Saturday, August 23, 2008

Searching for the Key

Over the course of my trading career I have met a lot of people who were trading or trying to trade. I met them at seminars I took, in trading groups, at seminars I gave, and at events where I have spoken. If we are to believe the statistics, most of them were doomed to fail. From the perspective of an outsider watching it is pretty easy to identify the ones who probably just won't succeed. I have seen the same mistakes made over and over by the same individual and by many different people. Instead of giving themselves an edge to succeed, they set themselves up for failure. I was reminded of some of the mistakes by someone who is doing it right. An old friend and partner called me today to tell me he was retired, had read my book, and wanted to trade. He asked for other study suggestions and said he was "chomping at the bit" after reading my book and another. At this point, my friend already has parted company with many who will fail as traders. He said he really wanted to start right away but knew he had just enough knowledge to be a danger to himself. How right he is. He sees the potential, but, even more importantly understands the risk.

Impatience is definitely an enemy of the successful trader. I can't tell you how many times I have witnessed people who were exposed to a strategy new to them begin trading it right away with real money. Most often they only understand the bare bones of the strategy, if that, and have no idea how to adjust a trade or when adjustments might be necessary. In many instances if asked what do they have at risk in a position they are unable to answer. They are just charging forward seeing only the "up" side until the down side jumps up and bites them.

Another common problem is the hunt for the secret strategy or for the automatic software that guarantees success. One fellow told me you couldn't earn big profits with the strategies in "Trade Your Way to Wealth" and complained that I didn't give away any secrets. Absolute nonsense. Of the many strategies discussed were things like buying stock and shorting stock along with many option strategies including buying LEAPS calls. Of course one can earn big profits with those strategies and many undoubtedly have. And, yes, there is no hidden secret. The secret is in the open. Know the strategy, know the risk, formulate a plan including an exit strategy and follow the plan, exercise sound money management, trade with discipline-- that's about it.

Most trading strategies are relatively well-known, and will lead to success if used properly by a knowledgeable, disciplined trader. Almost none will work for the trader who is not intimately familiar with the strategy or who permits his emotions to make his trading decisions.

Another common characteristic is the search for the perfect system or the perfect software. No one, absolutely no one, can know the future. How can anyone say that any system of trading the markets is going to be infallible? What will be the state of the world in 3 years? or in 5 years? Won't what happens in the world affect the markets? Will the U.S. be at war? If so, with whom? What will the capital gains tax structure be? What will have happened with inflation? We can speculate on those things all day long, but we can't know until we get there. No software or system can predict the unpredictable. Those who create and sell systems and software know that they cannot predict with certainty. That's why they can never and will never guarantee your success using the software. When the well-funded software developer is willing to guarantee your capital when using his system, it might be time to buy. Meanwhile, examine them with a careful eye. I don't mean that many systems and a great deal of software aren't helpful. Some definitely are; they are just not the panacea the eager trader seeks.

Though many of us understand that the future is unpredictable, we still try to trade by prediction. Some will advocate buying a stock because it has great fundamentals and, therefore, it "must go up." Over time they may be right (maybe not?). The question is when. Simply because a company is great doesn't mean that it's stock price will go up. GE is a great company in my estimation. In 2000 it traded at a split adjusted price around $60. Today it is trading at less than half that. Any prediction that GE will hit $70 may have to wait. Several months ago, a subscriber suggested that the only way to go was to buy and hold. He used his family's holdings in Citigroup (C) as an example. In 2000 Citigroup stock was trading in the low $50's. In mid-2007 it was trading in the low $50's. Today (August 20, 2008) it closed at $17.49. Well, some say, of course it dropped, that is because of the credit crisis. That is the fundamental reason, but as of about the middle of 2007 it was at least unpredicted if not unpredictable. I am unwilling to sit through the drops from $50 to $18 if I can avoid it so rather than trying to predict, I try to let the market movement take me out and put me in.

One last problem for this article that I have seen with unsuccessful traders is that they see a trade but don't make it because they are waiting for confirmation. I'm not against confirmation, but I have seen situations where the delay in entry causes the trader to miss the trade or much of it, or, even worse, puts the entry far from an exit in the event the play goes the wrong way thereby increasing risk rather than reducing it by awaiting more confirmation.

Down the road, we'll look at some other issues and, hopefully, some ways traders can make themselves aware that they are setting themselves up for the fall.

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

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Anonymous said...

As usual, your remarks hit the spot with precision. Most of us search for the Holy Grail of trading only to discover ( if you have any sense at all ) after wasting a good deal of money on books, courses etc ( I plead guilty ) that there are just a few strategies to approach the market and one my only enjoy some success if he sticks to one that is consistent with this temprament. That is something you have mentioned, but might pound home. Emotions play a huge part in our trading decisions - at least when we are unaware of them. If you do realize that, then you may have a decent chance of dealing with them and becoming a decent - if not outstanding trader. That is not easy - but no one would expect to be a successful surgeon without training and discipline.

Anonymous said...

Another great article.I have read alot of books and have been to a few seminars and webinars. I think I have heard all of the stratigies.
YES they have all worked in the past. They will work in the future. The major problem is finding the right stock to use the stratigy on.
I hear of people that look up data in 20 minutes a week.
I take longer and get more winners than loosers in trading.

keep up the great work.

Anonymous said...

Really enjoyed your article. There is much truth to it. When I was on the floor of the Merc an old trader told me, "Bulls make money, bears make money, but pigs get slaughtered." Then he went on to tell me that "if you take 50% of a move thank God and be happy."

Some of the best traders on the floor bat only 50% on their trades, but they can still make a living trading.

Remember the market giveth and the market taketh away. For those ardent individualists remember the market is a collective.

It is the quantitative expression of thousands of individuals expressing the fundamental emotions of fear and greed. No matter what you think, the market is always right.

Approach with humility and that for no matter how many years one has traded there is always something new to learn.

Anonymous said...

Great Article. Iam a new Trader in the Market I have started with a $1000. Iam trying to be sensibly about what I buy Mixing different types of stocks. Mixing Energy, Computer, health and keeping an eye on Minerals. I havent read your book yet but Iam tempted. I receive several news letters and they are full of strategies to Buy. But I take time and go on Google and find everything the newsletters are trying to sell me for free.

Bill Kraft, said...

Good points, Anonymous. Successful trading can be simple, but it definitely isn't easy and in many cases we are our own worst enemies.
Bill Kraft

Bill Kraft, said...

Thanks, Sam. As you say, finding the right stock to apply a strategy is a big part of the battle, but we do have some guidance with market and sector direction. As you suggest, the harder we work, the luckier we can get.
Bill Kraft

Bill Kraft, said...

To Anonymous from the floor of the Merc -- thanks for the important observations. People can and do make a living, as you said, when batting only 50%. That's why money management, cutting losses, and letting profits run are such significant keys to success, eh?
Bill Kraft

Bill Kraft, said...

Thanks for writing Dadday P. No doubt you are correct, you can learn almost anything through research on Google. The only thing I should say is make sure you take your own time into account when you think something is free. If you can read a book that pulls everything together, for example, it might save hours and hours of research on your part. Depending upon how you value the time you must spend ferretting out the same information on your own, it may be more efficient to buy and read a book or buy and watch a DVD set, or go to a seminar. Definitely, it is an individual choice, but never forget your time is valuable and you can never get it back.
Bill Kraft

Anonymous said...

Years ago I tested a horse racing system on paper. It won every week without fail. The first day I used money it lost. Trying a system out on paper is a must and even then be careful.

Bill Kraft, said...

Agreed, Anonymous. Paper trading is no guarantee of success, but it does help learn strategies well. Unfortunately it does little to quell emotions when real money is at risk.
Bill Kraft

Anonymous said...

I think all too often people think that trading is just buying and selling a stock or option or whatever. We need to constantly remind ourselves that we are here to "plan a trade and to trade a plan". No artisan can succeed if he focus only on the money and not his craft. Way to go Bill. - Diceyliving

Christopher Yeap said...

It is often easy to use $1000 to earn $10. How about $10,000 to earn $100 in a trading day? I find it similiar also. Needless to say that discipline, greed and patients is our own biggest enemy. It's true knowing just the strategy don't guarantee successful results consistently.