Category Archives for "Free CMU"

Dec 27

CMU: When the calendar matters and when it doesn’t

By Jani Ziedins | Free CMU

Cracked Market University: 

With 2020 only a few days away, I want to discuss the “calendar effect”. I alluded to this phenomenon in recent posts, but this is an important concept and worthy of the entire spotlight today.

In a lot of ways, the calendar doesn’t matter. For example, Year-to-Date gains/losses are a meaningless statistic, especially early in the yar. The same can be said for annual gains. 2019 will go down in history as the second-best performance of the last two decades and everyone is cheering these nearly 30% gains!

Unfortunately, 2019’s headline number isn’t so much about how good 2019 has been, but how bad 2018’s fourth quarter was. If we adjust the rolling 12-month period from October 1st, 2018 to October 1st, 2019, these impressive 12-months gains tumble all the way to a measly 0.5% annual return! That’s right, just half-of-a-percent in 12 whole months!  If our calendar went from October to October instead of January to January, the second-best year in two decades turns into a very forgettable performance. Ouch.

While we need to question these somewhat arbitrary rolling periods when making performance comparisons, there are times when the calendar actually matters to the market. It isn’t so much about the calendar itself or even the seasonality of the business cycle, but how institutional investors’ performance is measured and how their managers are paid.

Most institutional funds are judged by their annual performance and that means the managers running these funds live and die by where they stand at the end of every calendar year. There is nothing more important in their world. Next in importance comes the quarterly statements that get mailed to investors. If you want to keep people’s money, then you better show respectable gains at the end of every third month. And lastly, monthly gains, but they don’t matter as much because only the nerdiest of the nerds keep track of those.

Institutional money managers’ entire mindset revolves around March 31st, June 30th, September 30th, and December 31st. All of their decision are driven by how they will look on those four critical days. And since most market moves are propelled by institutional buying and selling, those four days matter to us too.

Currently, there is a lot of pressure on large money managers who are trailing this very impressive year. If they cannot match the market’s gains, at the very least they need to be able to tell their investors that they are in all the right stocks and that the results will come. This chasing of performance is what gives us strong moves in the final months of good quarters and years.

But here’s the important thing, once the calendar rolls over to the next quarter or year, these institutions are starting with a clean slate. Those that were compelled to buy in the final weeks of the year no longer need to chase prices higher because they have just been given three months of breathing room.

This herd buying and selling ahead of the end of quarters and years is what gives quarters and years consistent personalities. Quarters and years are most often up, down, or flat. But once those quarters/years end, we move into a new quarter/year, one that most likely will have a much different personality than the one that preceded it. 2019 was a good year for stocks. Chances are, 2020 will look a lot different. Be ready for it.

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Tags: S&P 500 Nasdaq $SPY $SPX $QQQ $IWM $STUDY

Aug 21

CMU: How to trade the news in our current environment

By Jani Ziedins | Free CMU

Cracked.Market University

How the news affects the stock market is one of the biggest enigmas in trading. Intuitively, bad news should make stock prices go down and good news makes them go up. Unfortunately, it is rarely that simple. This often contradictory puzzle of news and the stock market is the number one reason people claim “the market is rigged”.

While news is important to the stock market, the thing most people forget is news by itself doesn’t move prices, only traders buying and selling can do that. If we take this concept to the next level, it isn’t news driving market moves, but traders’ reaction to the news that matters.

Why this distinction is so important is because all traders come to the market with expectations. Expectations and beliefs about what will happen next. That means it isn’t whether the news is good or bad, but if the news is better or worse than the crowd expects. This is where the confusing paradox of “good news is bad” and “bad news is good” comes from.

Traders often correctly anticipate a piece of news and they trade the market ahead of it. And when their intuition proves right, rather than make money, the trader gets hit with a stinging loss when the market moves in the opposite direction of what it “should do”. When traders get the news right but lose money is when they start claiming “the market is rigged”. Sound familiar?

The mistake is thinking the market should react to the news. What we really should be focused on is the market’s reaction to the news, not the news itself. This is concept is extremely important in the current environment. Trade wars, Fed interest rates, and hints of a looming recession have may traders running scared. But paradoxically, the stock market remains stubbornly stuck near all-time highs.

If a person was only looking at the headlines, it would be easy to assume the market is well on its way into a bear market. But if we look at the market’s reaction to these headlines, we actually see the opposite. A market that is frustratingly indifferent.

If our goal is to make money, then we should be trading the market, not the news. No matter what we think of these headlines, the only thing that matters is what the market thinks. Keep that in mind when you place your next trade.

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Tags: CMU S&P 500 Nasdaq $SPY $QQQ $study

Dec 19

CMU: Bad Luck Brian buys the dot-com bubble

By Jani Ziedins | Free CMU

Cracked.Market University

If I asked a crowd what was the absolute worst time to start investing over the last few decades, no doubt the most common answer would be at the top of the dot-com bubble. Everyone knows the story. The tech-heavy NASDAQ peaked in March 2000 above 5,000, and it took another 14 agonizing years before the NASDAQ returned to those highs. In the meantime, the Nasdaq plunged more than 70% from those heady highs.

So exactly how bad would it be to start investing at the peak of the dot-com bubble? Let’s find out. For this exercise, we recruited Bad Luck Brian. In 2000, he graduated from college with an engineering degree and landed his first real job in March 2000. Following the advice of everyone around him, he started investing in the tech-heavy Nasdaq. He told human resources to take $500 out each month and put it into a zero-cost Nasdaq index fund.

And true to his name, Bad Luck Brian promptly forgot about his recurring investments in tech stocks. While the smart people were pulling out of their investments during the bloody tech collapse and subsequent recession, Brian continued throwing $500 away every month. He was buying the Nasdaq as it tumbled -10%, -20%, -30%, -40%, -50%, -60% and he even bought when the selling climaxed at -70%. What an idiot, right?

So given how unlucky Brian is, how horribly awful did his investment turn out? The attached chart shows his returns versus the Nasdaq. As expected, the first few years were terrible. Brian lost more than 40% his principle in those early years. But even then something strange was happening. Even though the Nasdaq kept falling, Brian’s losses were consistently smaller than the Nasdaq’s. When the index was 70% under the highs, Brian was only down 40%. While no one wants to be down 40%, that is definitely better than -70%.

And the outperformance didn’t stop there. Believe it or not, Brian’s account actually reached break-even in November of 2003, more than a decade before the Nasdaq could do the same. How could this be?

No doubt many of you already realized why Brian’s account was performing so much better than the Nasdaq. That’s because he kept buying the dip. With every paycheck, he stuck more money into the market. And the further the Nasdaq fell, the more stock Brian was buying.

If we assume one share of the Nasdaq fund cost 1/10th of the index value, with his first $500 in March of 2000, Brian bought approximately 10 shares.  But the next March after the index collapses 55%, Brian’s $500 bought more than 20 shares. In fact, the Nasdaq fell so far that at one point Brian’s $500 was buying nearly 40 shares a month!

And lucky for Brian, he kept buying those discounted Nasdaq shares for more than a decade. Accumulating 20 and 30 shares per month started paying off handsomely when the index finally climbed out of its hole. By the time the Nasdaq recovered to the old highs in 2015, Brian had been able to buy so many shares at a discount that his $93,000 of invested principle was worth $204,000! The index was flat, but amazingly Brian was up 120%!

And it didn’t stop there. Brian kept plugging away and just a few years later, Brian’s $500 per month in 2018 is now worth more than $300,000! Not bad for someone who started investing at the worst time imaginable.

What can we learn from Bad Luck Brian’s? Instead of fearing dips, we should embrace them. Rather than pull back on our contributions, we should double them.

Currently, the stock market is down 15% from the highs and people are running around scared. While they are afraid prices could fall even further, I’m over here wishing we could be that lucky. Bring on those cheap stocks!

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Oct 23

CMU: How much worse will this get?

By Jani Ziedins | End of Day Analysis , Free CMU

Free After-Hours Update:

Tuesday was another ugly open for the S&P 500 as overnight weakness in Asia and Europe pressured our markets. We crashed lower at the open and undercut this selloff’s prior lows near 2,710. But rather than trigger another avalanche of defensive selling, that early dip was as bad as it got. Supply of nervous sellers dried up after the first hour of trade and we recovered a majority of the losses by the close. Not very often does a 0.5% loss feel like a good thing, but that is what happened today.

Even though Trump’s tariffs haven’t done much harm to our economy, they are strangling the already weak Asian economies, most notably China. While this is Trump’s desired outcome, global markets are more intertwined than ever and what huts one is felt by everyone else. By taking down China, Trump is indirectly taking down our markets.

The biggest question is what comes next. Is the worst already behind us? Or are we on the verge of another tumble lower? I wish I knew for sure, but the best we can do is figure out the odds and make an intelligent trade based on the most likely outcome. For that, a look back at history is the most logical place to start.

The above chart shows pullbacks in the S&P 500 from all-time highs since January 1950. That gives us nearly 70 years worth of data to analyze.

One of the most notable things is how rare big selloffs really are. Over the last 69 years, only 11 times have prices tumbled more than 15% from the highs. We often think of big crashes like 1987, the Financial Crisis, or the Dot-Com bubble. But those events are exceedingly rare. All the other pullbacks over the last 69 years have been 15% or less. While 15% is a lot, it isn’t terrifying. And even better, all of those under 15% pullbacks were erased within a few months. Small and short. That sounds like something we can live with.

Currently we find ourselves 7% from the highs. Those losses are already behind us and we cannot do anything about them. But we can prepare for what comes next. Assuming we are not on the verge of another Financial Crisis or similar catastrophe, the most likely outcome is a dip smaller than 15%. From current levels, that is another 8%. But that is the worst case. The actual dip will most likely be smaller than 15%.

Over the last 69 years, the S&P 500 has tumbled between 10% and 15% 22 times. That’s about once every three years. Not unheard of, but not common either. The last pullbacks of this size were 15% in 2016 and 12% earlier this year. Are we due for another one? Maybe. But it definitely doesn’t seem like we are overdue given we already had two over the last two years.

More common are pullbacks between 5% and 10%. There have been 36 of these over the last 69 years, meaning these happen every year or two. From 7%, that means we could be as little as 1% or 2% from the bottom. And even better is most of these 15% or smaller pullbacks return to the highs within a few months.

We are down 7% and there is nothing we can do about that. But going forward we have a decent probability of only slipping a little further. And assuming the world doesn’t collapse, worst case is another 8%. While that wouldn’t be any fun, is that really worth panicking over?

The price action has been weak the last few days and that led to today’s weak open. And the market loves double-bottoms, meaning we could see a little more near-term weakness. But what is a little more downside if we will be back at the highs in months month? While I cannot say the bottom is in yet, the odds are definitely lining up behind buying this market, not selling it.

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Apr 04

CMU: Are you addicted to stock quotes?

By Jani Ziedins | Free CMU

Cracked.Market University

One-hundred years ago a person was lucky if they could find weekly stock quotes. Fifty-years ago most traders lived off of daily quotes from the newspaper’s financial section. Thirty-years ago we got 24-hour news networks. Twenty-years ago the internet gave us 20-minute delayed quotes. Five-years ago real-time and after-hours quotes came free with most trading accounts. And now countless phone apps give us access to global stocks and futures around the clock.

The question few are asking is if this abundance of information is actually helping the average investor? Given the success rates of the typical retail investor, the answer is clearly not. The question then becomes if this is not helpful, is it actually hurting investors? There is a pretty compelling case that information overload causes a person to make more mistakes, especially when it comes to something as tricky as the market.

Who among us hasn’t found themselves transfixed by an intraday move? We get an alert on our phone and stop what we were doing to read the linked article. Then we tune the TV to the financial news to find out what the “experts” think. All of a sudden we went from having a good day at work to being worried the latest selloff means will delay our retirement five years. But we won’t be innocent bystander. We won’t be a victim to the market’s wrath. Instead we take control of our financial destiny by whipping out our phone, logging into our brokerage app, and start selling. And best part is we do it all in the five minutes before our next meeting.

Unfortunately what started the day as a buy-and-hold investment quickly turned into a “sell everything before things get worse”. The problem for most long-term investors, turned spur-of-the-moment traders is that over the last 30 years, there have only been two instances when “sell now before things get worse” was actually a good idea. The 2000 dot-com bubble and the 2008 financial crisis. Two and only two times over the last 30 years was reacting to the fearful headlines a good idea. Compare that to the 1,000+ plus phony stock market crashes that spooked investors out perfectly good positions just before rebounding. Would you rather put your money on the 499, or the 1? Unfortunately most retail investors are so afraid of the next stock market crash that they have an irrational fear it is hiding around next corner. Combine those emotions with an endless stream of market headlines and stock quotes and that is the perfect recipe for over trading.

And I will be the first to admit this happened to me. I used to trade newspaper quotes. Buy something, forget about it for a few weeks or months. Check the newspaper and “wow, I just made 20%, cool!” Then the internet revolutionized trading and let me follow the market more closely. But the 20-minute delay kept me from obsessing over it too much since the prices I saw were already old news. I’d buy what I wanted to buy and then get on with my day. Then high-speed internet came along with real-time streaming quotes.  Now I could put charting programs and stock tickers on my second monitor (because one monitor definitely isn’t enough), and now I could start counting pennies. It would have been nice if it stopped there, but now my phone gives me access to S&P500 futures around the clock. (speaking of stock futures, they are up nicely in Asia as I write this at 10pm MDT) And the worst of all, if I wake in the middle of the night, it is hard to resist the temptation to see what the futures are doing in Europe. If my trade isn’t working, then I have to pull out my iPad and find out what happened. And people call this progress???

I’ve been there and done that, as have many of you. I can and will attest this most definitely didn’t help my trading. In fact, the access to endless information made me miserable and my trading suffered. These daily gyrations got to me, even small moves against me inevitably lead to second thoughts. Second thoughts lead to doubt. Doubt lead to anxiety. And anxiety lead to impulsive and emotional trading. All of this certainly makes me miss the old days of waiting for the daily newspaper, looking up my stocks, and then spending the rest of the day not thinking about the market.

More is most definitely not better and the addiction to endless streams of information is something we need to resist. Without a doubt the worst thing a person can do is check stock quotes in the middle of the night. Don’t do it. It doesn’t help and all it does is lead to crushing anxiety and sleepless nights. Same goes for getting alerts on your phone. Turn them off. If you are not a day-trader, you don’t need to have real-time quotes and charts on your computer. If you are a buy-and-hold investor, don’t look at daily quotes. Don’t even look at weekly quotes.

The most important thing to regaining control of your trading is only looking at the market with a frequency that is appropriate for your holding period. Retirement accounts? At the very most look at them quarterly and even then only for rebalancing. It would be better if you limited checking retirement accounts to once a year. Swing-traders who hold positions for days and weeks should limit themselves to daily quotes. Only day-traders need streaming quotes and live charts. For everyone else, all it does is shake your confidence and lead to impulsive and emotional trades. The first step to beating the market is getting your addiction to stock quotes under control.


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Dec 20

CMU: The dangers of trading sentiment

By Jani Ziedins | Free CMU

Cracked.Market University

All too often we hear the cynics claim the market is “too bullish”, or the optimists shout the market is “too bearish”. What they are really saying is they believe the market has gone too far in one direction and it is about to reverse. And they will be right…..eventually.

Without a doubt the market will reverse because it always does. Prices move in waves and I will cover the psychology behind these waves in another CMU post. (Sign up for Free Email Alerts so you don’t miss it) Unfortunately the key to making money is timing those waves exactly right. This is where popular sentiment indicators often let us down.

“Too bullish” or “too bearish” are vague and subjective. There are quantifiable sentiment measures like AAII’s weekly sentiment survey, but it is far from comprehensive and it tends to jump around. Stocktwits measures real-time sentiment in its $SPY stream, but that only tells us what a very small and highly active group of traders thinks. Other tools look at option premium, but they are equally flawed. That’s because sentiment can sustain extreme levels for months, even years.

It is best to think of sentiment as a secondary indicator. It tells us when to start thinking about something, but it doesn’t tell us when to make a trade. It is dangerous to say we should buy every time a sentiment indicator goes under 30 and sell every time it goes over 70. That’s because a 30 can stay a 30 for months or fall to 25, all while the market continues to selloff. Buying a dip a month or two before the bottom can definitely be a traumatic experience.

On the opposite end of the spectrum, sentiment has been “overly bullish” almost this entire year. It started with Trump’s election and continued all year based on hopes of tax cuts. Anyone who sold early in the year because the market was “too bullish” missed out on a nice rally. And anyone who was foolish to short this “overly bullish” market had a very painful year.

The reason sentiment measures can stay elevated for so long is they often only measure a subset of traders. For example highly active traders that fill out weekly surveys. Or the options market. While these give us a good idea of what short-term traders think, it leaves out the opinions of 401k investors who don’t follow the market. These passive investor’s opinions change much slower and this year it was their gradual warming up to the benefits of tax cuts that allowed us to rally so consistently and for so long. Even though active traders were “overly bullish”, the wider pool of investors was only beginning to warm up. And it is buying that kept pushing us higher even though most sentiment measures told us we were topped out months ago.

I love trading against extremes in sentiment, but I need the price-action to confirm my trading thesis before I will stick with a sentiment based trade. If the market doesn’t act the way it is supposed to, I bailout quickly because I know how unreliable these signals can be. Don’t let a stubborn opinion about “too bullish” or “too bearish” lock you into a losing trade.


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Dec 18

CMU: Why it is too late to buy the tax cut rally

By Jani Ziedins | Free CMU

Cracked.Market University

Many times you hear market commentators claim an event is “already priced in” even though it hasn’t occurred yet. What does this mean, how does it happen, and what does that mean for trading? Read on to find out.

The most important thing to keep in mind is people don’t make trading decisions based on what has already happened, they trade what they think will happen. That’s because it is too late to profit on the past. If a stock already went up 10%, then it is too late to profit from that 10% rise in price. But if you think a stock will rise 10% and you buy it now, you make 10% when it increases in price. Successful traders buy before something happens, not after. This concept is obvious, but it has profound implications for how we approach trading.

As traders we are always trying to figure out what will happen before it happens. Will the next iPhone be a hit or a flop? If we know the answer before everyone else, we can profit from that insight. But since we are trading based on speculation of something that hasn’t happened yet, there are risks we could be wrong. And that risk is what creates the profit opportunity. Some people will bet the next iPhone will be a hit, while others believe it will be a flop. The current market price balances these two extreme views and every shade in between. And when sales numbers are announced, one side makes money and the other side loses.

If the outcome is random, then by rule this event cannot be priced into the market because the crowd doesn’t have insight into what will happen. But this rarely occurs because someone always knows something and eventually that knowledge spreads through the market.

Sticking with the iPhone example, we only know for sure how many iPhones were sold in a quarter when the company reports its earnings several weeks after the quarter ends. But there are plenty of ways to get ahead of the news and figure out what those sales numbers will be good or bad. The simplest is your personal opinion. Does the new iPhone excite you? Are you tempted to upgrade? How about your friends? Are they talking about the new iPhone? Do tech writers recommend upgrading or keeping your existing model? What about the lines at the launch? Bigger or smaller than last year? How quickly does the iPhone sellout? How long are backorder times? What are suppliers telling analysts about the size of Apple’s component orders? Even though we won’t know what the official iPhone sales numbers are for several months, traders paying attention to these clues will have a good idea of what the sales will be. And these traders start buying or selling based on what those clues tell them. Once those clues are obvious to the crowd, it is too late to buy or sell the news because it has already been priced in. Great reviews and the stock’s price shoots up. If most reviewers say it isn’t worth upgrading, then the price falls in anticipation of a bad earnings. If you wait to trade the earnings announcement, you will be too late.

This phenomena occurs naturally because traders are always trying to get ahead of each other. Getting there first is how we make money. We buy before the price goes up and sell before it goes down, but we can only do that if we make our trades before everyone else. And to trade before everyone else means we need to be early. And we’re not the only one who trades this way. When the crowd trades early, the expected result gets priced in long before it happens. And if the crowd is right, which it usually is, then the stock market only moves a small bit when the news becomes official. That’s because the bulk of the move occurred in anticipation of the news.

A current example is Tax Reform. Traders have eagerly been looking forward to tax cuts since Trump won the election last November. The S&P500 has risen nearly 30% since Republicans won the White House and maintained control of Congress. In finance class we learned stock prices are based on corporate earnings, but S&P500 earnings are only forecast to be up around 10%. That’s a pretty big gap between earnings growth and stock market gains.  The bulk of the stock market’s gains over the last 13 months are based on hope and anticipation of regulatory relaxations and tax cuts.

If a person was waiting until Trump signed the tax cuts into law, they would have missed 30% in gains over the last 13 months. Thirty percent is a tremendous number and reflects almost all of the tax cut gains. Congress will vote on and approve the bill within days and Trump will sign it into law before Christmas. Without a doubt we could see a one or two percent pop when this happens, but one or two percent pop is peanuts compared to the nearly straight up 30% move we’ve witnessed over the last 13 months.

If a person is waiting to buy until after Tax Reform is signed into law, they are really, really late. And not only did they miss almost all of the gains, they are putting themselves at risk because following highly anticipated headlines we often run into a “sell the news” phenomena. If everyone bought in anticipation of a widely expected event, then there is no one left to buy the news when it finally happens. And the law of supply and demand dictates that if no one buys the news, ie no demand, then prices fall. So not only is the person who waits for the news too late to profit, they could actually end up losing money in the subsequent pullback. There is solid science behind the market cliche, “Buy the rumor, sell the news”.

Without a doubt the stock market can rally can continue in 2018. But we need new reasons to rally once Tax Reform becomes law.


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Dec 13

CMU: The part of Technical Analysis no one talks about

By Jani Ziedins | Free CMU

Cracked.Market University

Pick up any Technical Analysis textbook and you are bound to find countless examples of highly profitable chart patterns. Most books include a plethora of real-life charts showing a pattern developing, the buy signal, and the predicted move. The general idea is to memorize the various patterns, look through charts to find them, place a trade, and profit. Easy-peasy. Repeat over and over until fabulously wealthy.

Or at least that is how it is supposed to work. Unfortunately nothing in the market is ever that easy. While most of these patterns are valid and have sound human psychology principles backing them up, the problem comes from false positives. When a chart starts with the perfect setup, but it fails to complete the pattern. The idea of false positives is further complicated because so many patterns look similar. While this wouldn’t be a problem if similar setups told us to do the same thing, unfortunately most setups can give us conflicting advice.

  • Buy the higher-high, or sell the double-top?
  • Buy the dip, or sell the violation of support?
  • Cup-with-handle, or stalling at resistance?
  • Meaningful pattern, or random noise?

There are countless examples where a pattern works beautifully and any Technical Analysis writer worth his salt can find charts showing the pattern working exactly as it should. The problem comes from all the false positives. How many times did this exact pattern show up and fail to behave as predicted? False positives are the bogie no one talks about and is the biggest challenge in trading with Technical Analysis.

The pure technical trader claims nothing matters except the price-action. The company name, industry, financials, profitability, news, and all the rest doesn’t matter because the market has already incorporated all of that information into the price. The pure technician believes fundamentals are redundant and he ignores them.

Unfortunately ignoring everything except price leaves out a lot of useful information. Take one of the conflicting examples I listed above, higher-high or double-top. Nearly identical setup, but much different outcome.  One interpretation tells you to buy, the other tells you to sell. What should you do? Like everything in the market, the answer depends.

Most of the time the answer lies in the pieces of information the true technician ignores. Namely the news and the market’s reaction to it. No matter what the chart tells you, a stock that goes up on bad news is a great buy and a stock that stops going up on good news is one to run away from. I will dig a lot deeper into interpreting the news in another CMU post. Sign up for Free Email Alerts so you don’t miss it. 

Now don’t get me wrong, I’m not bashing the usefulness of Technical Analysis. It is a great tool and I use it every day. But like any tool, it has its limitations. Successful traders recognize profitable patterns, but they also recognize the false positives. Or which pattern is more meaningful when similar setups are giving conflicting recommendations. Learn and use Technical Analysis, but always be aware of the risks posed by false positives and develop a process to weed them out.


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Dec 11

CMU: The fallacy of “more buyers than sellers”

By Jani Ziedins | Free CMU

Cracked.Market University

Spend any time following the markets and you are bound to hear the phrase, “The market went up today because there were more buyers than seller.” You hear the opposite on down days when “there were more sellers than buyers.”

While that shorthand works well enough for casual market commentary, it is factually inaccurate. The first thing to realize is the market doesn’t create or store stocks. The stock market doesn’t have printing presses or storage vaults in the basement. At its core, exchanges only do what their name suggests, act as a meeting places for people to exchange stocks and money.

One hundred shares arrive at in one person’s possession, some money changes hands, and they leave in another person’s account. After the market closes, all the money and stocks go home with their owners. There is nothing left behind but an empty trading floor. Stocks and money was created or destroyed, all it did was change owners.

The fact stocks cannot be created or destroyed means for every stock sold, there is one and only one stock bought. To further complicate the situation, the number of buyers and sellers can vary and doesn’t have a bearing on whether prices go up or down. A large buyer can buy from dozens of sellers, or one seller can sell to dozens of buyers. The only thing that matters is the number of shares available for sale and the amount of money willing to buy those shares.

So as a matter of rule, there can never be more stock bought than sold. But there can be more people interested in buying than selling, or selling than buying. This is where market price plays the role of matchmaker and finds the exact balance point between buyers and sellers.

If a good piece of news comes out that creates additional interest in a stock, all these excited buyers start looking for sellers. But sometimes there are not enough sellers to meet demand. In these cases, buyers start offering a premium price to persuade owners to sell their stock. When enough buyers bid up the price, the rising price changes the supply and demand dynamic. At a the new higher price, some people are less interested in buying and drop out of the market. Other owners find the new higher price irresistible and are now converted into willing sellers.

The thing to remember is the number of stocks sold is always exactly equal to the number of stocks bought. The driver making this exact balance possible is the ever-changing price. Every time the price moves, even a penny, it is finding the exact balance point where the amount of stock for sale matches the amount of money willing to buy it. Prices might seem to wander randomly, but there is a very real purpose for every tick of the tape.


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Dec 06

CMU: How much money should you keep in your trading account

By Jani Ziedins | Free CMU

Cracked.Market University

On Monday I wrote about how many stocks a trader should keep in their trading account to protect themselves from unexpected drawdown while also making the most from their best ideas. Today I will cover another portfolio question I frequently get from subscribers, how much money should they keep in their trading account. Again I start with the same disclaimer the following are just guidelines and only a licensed investment advisor can give you individual advice specific to your situation, goals, and risk tolerances.

The first thing to understand is trading is risky. You can and will lose money. But this isn’t always a bad thing. Losing trades are simply an expense of trading and is no different than the cost of inventory for a retailer. And just like a small business, the goal is to keep our revenues larger than our expenses.

Making a profit is an obvious goal, but it is more than just making money. We need to make more money than the alternative, which for most people is buy-and-hold index funds. A 20% return sounds great, but what if the S&P500 made 25%? Does that 20% still sound good?

And more than that, our goal is to make enough extra that it is worth our time. Beating an index fund by $30k sounds great, but if you traded full-time, is $30k enough to be worth your time if you could make $150k doing something else?

Trading is definitely a tricky business and for most people it makes more sense to keep it a hobby and not rely on it as their primary source of income. Trade because it is fun, not because you think you can replace your day job. Beating the market is hard enough. Beating it by enough to pay all of your living expenses is a much larger task.

As I already alluded to, there are different ways to make money in the market. The first is trading. The other is diversified, buy-and-hold investments. What does a savvy person do, trade or buy-and-hold? That’s a trick question because this isn’t an either/or question. Both is the best option for most traders.

It is hard to beat the stability and consistency of buy-and-hold investments. Even after market crashes like the dot-com bubble or the 2008 housing meltdown, the market always comes back. Sometimes it takes a while, but buy-and-hold investments have long time horizons and patient investors are always rewarded for at the end of the day.

That said, a trader can do better than buy-and-hold during sideways and down markets. The hard part is knowing precisely when the market is transitioning from up to sideways or down. But just because something is hard doesn’t mean it isn’t worth doing.

I will assume everyone reading this blog is doing so because they are interested in trading, so that means a portion of your investable funds should be allocated to a trading account. The key question is how much. This is where things get highly individualistic and many of these decision need to be made between you and a financial advisor, but here are some guidelines to think about.

Buy-and-hold is the safest and most proven way to grow rich slowly. This should be a cornerstone of everyone’s long-term investing plans. For most people this comes in the form of a 401K retirement plan. This is the slow money that you will live off of after you stop working. And because this money is so important to our financial well-being, we need to be careful with it. That means not taking unnecessary risks. For the average person, that means keeping at least 80% of your investable assets in safe, long-term, buy-and-hold investments. Something that you put away and only trade once every few years.

With a big portion of our retirement money invested safely, that means we can put the rest into more speculative investments that can produce much higher returns, but also come with greater risk. For a new investor, I would suggest allocating no more than 5% of your investable assets to trading. For more experienced traders, 20% to 25% is reasonable. But even the best traders should not speculate with a larger percentage of the money they will need later in life. While it is possible to produce larger returns in your trading account, it is also possible to crash and burn. The key to surviving the market is always protecting yourself in such a way that you can live to fight another day. That means making sure you always have plenty of money left over even if a trade fails in a spectacular way. 

The thing about the market is sometimes one strategy works better than another. In years like 2017, buy-and-hold works brilliantly because every dip bounces and any defensive sale turns out to be a mistake. But other years the market is flat or even declines. That is when our trading accounts outperform buy-and-hold investments. But the great thing about using both strategies is we benefit when either one of them are doing well.


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