Nov 13

CMU: Why experienced traders don’t brag

By Jani Ziedins | Free CMU

CMU: Why experienced traders don’t brag

Spend any time on trading social media and a person is bound to come across braggarts. Traders who are so supremely confident in their prowess they feel compelled to harass everyone who disagrees with them. While their partisan views are obnoxious, the thing to keep in mind is almost all of these braggarts are novices. Veteran traders have been humbled by the market far too many times to be so bold about their winning positions.

I wrote a previous CMU post about beginner’s luck. In it I described why beginner’s luck is a very real thing in trading circles. The Cliff Notes version is new traders who get lucky keep trading while those who lose money abandon the market and never look back. Many of the internet’s biggest braggarts are those riding a wave of beginner’s luck. Their early success fools them into thinking they are smarter than everyone else and they feel the need to boldly tell the world how great they are.

This is the polar opposite of a veteran trader who learned the hard way (often many times over) that one moment’s fortune can easily turn into the next moment’s failure. Experienced traders know the best time to sell is often when they feel the most confident. They are the last ones to run around telling everyone how great they are because they know what the market does to people like that.

As a way of giving back to the community that has given me so much, I share my experience and insights in order to help other traders. Being a contrarian by nature, that means I am frequently on the opposite side as these braggarts. I warn readers when move has gone too far, but these bold novices are fooled into thinking the good times will keep rolling because that is the only thing they’ve known. They make the fatal error of mistaking luck for skill and keep doubling down because they assume they have this game figured out. Unfortunately emotional and bold trading strategies rarely end well.

I freely admit I often enter and exit trades too early. That means the previous trend continues for another few days. These bold traders love to use that initial period of being too early as proof they are right and I am wrong. But it doesn’t affect me. In fact the more criticism I receive, the better it makes me feel because nothing scares me more than when everyone agrees with something I’ve written. I make a lot of money starting wrong and finishing right, and will always take that over starting right and finishing wrong.

I’ve been doing this long enough to know most hecklers are novices and their opinions are not worth the ‘paper’ they are written on. But newer traders don’t have the same level of confidence when it comes to hecklers and often the doubts turn into second guessing. It is smart reevaluate your positions on a regular basis, but never let the hecklers get to you. Remember they are some of the most inexperienced and emotional traders in the market. And that’s not a bad thing. Our profits come from someone else’s pockets and this game would be a lot more challenging if everyone knew what they were doing.

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Nov 09

What Thursday’s choppy trade tells us

By Jani Ziedins | End of Day Analysis

End of Day Update:

Thursday was the ugliest session in weeks. A one-way selloff pushed the S&P500 down more than 1% by lunchtime. But not long after undercutting 2,570, supply dried up and we recovered more than half of those early losses. Ugly, but it could have been worse.

Before Thursday’s open, Trump appeared to abandon the House’s version of Tax Reform and threw his weight behind the Senate’s yet to be released proposal. Even more unnerving is he claimed the Senate’s version would be a lot more Democrat friendly. The market’s disappointment seems to indicate it is afraid the Senate’s version will be more watered down and populist oriented. Early leaks also tell us the corporate tax cuts will be delayed until 2019, not something the market was happy to hear.

Even though prices has been drifting higher over the last few months, including a record close on Wednesday, volatility has definitely been picking up. This was the fourth whipsaw session in as many weeks. While most of these dips bounced within hours, it reveals a growing struggle over where the market is headed next. Thus far we have been drifting higher as defeated bears were steamrolled by confident bulls. But this volatility tells us the Bulls are losing their grip is and Bears are putting up a better fight.

And it shouldn’t come as a surprise. Everyone knows the market moves in waves and there is only so much up we can do before stumbling into a bout of down. The last meaningful dip was nearly three-months ago. While momentum is definitely still higher, without a doubt that next dip is coming. Today’s whipsaw session tells us the battle is heating up and it will likely get even choppier over coming weeks.

The saving grace is most owners are blissfully complacent and confident. No matter what the cynics claim should happen, if confident owners don’t sell, supply stays tight and it is easy to prop up the market. While today’s selloff was dramatic, almost all owners were still sitting on piles of profits and the only ones feeling the squeeze were recent buyers. Once those recent buyers fled, there was no one left to sell and we rebounded.

The real question is where do we head from here? I’ve been cautious the last few weeks. I know the market cannot go up in a straight line and the rate of gains since the August bottom were bound to slow down. That is why have been telling readers this is a better place to be taking profits than adding new money. And that analysis has been spot on. Even though we continue creeping higher, the gains have been far slower and the choppiness has definitely picked up. The easy gains are long behind us and the road ahead is a lot more difficult.

That said, prices have been holding up amazingly well. Extended markets heal themselves one of two ways. Either the slip back to support and key moving averages, or they trade sideways long enough to allow the moving averages to catch up. While we are still a good ways above the 50dma, the slower rate of gains over the last few weeks is allowing it to catch up.

Today’s whipsaw session was the fourth bout of volatility we’ve seen recently. And just like the other times, Thursday recovered a big chunk of those early losses within hours. Confident owners are simply not interested in selling no matter what the headlines say or the price-action is. Their determination is keeping a solid floor under our feet.

Previously I was wary of a dip back to support, but the market has held near the highs amazingly well. If we were vulnerable to a pullback, it would have happened by now. That said, this is still a challenging place to own stocks. Volatility will continue to haunt us over the near-term as traders reconcile the flurry of encouraging and disappointing Tax Reform headlines. The rate of gains is definitely slowing down and traders trying to sit through this sideways stretch better buckle in.

Everyone knows picking a top is a fool’s game. As traders that means we must decide if we prefer selling too early, or too late. Personally I like selling too early because it means I get to skip all the heartburn that comes from trying to decide if days like today should be held or sold. Sideways stretches are the worst because you hold all the risk, but you don’t get paid for it. Personally I like watching this choppiness from the sidelines so I am fresh and ready to go when the next opportunity presents itself. It is hard to profit from a dip when you are already fully invested.


Nov 08

CMU: Timing is everything

By Jani Ziedins | Free CMU

Cracked.Market University

Knowing what the market is going to do is easy. Predict a bear market for long enough and eventually you will be right. Telling people a dip will bounce is a no brainer because every dip goes too far and then bounces. Predicting is easy because the same things keep happening over and over again.

Without a doubt AAPL and AMZN will either fail or be acquired at fire-sale prices. How do I know? Because it happened to countless other innovative and disruptive companies. Amazon’s disruptions are minor when compared to what the Sears catalog did for rural consumers 100 years ago. At one time Sears was the largest employer in the United States, but now it is struggling for survival. More ‘experienced’ readers remember what Sears used to be, but there are also contemporary examples too. Only the youngest millennials cannot remember the ubiquitous ‘Crackberry’. Of course not even ten years later I cannot remember the last time I saw someone using one. There are a few still out there, but they are definitely on the endangered species list.

The challenge isn’t knowing if AAPL and AMZN will crumble, but when they will crumble. Don’t get me wrong, I’m not criticizing Apple and Amazon’s near-term prospects because both companies are at the top of their game and I am a happy and loyal customer of both of them. But I am also not naive enough to think their success will last forever.

Far and away the hardest part of trading is getting the timing right. Never forget this is where all our profits come from. Even over shorter timeframes, the difference between good timing and bad timing is the difference between making money and losing money.

People love to tell everyone they know how bearish or bullish they are, but what they often fail to mention is their timeframe. Bulls and bears often get in bitter arguments. One claims something is a fantastic buy while the other accuses it of being a house of cards. But you know what? Often they are both right!

In trading, timeframe is the only thing that matters. Your profit and loss is determined entirely by when you buy and when you sell. End of story. Good timing on a bad idea results in a profitable trade. Bad timing on a great idea ends in tears. If the bull is a swing trader, he could be totally right that the stock is poised for another breakout, but the bear could also be right that the longer-term demand for a company’s products is deteriorating and it will only be time before it shows up in the earnings. In this example the Bull hauls in a nice profit this week and the Bear’s trade reaps big profits next quarter.

This is why people should not get hung up on Bull and Bear monikers. Too often people treat this like a sporting match and they stick with their side through thick and thin and they hurl insults at the other side. The market doesn’t care what we think and we definitely shouldn’t let these false allegiances and counterproductive biases skew our perception of the market and other traders in it. I’ve seen way too much bitterness and hostility primarily from inexperienced traders who are way too emotionally committed to their positions. Most of the time the differences in opinion are easily be explained by different timeframes.

One of the most fatal mistakes traders make is changing their timeframe in the middle of a trade. For example they buy a company because they like its long-term prospects, but chicken out during a near-term test of support. Of they buy it for a quick bounce, but it turns into a long-term holding when it keeps going down. Never, ever change your timeframe in the middle of a trade. If a trade is not working, get out. If this is a normal gyration and your trading thesis remains intact, stick with your position. It is okay to admit defeat when a trade is not working, but never change your timeframe simply because the market’s price-action is making you second guess yourself.

In another educational post I will dig deeper into identifying when you should stick with a trade that needs more time, and when you should proactively bail out of a position before your losses get worse. Sign up for Free Email Alerts so you don’t miss it.

Never underestimate the importance of timeframe. Getting it right is only thing separating those that struggle and those that are successful. I wish there was some easy trick to getting it right, unfortunately the market is never that easy. This definitely falls under the art of trading and it takes time and experience to master. Don’t get discouraged. Keep at it and this will definitely get easier.


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Nov 07

Finding the right risk/reward

By Jani Ziedins | End of Day Analysis

End of Day Update:

After a little up and a little down, the S&P500 ended Tuesday right where it started. Early strength gave way to midday selling, which was followed by a late surge back to breakeven. As dramatic as that sounds, the price swings barely got larger than one or two tenths of a percent. For all practical purposes, nothing much happened on this largely indecisive and irrelevant day.

That said, spending another day at or near all-time highs shows there is still good support behind this market. There is very little chasing going on since breakouts to record highs stall within hours, but confident owners have zero interest in selling no matter what the headlines and price-action are. Their refusal to sell keeps supply tight and makes it easy to hold these levels.

As I wrote last week, if this market was going to tumble on disagreements within the Republican party, it would have happened by now. I viewed this as the biggest headline risk to this extended rally, but so far the market doesn’t care. If the market doesn’t care, then neither should we. It is tempting to get stubborn and argue with the market in these situations, but that only leads to bigger losses. Right or wrong, the market is bigger than we are and it will run over us if we get in its way.

Even though the path of least resistance continues to be higher, only two kinds of traders are making money these days. Buy-and-hold investors who ignore all the noise. And the most nimble of day-traders. For the rest of us, these ultra-small daily fluctuations don’t give us much to trade. When confident owners don’t sell, dips don’t happen. When people don’t sell the dips, there is no one scrambling to get back in during the rebound. Without emotion on either side, volatility shrunk to a level where most days moves are measured in single tenths of a percent. Buying a 0.1% dip in anticipation of a 0.1% rebound doesn’t make a lot of sense for me and my style of trading.

My favorite trades occur when fear and uncertainty consume the crowd. That is when sellers offer steep discounts so they can “get out before things get worse.” Unfortunately for those emotional and reactive sellers, the dip ends not long after they bailout. Fortunately for me, their pain is my gain. (God, I miss those days.) Now we find ourselves at the opposite end of the spectrum. Confident owners refuse to sell for any reason and the few that are willing to deal demand steep price premiums. The path of least resistance is clearly higher, but there is not much margin for error when paying premium prices.

Everyone knows the market moves in waves. Unfortunately most forget that just as the latest wave is cresting. While I’m not calling a top here, I know we’ve done a lot of up without much down. The last meaningful dip was nearly three months ago. The next one is coming, the only thing we don’t know is if it will happen this week, next week, or next month. But with each passing day, it is closer than it has ever been.

Anyone can get lucky and make money on a single trade. But success over the long-term depends on buying when the risks and rewards are in our favor. Given how small the near-term upside is and how much air there is underneath us, it is hard to claim buying at these levels presents a trader with a good risk/reward. Long-term investors should ignore the noise and stick with their favorite stocks, but short-term traders should wait for a better risk/reward.

The biggest upside catalyst is Republicans reaching an agreement on Tax Reform. Given how far apart the views are, Trump’s Thanksgiving deadline seems highly unlikely. Even Christmas would be a stretch and require a lot of things falling into place. Until then, at best the market keeps inching higher. At worst traders get spooked and we test support. Small reward, large risk. You decide how to trade that.


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Nov 06

CMU: Money Management and Position Sizing

By Jani Ziedins | Free CMU

Cracked.Market University

Making money in the market is easy. Even trained monkeys with darts can find winning stocks. The challenge is not giving those profits back in the next losing trade.

Losses are inevitable. Anyone who believes they can achieve a 100% win-rate is not realistic and coming to the market with unhealthy expectations. Losses to a trader are like inventory for a retailer. They are simply a cost of doing business. As long as revenues exceed expenses, the business is profitable and everyone is happy.

There are two ways to make money in the market. One is taking small profits from a large number of trades. This is how market makers, high frequency traders, and option sellers make their living. The challenges in this business model are avoiding big losses that wipe out all the small profits. The other strategy is capturing huge profits from just a few trades and breaking even or taking a small loss on everything else. These are the black swan traders betting on the next big crash, or high-growth speculators targeting the next big thing.

The small profit trader typically has a laser focus in one area of specialization. The market maker specializes in just a few securities or stocks. High frequency traders find a niche and exploit certain pricing phenomena. Option sellers focus on one stock, index, or strategy. Each of these specialists has the knowledge and experience necessary to avoid taking a big loss and can comfortably concentrate his entire portfolio in a single area, idea, or strategy. This is the proverbial doing one thing and doing it well.

The big-hit strategy is on the other end of the spectrum and makes a lot of small bets in the hope that a few will pay off huge. Rather specialize, this approach requires diversification. The rate of success is abysmal and successful traders often lose money more than 60% of the time. But they can sustain these high failure rates because the losses are small and the winners huge. Since the big-hit trader doesn’t know which one will work, he has to try lots of different things.

But no matter what approach a trader uses, money management techniques are similar. A good rule of thumb is never risk more than 3%-5% of your total account value in a single trade. The reason for this is quite simple, it is easy to recover from a 3%-5% loss. Even a series of them. In fact it would take 24 consecutive losing trades to cut your account value in half. While losses are normal and expected, 24 losses in a row is an extraordinary stretch and highly unlikely. But even following a historically improbable string of bad luck, the trader still has 50% of their account balance remaining. The key isn’t avoiding losses, but ensuring we live to fight another day.

Now I will clarify what I mean when I say never risk more than 3%-5% of your account value in a single trade. This doesn’t mean everyone should use 3%-5% stop-losses on all of their trades. Several examples are the easiest way to explain this concept.

Bob has a $100k trading account. He has his portfolio diversified across five different trades in equal amounts of $20k each. Bob tends to be conservative and uses the 3% loss limit in this trading. Losing 3% of this $100k account value equates to $3k. When applied to each $20k investment, that $3k loss means he can afford to take a 15% loss on an individual trade without doing serious damage to his account.

(A word of warning, diversified means dissimilar trades. Five airline stocks or five 3D printing stocks is clearly not diversified since a failure in one trade likely means a failure in all five.)

For an index trader, if his entire account value is in a single trade, then he can only afford to lose 3% to 5% on that single trade before he should be pulling the plug.

Another way to use the 3% to 5% loss limit is to help you size your trade. Let’s say John is an aggressive options trader also with a $100k account. John is willing to risk 5% of his account value on a single trade, which comes out to $5k. His strategy uses a stop-loss if the option value falls to 50% of what he paid. That means his position size should not be more than $10k. If John is willing to let his premium go all the way to zero, he should not put more than $5k into any single trading idea.

Losses are an inevitable part of trading. But it will never be a problem if you manage your money properly and ensure you always live to fight another day.

Of course the above assumes a worst case loss. Successful traders learn to recognize their mistakes long before a stop-loss is reached. I will cover closing a losing trade proactively in another CMU post. Sign up for Free Email Alerts so you don’t miss it.

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Nov 02

So far, so good

By Jani Ziedins | End of Day Analysis

End of Day Update:

The S&P500 finished Thursday flat after spending most of the day in the red. Republicans unveiled their Tax Reform proposal and traders chose to sell the news. But “sell” is an over-statement since we were only down a fraction of a percent in midday trade. The tax plan was everything the leaks told us it would be, so there was little to get excited or disappointed over. Exactly as expected resulted in a mostly flat day.

I’ve been wary of this market for a few weeks, but it held up surprisingly well. My biggest concern was how traders would react to infighting within the Republican party. But so far the market has tolerated criticism from Trump and 21 Republicans voting against the budget. If infighting was going to spook the market, it would have shown up in the price-action already. Without a doubt volatility has picked up, but the slow climb higher is still on track.

A few weeks ago I said this was a better place to be selling stocks than buying them. And I stand by that statement. Just because the market continued creeping higher doesn’t mean betting on the continues rally was the smart trade. Long-term success is about managing risk and sticking with high-probability, high-reward trades. Trades will always go against us, that is simply the nature of this game. It is no different than inventory expense for a retailer. But just because a trade lost money doesn’t mean it was a bad trade, and just because a trade makes money doesn’t mean it was a good trade. Success isn’t measured over how this trade or the next trade does, but how all of our trade so.

My reluctance to trust this market was largely built on the the size of the rally since August’s lows and the looming battle over Tax Reform. So far my concerns have been unnecessary. If we were going to pullback because of Tax Reform infighting, it would have happened by now. If the market isn’t worried about infighting, then we don’t have to worry about it.

That said, the risks are still elevated and buying up here is definitely not a low-risk, high-reward trade. The market will likely keep creeping higher over coming weeks, but creeping higher is not a great reward given the risk underneath us. Long-term investors should keep holding, but traders can wait for a better risk/reward. The higher this market goes without resting, the harder we fall when it eventually happens.


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Oct 26

It won’t be pretty and it won’t be fast

By Jani Ziedins | End of Day Analysis

End of Day Update

The S&P500 inched higher Thursday, but for all practical purposes this was another flat session. We smashed through 2,540 earlier this month, but have been struggling to add to those gains ever since.

Volatility has been picking up over the last several days, producing the largest intraday swings since Trump’s war of words with North Korea. Most of these gyrations have reversed within hours, but the transition from calm, one-way moves higher is a material change in behavior.

Previously the Bulls were firmly in control and Bears were helpless to stop them. But this uptick in volatility tells us Bulls are losing their grip and Bears are growing stronger. Volatility often increases just before a reversal in direction. We saw that during the North Korean lows and could be witnessing the same thing now as the latest rally runs out of steam. Markets go up and markets go down, that’s what they do. There is nothing wrong with a healthy and normal pullback to support there.

After Thursday’s close, GOOGL, AMZN, and MSFT put up strong results. Without a doubt parts of the tech sector are doing very well. But this strength doesn’t seem to be carrying over to the broad market as overnight futures are only up a tenth of a percent. If tech earnings were poised to launch us higher, we would see a larger reaction in the futures.

But this isn’t a surprise. There is only one thing that matters to this market and that is Tax Reform. The House passed the Senate’s budget. Last Friday the market surged to record highs when the Senate passed their budget, but today market was much cooler to the House doing the same thing. That’s because 20 Republicans voted against the budget in protest over cuts to state income tax deductions.

Everyone loves tax cuts and the market has been rallying on that positive sentiment. But now we are transitioning to the debate over what taxes will be raised in order to pay for all those lovely tax cuts. Interest expense, 401k, and state income tax deductions all find themselves on the chopping block. On Thursday twenty Representatives demonstrated their displeasure with the proposed changes. Trump already said he was opposed to cutting  401ks. And let’s not forget our president is a real estate mogul. Anyone think he will sign a bill that eliminates interest deductions for his business and real estate loans? Yeah, me neither.

November 1st is when we are supposed to see this widely anticipated bill for the first time. If the healthcare debate is anything to go by, there is a good chance this bill will be delayed coming out of committee. Once it finally sees the light of day, it will get shredded by special interests. If there was one thing Republicans could agree on, it was their disdain for Obamacare. Yet even with that unity driving them, they still couldn’t repeal it. What is going to happen populist moderates, fiscal conservatives, and pro-business Republicans duke it out? It won’t be pretty and it won’t be fast.

Expect the hope of Tax Reform to give way to despair over political infighting. There is a good chance Republicans will pass something…..eventually. But it definitely won’t be as grand as many are hoping for. In the meantime, expect the stock market to give back a chunk of recent gains as it consolidates and allows the 50dma to catch up. This is definitely a better place to be taking profits than adding new money.


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