It didn't. I have heard people say that the only way to make money in the markets is to buy and hold. It isn't. I have heard people say that no trader can make money trading. That's just not so. Maybe the one saying that takes the cake is "It's going to come back."

The truth is that little, if anything, is certain in the markets. A few things that seem to be pretty close to certain are:

  • Some trades will lose

  • Every trader or investor will make some emotional market decision(s)

  • It is difficult to remove emotion from trading decisions

  • No strategy is perfect

  • The more knowledge and experience a trader gains, the greater chance he gives himself to be successful

  • Sometime you will cut your profits and sometime you will let your losses run even though you know you should do the opposite

    I have an unconfirmed suspicion that those whose personalities work in terms of beliefs in market certainties like "it'll come back," or "there is only one way to make money in the markets and that's to ....," or "there is no way anyone can make money trading" are less likely to be successful than those who simply accept that there are no real certainties. Of course, I am speculating and many may disagree, but I am guessing that those who pronounce "certainties" may be too rigid to accept the vagaries of market movement and may have difficulty in seeing alternative ways to deal with situations. Again, it is just my speculation, but I believe that those who are less rigid, who are able to reverse positions or who are willing to adjust strategies when they encounter a changing or unpredicted situation are more likely to succeed in the long run.

    A "buy and hold" investor, for example, is bullish by nature. Essentially, their argument is that if they buy stock in a fundamentally sound company, the stock price will go up over time. Over what time is not ordinarily defined, but from a long term historical perspective, the argument is sound though it certainly has many exceptions. For example, if we look at the Nasdaq Composite (COMPQX) we see that it is up relatively substantially since its low in 2002, yet it is nowhere near its high in 2000 and it is currently trading at approximately the same level as it did 10 years ago in 1998. The results, therefore, for a "buy and hold" investor would be quite different depending upon when they made the decision to buy.

    Would it be worth the trouble to learn to trade the market in both directions? An investor could have traded bullish strategies on the COMPQX as it rose from 1994 to 2000 and then traded bearish strategies from the break in 2000 until 2002 or 2003 and then climbed aboard the bull again into 2007. The whole move up from 1994 to 2000 was approximately 4300 points; the move down from 2000 to 2003 was about 3750 points and the move up from there to the present about 1200 points. While the bullish buyer in 1994 would have about an 1800 point gain today, the trader who used strategies to trade both directions, even if he captured only 50% of the moves would be up over 4600 points over the same time. Certainty that buying and holding is the only way to go could have been costly in that scenario.

    Please understand that I do accept buy and hold as a very viable strategy. I just believe there are many other strategies, including ones to benefit from bearish moves, that might be worthwhile for each of us to consider. In "Trade Your Way to Wealth," my recent book, I examine a number of these strategies and emphasize the importance of money management and risk control. Understanding and using these concepts may very well add to your trading abilities if you are willing to accept the proposition that certainty in the markets is, most often, illusory.

    by Bill Kraft, Editor
    Copyright 2008, Makin' Hay, Inc.
    All Rights Reserved


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    To comment on Bill's article click on the "comments" link below.
  • 10 comments:

    Anonymous said...

    Certainty?
    As I said to my broker when he said "Hold. Even a broken clock is right twice a day"
    "Yeah, but that's only two minutes out of 1440!

    Bill Kraft, MarketFN.com said...

    Right on, Anonymous. Being right only 2 minutes out of 1440 doesn't seem like the way to go, does it?
    Bill Kraft

    papa_hog said...

    THANK YOU FOR YOUR WEEKLY WORDS OF WISDOM BILL. I FOR ONE AM DEEPLY APPRECIATIVE OF THEM. IT SEEMS THE KEY IS TO DEVELOP RELIABLE SIGNALS AS TO WHEN TO GET IN OR OUT OF AN INDIVIDUAL STOCK AND WHEN TO PLAY THE MARKET BULLISH OR BEARISH. THAT'S WHAT I AM WORKING ON NOW. papa_hog@higheronthehog.com.

    Bill Kraft, MarketFN.com said...

    Good points, Papa. Along with money management and risk awareness, I think a good exit strategy is critically important. Entering directional plays in the direction a market is moving also helps get a little edge, I think. Thanks for the kind words.
    Bill Kraft

    Anonymous said...

    i think a person needs to consider both trading and investing . for instance if someone has a small amount of money to start and they
    enter correctly they can simply reduce what they own near cycle tops and then add to what is near lows near cycle lows and over time they will have accumulated a fair amount of stock and there initial investment would have a reduced risk . short term cycles will always be here
    joe
    http://www.tradersaffiliates.com/WEEKLY%20UPDATE.htm

    Bill Kraft, MarketFN.com said...

    Agreed, Joe. Of course entering correctly is very important as is exiting correctly.
    Bill Kraft

    Anonymous said...

    A few comments:

    You get make money from trading. But it is those who understand values that become rich. Seems that value investors do better over time than traders. Agree?

    If yes, then the one factor trader should note is the trend. Upon understanding the value of the company, jump into the stock and ride the trend once it shows up itself.

    Most technical indicators are proven statistically inconsistent except for trends and momentum.

    Bill Kraft, MarketFN.com said...

    Well, Anonymous, I agree that sometimes value investors do better than traders, but like many other things, I don't agree that it is true all the time. I suspect, for example, that I have done much better than a lot of value investors. If you are saying a trader can't get rich, I disagree completely. With respect to your comment about trading the trend, I am in agreement, hence the name of one of my subscription services that has done quite well -- Trend Trader. Value investors can do well, growth investors can do well, and traders can do well. I have seen examples in each category that fail as well.
    Bill Kraft

    Anonymous said...

    The only thing that is certain is that the market's job is to facilitate trade. Since daily bar ranges are formed, which forms weekly and monthly bar ranges, that tells us that there will always be trades to be taken to form those ranges AND also that price action does three things 100%of the time: it goes up, it goes down, and it goes sideways. This is at the heart of the price discovery mechanism. It is HOW IT WORKS.

    So if we want to experience max potential in trading the markets, we should accept the fact that it is desirable to be be flexible and trade both UP and DOWN price action.

    Maintaining only a buy-side mentality equates to missing out on a huge percentage of tradeable moves. As far as value goes, that is a matter of subjectivity based on information that may or may not be accurate. Remember Enron or Worldcom anyone?

    The way I see it, is that the only value is in the truth and the only truth there is resides ON THE CHARTS! And I am not referring to indicators either. I am referring to PRICE BARS on multiple time frames. Learn to read those charts correctly, and the truth will set you free.

    Quote: "Seems that value investors do better over time than traders. Agree?" DISAGREE!!! Define value...and remember, honor dies where self-interest lies. A CEO or CFO might -possibly- stretch the truth just a little when his stock options profitability is on the line...so where is the truth? It lives on the charts of price action and is no random walk...

    Anonymous said...

    i dont agree that value investors out perform traders , i do think that both have there place and should be considered though . a value investor would buy when a stock is undervalued and sell when overvalued , yet most people buy and hold . even warren buffet the kind of value investing has held coke for example for many years .
    was it because of its value or because of its bussiness ??
    buying based on technical as well as value would get you in a trade
    but if the stock got overvauled and yet the fundementals remained strong would you then sell ??
    or what if the technicals looked bad and the fundamentals changed and yet the stock was still undervalued would that mean it is time to buy ??? just use this yrs decline as an example , many stocks which were undervalued became more undervalued and to add to this others had there values change to the downside right with the stock mkt leaving them the percent wise undervalued all the while declining , valuations alone would then cost you with out technical skills to read the mkt .
    so to sum this up you need both trading skills and valuation skills to survive