Tuesday, July 2, 2013

The Enemy Of Your Trading and the Antidote

One of the big enemies of market timers are emotions mainly because they are trading REACTIONARILY. the market goes down they sell then it goes up and they buy back higher. The market goes down and they hang on because they believe it's going higher this time, and then it continues lower beyond their threshold and they sell and it goes higher.
The market isn't rigged, it's just that the market starts going down and once everyone clears out that was going to around those prices, it no longer has the pressure from the sellers and finally it doesn't take many buyers to push it higher again. As such, the short term traders that drive the liquidity for the long term investors often end up holding the bag.
There are several ways you can switch from being reactionary to anticipatory.

1)Volume profiles. You should anticipate that a stock will continue it's upward charge and
potentially pop into the volume pocket and above it and hold at support. This way you know if there is a psychological basis in the REST of the market for support/resistance or not.

2)Sentiment chart. If you understand how the sentiment works to shake you out of the position, rather than panic and sell and react, you can anticipate how others WILL react, and capitalize off them.
3)Valuations- The long term investor benefits from buy low and sell high. The trader doesn't always have that luxury. However if you grab a stock with upward momentum AND it's still undervalued, you at least are sticking to the principal of not buying "too high" and you have a tailwind of value investors at your back. The value investor is anticipatory because he anticipates prices will return to it's fair value at some point.
4)Technical signals, but mostly oscillators that give you an "oversold" and an "overbought" signal to base your decisions off of. If you learn to follow indicators, particularly those that "buy low and sell high" variety or buying at support or buying an oversold stock AFTER momentum has shift positive again then you can start to time the market more effectively.
5)index Seasonals, sector seasonals, commodity seasonals, and individual stock seasonal data.
The seasonal charts really help along with your other indicators because you may identify a time when you "can't afford to wait" as opposed to a time when you definitely can and probably should wait before buying an oversold stock.
6)Sector rotation. This doesn't really help you a ton if you are a short term market timer, but at least if you continuously LOOK for the short term trades in the area that represent long term strength you will increase your chances of being able to ride a much more significant trend. You are still anticipating that throughout the periods in which you trade, there is an increased chance of capital rotating into that area.
7)Trade management strategies. One method will hold an 8% stop until the stock really takes off and then switch it to a trailing stop of 25%. This prevents you from fear based selling if you have the strict discipline required. Another strategy might just have you hold it 5 days and then sell it regardless. Another has you sell at a target price or stop price adjusted for volatility (ATR) of the stock.Another will sell at 10% and hold 3 days if it continues lower and then sell it but will buy oversold stocks which have a chance to rally. If the stock is flat or down in 3 days they will sell it. If it is up but not at the target, they will give 3 more days to reach a 5% target. That same concept can be applied to momentum traders and trend traders and day traders with just different targets
8)Historical data. Historical data PROVES the strategy works, and with that knowledge, you can anticipate your expected return if you trade that way. That will provide the incentive to not worry about what happens day to day.For example this type of historical data about using multiple stops can provide you with the knowledge that a system works so that you don't suddenly change your mind and get nervous half way through and change your own rules.
9)Law of mathematics. This one is great, but may require lots of work to get everything set up so that you know it works. For example, I manage a portfolio with knowledge of various strategies and how they work with regard to FEES as well as multiple bets and various levels of capital at risk. I used a modified kelly criterion calculator to determine the various strategies and I am in the process of cleaning everything up to determine what the best approach annualized AFTER accounting for fees, and then determine an acceptable risk amount.
8)Correlation - Correlation and volatility can be your friend. The key is trades that are commission free. If you use correlation and volatility to rebalance a multiple asset portfolio you can profit from the volatility and add low and reduce high.

9)Simplicity. Perhaps lost in all of this is if you have too many things going at once that you aren't prepared to understand; it can actually do more harm than good. At times until you trade profitably maybe you should just keep things very simple. Then you can progress onwards and begin to introduce other aspects.

10)A parent or friend or spouse or mentor of some sort that places the trades for you (upon your request) but also knows your system and can tell you when you're violating one of your rules. If you have some sort of custodial account and you have to go through them to trade, it may make you think twice about making dumb decisions.

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