Saturday, November 01, 2008

Predictions

"I contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself by the handle." Winston Churchill

After stirring up the hornet's nest last weekend, I'm returning to some considerations for traders. Last weekend, I had the privilege to speak at the Trader's Library event in Chicago and was humbled to be in the company of legends like Dick Arms (creator of the Arms Index) who was inducted into the Trader's Hall of Fame and Charlie Kirkpatrick, a two time winner of the Charles Dow award. Conversations with these men and several of the other speakers provided an invaluable learning opportunity; one for which I am extremely grateful.

Among the topics of discussion was the concept of predictions. We hear and see so much in the media devoted to whether the markets have found a bottom and where the bottom might be, but the truth is no one knows. Prediction is little but speculation and has no value. Look how well the weather forecasters do. Tell me, is the market going to be up or down next Thursday? Six months ago, who predicted that Lehman Brothers would no longer exist? In his excellent recent book, Beat the Market, Charles Kirkpatrick quotes commentator and chief market strategist Barry Ritholtz as saying the SEC should require all analyst and pundit forecasts to publish the following caveat: "The undersigned states that he has no idea what's going to happen in the future, and hereby declares that this prediction is merely a wildly unsupported speculation."

All we can know is the past and the present. If I knew the future, I certainly wouldn't be trading stock and options, I'd buy a winning lottery ticket and be done with it. Yet, as I talk to coaching students, I regularly hear things like: "this will be a long term trade" or "I'll be out of this trade in a week" or "I know XYZ will come out with a good earnings report and the stock will rocket." I always ask: "How do you know that?" Predicting that we will be in a long term trade may be tantamount to saying I'm going to let my losses run no matter what. Predicting that we'll be out of a trade in a week may be the same as saying that I've decided to cut my profits. Predicting that a stock price will jump on an earnings announcement doesn't make it so. Often, in fact, even when relatively good earnings are announced, a stock price will fall.

As Mr. Kirkpatrick notes in referring to David Dreman's research which studied 78,695 earnings forecasts by analysts over a 20 year period from 1973 to 1993 only 1 in 170 forecasts were within 5% of any four consecutive quarter's actual earnings. Why do we continue to rely on such speculation?

As I emphasized in my own talk on Sunday, I emphasized, as I always do, that one of the keys to successful trading is to have an exit strategy in place before ever entering a position. That enables a trader to get out if he is wrong on direction. As I've regularly taught in past seminars, the strategy needs to be one that permits profits to run while creating a disciplined unemotional exit that initially is both clear and close to the entry. In that fashion, prediction no longer controls. The successful trader, instead, simply reacts to the price movement. Having a plan that incorporates money management, reward to risk potential and disciplined exit strategy can supply an edge that prediction doesn't. After all, even the best traders in history rarely win more than 50% of the time. The key, of course, is to learn how to make the profits from the winners significantly exceed the losses from the losers. Few retail traders enlighten themselves on how to do that. Hopefully, you are among those who do make that effort for without it you will continue with the vast majority who fail in their trading efforts.

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.

23 comments:

GUIDO said...

I bet even you would agree with this prediction. "Following your advise will help me become a better trader in the future."

Bill O'Donovan said...

I have been reading your weekend columns for several months now and I find it refreshing that there is a calm voice amidst all the market turmoil lately. As to your most recent column, I agree that these "talking heads" (Jim Cramer, especially) don't have anymore idea of an overall trend than a monkey throwing darts at stock quotes (I'll take the monkey the majority of the time). My theory is that anyone who wants to predict the market, should have his own "skin in the game". If your prediction is off-base, you should lose some of your capital. How many of these psuedo-gurus do you think would be posting predictions then?

Charles said...

Taxes are the price we pay for civilization. I value civilization. Others may not. I refuse to argue with these folks. However, even those who value civilization can disagree how best to collect taxes - I think a flat tax (no exemptions, and no FICA cap) could be fair - and how best to spend tax money - I think using tax money to rescue corporations from stockholders and management that are incompetent or worse is simply not a very good use of my hard-earned tax dollars. Others - like Bush and McCain - may differ, arguing that the real function of taxes in a democracy is to collect wealth from the poor to support the worthy wealthy. I disagree. So does Warren Buffett, who actually collected the data and did the math to show that he personally paid the lowest tax rate of anyone working in his Omaha office. I think that is disgraceful. Bush and McCain do not. Apparently the writer ot this column does not either.

Anonymous said...

THANK YOU FOR YOUR VERY SENSIBLE ARTICLE. FOR ME, IT PUT SOME SANE INTO THESE INSANE TIMES.

Anonymous said...

Right On. But I do find that a combination of certain elements I follow provides me with a significant number of winners over losers, although waiting for the expected result is often nerve wracking and the urge to escape(cash out early) almost overpowering. But the consideration that it is MY plan not some advisors, helps me hang on. Thank you.

Bruce Serwin said...

As usual, Bill, you are right on the mark. I would add all investors, You are so very correct each trade should/must have an exit strategy.

Bill Kraft, MarketFN.com said...

Thanks, Guido. I would hope that is true, but I'm not right all the time myself.
Bill Kraft

Bill Kraft, MarketFN.com said...

Thanks for writing, Bill. I once heard a talk by a CNBC personality who told the audience that the commentators had to advise the network quite some time in advance (a month as I recall) of any trade they were going to make. I think it would be really difficult to do something like that with any degree of success. The other day I saw something that said Jim Cramer had commented that there was nothing to worry about Bear Stearns a short time before it failed. Prediction is just about impossible and the only thing I think we can do is react to the right side of the chart.
Bill Kraft

Bill Kraft, MarketFN.com said...

Say, Charles perhaps you failed to catch on that the quote was from Winston Churchill, not me. If Warren Buffet would like to pay more, there is nothing to prevent him from doing just that. Incidentally, I agree that a flat tax would be the best solution. Apparently you forget that the Hon. Nancy Pelosi and the Hon. Harry Reid and the Democrat Congress were the ones who passed the bailout. I, too, disagree with it, but I say to you that it is intellectually dishonest to point the finger at just one political party. Both have fault here.
Bill Kraft

Bill Kraft, MarketFN.com said...

Thanks, Anonymous. We surely do need some sanity.
Bill Kraft

Bill Kraft, MarketFN.com said...

Anonymous, it sounds like you are doing very well following your own plan. Congratulations and a tip of the hat to anyone who does that and has the significant number of winners over losers like you do.
Bill Kraft

Bill Kraft, MarketFN.com said...

Thanks, Bruce. Here's to good trading!
Bill Kraft

Anonymous said...

go onto bloomberg and watch prechter's video's..the one he made n 11/07 is most illuminating he predicted then that the markets would fallll and the correction would be worse than in 87...he suggested a move into cash at that time...

he was right! "a prediction?"

Anonymous said...

If one pays attention to the vocal tone of even successful contrarians comment on bottoms, one can detect the "hopeful" note in tone of voice. I, for one, could intuit that they WERE being hopeful, not making some scientifically calculated prediction. But, in language the mind is, at the same time, being authoritative about it. Listen between the lines of pundits.

Secondly, Bill. You speak about "exit strategy." I'm very much a young student. I don't understand yet the necessity of if one has a VTSO trailing stop in place. Won't that pretty much take care of a reversal when it happens?--barring a gap down? Wouldn't this protective stop safely maximize profit in a trend trade, for example? I would a direct reply from anyone to: William Comer, healng_current@yahoo.com.

I so enjoy your practical wisdom, Bill. There's nothing more refreshing than honest appraisal ...except maybe an excellent glass of Ginnis.

Bill Kraft, MarketFN.com said...

Anonymous, of course some predictions will be right. If you want to follow predictions, go ahead. My prediction is you'll go broke.
Bill Kraft

Bill Kraft, MarketFN.com said...

Thanks for writing, William. As you suggest, a trailing stop IS an exit strategy. Of course a trader has the option to apply many different strategies and that is just one. Personally, I will often start with an exit strategy like a break in a price support and as a position becomes profitable switch to a trailing stop.
Bill Kraft

tom said...

Bill,
I couldn’t agree more with last week’s column. You are exposed to the public plenty with your services, books and coaching. You just can’t account for what people will do, say or their attitudes. I used to joke that I was working on a business plan that didn’t have a product to sell, didn’t deal with the public and was all cash. Trading is that business, if you can make it work. It is possible but takes all you teach, overcoming all your human frailties and iron discipline.
I have benefited and continue to benefit from your weekly column. I have purchased 3 copies of your book. My wife, son #2 and I have read copy one. Copy two I sent to son #3 in Colorado. Copy #3, to a life long friend who has 10’s of thousands of shares of stock with no exits (you know what has happened to him in 08). I also recommend your book, as the first to read, to everyone who asks me about trading. The other book I recommend is Dr. Elder’s “Come into My Trading Room”, as you do.
I’m new to trading, two and half years. We did start with an expensive education, but that didn’t prevent us from losing money. We have always traded with stops so no losers were allowed to run but I had trouble being consistent. If your book had been part of that education it the beginning I’m confident learning this would have been easier and we would have arrived where we are now sooner. I, we, continue to read, study, and attend classes that aren’t free. Since May our trading has moved to a new level. We have closed 31 trades, 3 losers (small), 3 breakeven and the rest profitable. Not sure what has happened exactly but I think more than anything it’s been me overcoming fear and taking the trades we engineer. Your book seemed to “ice the cake” so to speak. We are trading small lots just trying to get consistent; we will slowly scale up as the success continues.

Thank you,
Bern

Bill Kraft, MarketFN.com said...

Thank you Bern. I'm really glad that Trade Your Way to Wealth has been so helpful to you. It really sounds like you are doing the things so many would-be trader don't and as you are finding, success can come to those who make the effort and employ the necessary discipline. Again, thank you for buying the copies of the book and recommending it to others.
Bill Kraft

Anonymous said...

I am still in the learning stages of trading, but I read your weekend newsletters every week. I agree there is nobody that can predict what the markets are going to do, and that a trader needs to stick to a plan like yours to be successful in trading or any other aspect of life!

Thanks.

Alexander said...

I really enjoyed this weeks news letter and wanted to thank you for writing such informative and beneficial letters. With all the market turmoil your words bring me back to the strategic side of trading which is much more sound then the emotional side. Thanks a lot!

Bill Kraft, MarketFN.com said...

You're welcome, Alexander. Thanks for writing.
Bill Kraft

Anonymous said...

I scan read your letter and it occurred to me this joke I heard. It was about this apartment owner back some place where its really cold , so he calls the repairman to fix his boiler and he comes out in the dead of winter and looks at the boiler hims and has a little goes to his toolbox gets out his medium size hammer and walks up to the boiler and gives it a good rap. He turns to the guy and says that's $500 please. The guy complains like your letter, so he tells the guy it was $50 for the hammer and $450 dollars knowing where to hit it.

Bill Kraft, MarketFN.com said...

It's so true, Anonymous. Thanks for the joke.
Bill Kraft