A good day. The Dow down .32% & I'm up .06%. Nice. Thank Mr. Ford.
For my Best of Financial Blog #18 I copied down some of John Maudlin article "The Not So Simple Rules" of Trading (
http://www.trade2win.com/section/articles/1060-not-so-simple-rules-trading). Here is an edited version, it nicely captures the rules a Trend trader should live by:
Thoughts by John Mauldin: <this is the meat of the trend follower>
GO WHERE THE STRENGTH IS R U L E
The objective of what we are after is not to buy low and to sell high,
but to buy high and to sell higher,
or sell short low and to buy lower.
We can never know what price is really "low," nor what price is really "high." We can, however, have a modest chance at knowing what the trend is and acting on that trend. We can buy higher and we can sell higher still if the trend is up. Conversely, we can sell short at low prices and we can cover at lower prices if the trend is still down. However, we've no idea how high high is, nor how low low is.
Sell markets that show the greatest weakness;
buy markets that show the greatest strength.
Metaphorically, when bearish we need to throw our rocks into the wettest paper sack for it will break the most readily, while in bull markets we need to ride the strongest wind for it shall carry us farther than others.<follow the trend>
MAKING "LOGICAL" PLAYS IS COSTLY
In a Bull Market we can only be long or neutral;
in a bear market we can only be bearish or neutral.
This addresses what might seem like a logical play: selling out of a long position after a sharp rush higher or covering a short position after a sharp break lower--and then trying to play the market from the other direction, hoping to profit from the supposedly inevitable correction, only to see the market continue on in the original direction that we had gotten ourselves exposed to. At this point, we are not only losing real capital, we are losing mental capital at an explosive rate, and we are bound to make more and more errors of judgment along the way. <I've gotten burned making this mistake many times>
Actually, in a bull market we can be neutral, modestly long, or aggressively long--getting into the last position after a protracted bull run into which we've added to our winning position all along the way. Conversely, in a bear market we can be neutral, modestly short, or aggressively short, but never, ever can we--or should we--be the opposite way even so slightly.
"Markets can remain illogical far longer than you or I can remain solvent."
I understand that it was Lord Keynes who said this first
Trading runs in cycles; some are good, some are bad, and there is nothing we can do about that other than accept it and act accordingly.
The academics will never understand this, but those of us who trade for a living know that there are times when every trade we make (even the errors) is profitable and there is nothing we can do to change that.
Conversely, there are times that no matter what we do--no matter how wise and considered are our insights; no matter how sophisticated our analysis--our trades will surrender nothing other than losses. Thus, when things are going well, trade often, trade large, and try to maximize the good fortune that is being bestowed upon you.
However, when trading poorly, trade infrequently, trade very small, and continue to get steadily smaller until the winds have changed and the trading "gods" have chosen to smile upon you once again. The latter usually happens when we begin following the rules of trading again. Funny how that happens!
To trade/invest successfully, think like a fundamentalist; trade like a technician.
It is obviously imperative that we understand the economic fundamentals that will drive a market higher or lower, but we must understand the technicals as well. When we do, then and only then can we, or should we, trade. If the market fundamentals as we understand them are bullish and the trend is down, it is illogical to buy; conversely, if the fundamentals as we understand them are bearish but the market's trend is up, it is illogical to sell that market short. Ah, but if we understand the market's fundamentals to be bullish and if the trend is up, it is even more illogical not to trade bullishly.
Keep your technical systems simple.
Over the years we have listened to inordinately bright young men and women explain the most complicated and clearly sophisticated trading systems. These are systems that they have labored over; nurtured; expended huge sums of money and time upon, but our history has shown that they rarely make money for those employing them. Complexity breeds confusion; simplicity breeds an ability to make decisions swiftly, and to admit error when wrong. Simplicity breeds elegance.
The greatest traders/investors we've had the honor to know over the years continue to employ the simplest trading schemes. They draw simple trend lines, they see and act on simple technical signals, they react swiftly, and they attribute it to their knowledge gained over the years that complexity is the home of the young and untested.
UNDERSTAND THE ENVIRONMENT
In trading/investing, an understanding of mass psychology is often more important than an understanding of economics.
Markets are, as we like to say, the sum total of the wisdom and stupidity of all who trade in them, and they are collectively given over to the most basic components of the collective psychology. The dot-com bubble was indeed a bubble, but it grew from a small group to a larger group to the largest group, collectively fed by mass mania, until it ended. The economists among us missed the bull-run entirely, but that proves only that markets can indeed remain irrational, and that economic fundamentals may eventually hold the day but in the interim, psychology holds the moment.
And finally the most important rule of all:
THE RULE THAT SUMS UP THE REST
Do more of that which is working and do less of that which is not.
This is a simple rule in writing; this is a difficult rule to act upon. However, it synthesizes all the modest wisdom we've accumulated over thirty years of watching and trading in markets. Adding to a winning trade while cutting back on losing trades is the one true rule that holds--and it holds in life as well as in trading/investing.
If you would go to the golf course to play a tournament and find at the practice tee that you are hitting the ball with a slight "left-to-right" tendency that day, it would be best to take that notion out to the course rather than attempt to re-work your swing. Doing more of what is working works on the golf course, and it works in investing.
If you find that writing thank you notes, following the niceties of life that are extended to you, gets you more niceties in the future, you should write more thank you notes. If you find that being pleasant to those around you elicits more pleasantness, then be more pleasant.
And if you find that cutting losses while letting profits run--or even more directly, that cutting losses and adding to winning trades works best of all--then that is the course of action you must take when trading/investing. Here in our offices, as we trade for our own account, we constantly ask each other, "What's working today, and what's not?" Then we try to the very best of our ability "to do more of that which is working and less of that which is not."
We've no set rule on how much more or how much less we are to do, we know only that we are to do "some" more of the former and "some" less of the latter. If our long positions are up, we look at which of those long positions is doing us the most good and we do more of that. If short positions are also up, we cut back on that which is doing us the most ill. Our process is simple.
<As always if anything I copy steps on toes or copywrights etc. let me know and I'll remove it>
Here are a few notes I've copied from Phil's Stock World-Phil Davis:
Phil 11/8/10 <pessimistic as he's been the last few weeks>
Yes, but until we really break over, this is as likely to be a top as anything else. Invest when you are sure, not when you just don’t want to miss out. If the dollar breaks 76, then we’re sure stocks will go up until it recovers. That’s easy enough to wait for isn’t it? If copper breaks $4 or oil breaks $77.50 or gold $1,400, then we have good signs that money is continuing to pour in and we can makes some bullish bets to cover the moves up but if you know that one bad article in the WSJ can tank this market – they why roll those dice on trades you don’t believe in?
If you play the market ALL the time bullishly, the only thing you guarantee is that you will get burned one day. Having an itchy sell trigger-finger is not a negative thing because, if you make 10% a year and get back to cash, you can retire very wealthy, even with inflation.
Short plays in general are dangerous until we see inflation break down and shorting commodities are the most dangerous. We were looking at shorts on valuation but now you have to give all those stocks another 10% at least to the upside to account for QE2. I guess this would be a good time to mention my preference to cash over endless playing in an uncertain market.
ABX is better than TBT at the moment for an inflation hedge as the Fed is not directly spending $600Bn to keep ABX down (quite the opposite).
