Insightful thoughts for traders

[Kim 7,475]

Excellent collection of ideas from Dynamic Hedge

By Dynamic Hedge. Since I started this blog I’ve had a number of aspiring traders send me messages about getting started in the trading world. This post is inspired by a series of letters between these gentlemen and me.

This post in no way implies that I have all the answers. I consider myself new to this game every single day. I’m always fascinated by the reactions I get when I write people back (I answer every email). Most don’t like the answers I give. Trust me when I tell you that every lesson I share has been paid for in blood by way of excruciating capital losses.

On seed capital

:

“…I just got $25k from my Aunt and I’ve always wanted to be a trader. Do you think this is enough for me to go at it full time?”

Capital is the lifeblood of this business. The short answer is emphatically: NO, $25k is not enough to make it as a full-time trader. I know a few people who have done it, but I know a magnitude more who have failed. Small accounts are usually hungry for leverage or concentrated bets. Concentrated bets and/or leverage exponentially increase the number of variables that can take your account to zero in a day. Take this seriously. I didn’t say you could lose a little. I said ZERO.

As a side note, never put all your money into your trading account. Maybe that sounds obvious, but there are plenty of people who get to their perceived capital start line (25K, 100k, whatever) and just go all in. Never do this.

On proprietary trading

:

“It doesn’t seem like many proprietary trading firms are hiring these days and large financial firms are basically on lock down since 2008. I received an offer from a firm called [insert firm name] but turned it down. I got a bad gut feeling about it and they wanted me to pay them initially, then get firm capital.”

Prop shops are dying. Only one in a hundred are worth your time and they’re not hiring because the business model is dead. It’s the end of an era. The truth is that prop trading hasn’t been that great since the the days of decimalization.

Keep in mind that not every place that requires you to put up capital is a scam but they do deserve extra scrutiny and due diligence. The previous notes on seed capital apply.

On Losses

:

“…I wish I was emailing you to let you know that I was still crushing the market. Things started out so great but unfortunately I’ve suffered some pretty huge losses and I don’t know if…”

The only thing that matters is that you live to fight another day. I’m not being flippant about money lost because the money is important. It represents time and opportunity. Take some comfort in the fact that almost every successful trader I know blew up a small account at some point in their career. It’s so common it should be considered more of a twisted hazing ritual than failure. Yes, it sucks. But don’t let that experience define you. Take some time to discover the real reason you lost the money. Be brutally honest with yourself. Once you figure it out — learn the lesson and never repeat it. You paid for it. How you emerge from this is what defines you.

On education

:

“I go to school at [insert university] and I’m really interested in becoming a trader when I get out. I’m mostly taking business courses…”

Stop right there. If you’re still at school and you want to be a trader it means you should be taking as much math and computer oriented stuff as you can. Either that or you better introduce a star programmer to your future spouse and become best friends and business partners. You need programmers as allies or you need to be a programmer yourself. Trading is a quant game now. You can bitch and moan about it or you can do something about it.

On mentors

:

“I’ve been following [insert mentor name] trading for months and for a while things were great. It turns out that [insert betrayal]…”

In the finance world you will experience many false mentors. I have wholeheartedly placed my trust in people who turned out to be complete frauds. Besides outright fraud, there are also a lot of people who have made their career from sucking ideas out of bright young people. There are a lot of brokers who have made their careers sucking the capital inflows out of hardworking young people with no plan to help them grow. Don’t worry too much about this, just know that it happens a lot and it will probably happen to you. It’s a great feeling when you finally find a true ally and mentor and it’s usually accompanied by huge breakthroughs in your career. The real breakthrough occurs when you learn that there’s no one else in the world that you can rely on but yourself and you trust yourself to deliver.

On “systems”

“I read your blog and I really like you ideas on [insert any topic I've written about]. It’s very similar to something I’ve been working on. Before we go any further I want to know if you are comfortable signing the attached non-disclosure agreement…”

I have a mental exercise that I go through when I feel like I’ve “cracked the code.” I visualize three other people in the world having the exact same idea as me at the exact same second as I did. There is nothing new under the sun. Ideas are cheap. The only thing that matters is execution and process. How you react to draw downs and the realities of having money on the line are much more important than any “system.” I don’t want to discourage innovation, just know that the ideas aren’t what make you the money, it’s the execution.

On chasing the rainbow

“…I’ve been having some success with [insert indicator] but I think I really need to incorporate [insert needlessly complicated financial theory]. I heard that all the guys at [insert TBTF bank prop desk] use it. Do you have any code for this…”

The big “secret” of financial markets is that nobody knows what they’re doing. They only want you to think they do. No one can pull back the kimono and show you how the world works. There is no “god particle” of trading. It’s all testing, applying, and iterating processes. Think about this point for a good long minute. It means that while you are essentially hopeless and no one has the answers in this world you also have more power and possibility in your life than you previously thought.

Don’t endlessly toy around with indicator settings. This is a colossal waste of time and energy. There is no more salvation in a 6-period moving average any more than there is a 7-period. The trade that one kept you in the other got you out of. Stop.

On “making it”

“…I don’t feel like I’m a greedy person. I’m just looking for a way to consistently make $400-$500 per day to cover expenses and build my account slowly. When do you think I will get to that level?”

Never. When trading is good, there nothing better in the world. When it’s bad, it’s the worst. The concept of “lunch bucket” trading is not realistic. Trading is all about nirvana followed by crushing agony. I wish I was joking. You avoid more disastrous situations and you feel it less as time goes on but it’s always there. Most money is made during a couple of good months of the year and the rest of the time is spent avoiding murder holes.

As a universal rule, the process will take roughly three times longer than you budget for. For most people it takes a good 5 years to even be considered competent at managing money. Getting objectively good at it? Lifelong journey.

Conclusion

There’s nothing in this world that anyone can do or say to a stop a man in his 20s with a bankroll and a desire to trade. Hopefully there are some lessons in here that make your journey smoother than mine.

Team up with people you trust and have complimentary skills. Find an edge you have confidence in. Reach out to people online. Micheal Bigger is setting a great example of this.

Never take your foot off the gas of forward momentum. Do whatever it takes. Everyone has done a few things that they were a little bit embarrassed about at the time, but they look back on with pride.

[cwelsh 1,497]

Great post -- if you enjoyed that, I'd encourage everyone to read the market wizard books -- much along the same vein. And for my thoughts on the same topics:

On seed capital

:

Unless you are just starting out, you will, in all likelihood, blow out your account sooner or later -- particularly if you don't have enough to start with. Until you have 3-5 years experience "in the trenches" plan on seed capital being your tuition. You'll lose it, but you'll learn. I don't say this to be discouraging. However, I view myself as a very intelligent individual, with degrees in economics, computer science, and law. I spend lunches working through quantum mechanics with physics professors. I thought I had a handle on everything, and after two years of paper trading, lost my seed capital in two weeks when my "models" went to hell in a hand basket.

The single most important thing in trading is risk management and loss management. Learn to do that and there are numerous ways to make money in the markets. Losing 50% on one trade is not bad if it was expected and allocated for. Losing 50% of your initial capital on your first trade.....well that is just depressing (been there, done that.....twice).

On proprietary trading

:

I'd be surprised if there were many of these left in a decade. Look elsewhere.

On Losses

:

I agree with the original poster. Plan for losses, expect them, expect long streaks of losses. Expect your perfect strategy to not behave as expected. And allocate for risk accordingly. Figure out the worst possible result, increase it, and assume it'll happen at least twice as often as it should. Now build a position sizing plan and risk management around those assumptions. If you come up with one -- you'll do just fine. As long as you don't overreact when those losses actually happen.

On education

:

Learn statistics, learn computer science. If you didn't learn in college go buy a #*$(& textbook and teach yourself. Buy c++ for dummies, java for dummies,and anything you can get your hands on. If you're intelligent enough to be reading this post, you can teach yourself to program and to learn statistics. (Calculus helps too). If you spend 99% of your time for two years learning that, you'll trading career will be much better.

On mentors

:

The best mentors provide counseling, advise on risk management, and help you avoid pitfalls. Mentors who offer the best market "secrets" are probably frauds. Anyone who advertises they made 300% three years in a row is, in all likelihood, just lucky. I know someone who dumped his entire account into NFLX puts right before it plummeted. His account increased over 10x. Now he writes advisory letters and sells his "advice." Give me a break.

On “systems”

Any system not based, at its heart, on risk management, will eventually fail.

On chasing the rainbow

Trading is hard work. Don't do it unless you REALLY enjoy it. If I had put the effort into any number of things that I have put into trading in the last five years, I'd probably be much better financially off. Hopefully that will change. But if you don't like this, and think it's just a way to make some money, or retire quicker, save your money and start a business doing something you like.

On “making it”

Don't every say I "need $500 a week trading." You'll chase trades and eventually hurt you capital. Aim for a goal per year and work for that. If you have a bad month, or two, or three, so what as long as you've risk planned accordingly and have a sound trading strategy, you'll PROBABLY be ok in the long run.

Conclusion

I love doing this. You should too. I have learned that there (i) there is always someone smarter than you, (ii) it is highly unlikely that your "secret" strategy is something that has never been thought of -- read everything you can, you can learn from someone else doing the same things you have, and (iii) risk management is the most important thing you can do.

Sorry for the pontificating, it's pouring rain outside, I have a nice drink, and the Rangers lost. Everyone have a great weekend.

[ammarmalhas 5]

Kim & Chris,

Indeed these are great posts and very insightful. I would like to add my share to these two posts and I ask to be excused, upfront, for my blabbering, but I have to get things off my chest, before I burst !

These two posts up there seem to mostly address day-traders who think they can create a system of their own to beat the markets, they also recommend what not to do when trading ...etc.

Most of us here, I think (!), are simple traders trying to make a few bucks off the knowledge of more experienced traders with math degrees, computer science degrees and even law degrees. Most of what is in the two posts does not fit me, personally. For sure i will not go learn Java, C++ or Quantum Physics! I do not know how any of these might ever help me "guess" the markets or even analyze them!

I have become more aware that we tend to review "history" of trades and build upon "previous" trades but there are too many variables to consider and I do not believe it is as simple as that, and hence I do not see myself able to do it. We, here at SO, concentrate on "volatility" and in a sense that is the measure of "people's uncertainty", the more confused the people are the higher the volatility! I may be dead wrong but the markets in the last decade or more have turned into a chaotic place where retired old ladies, cab drivers and the likes of me, with a $100 bucks of spare cash trade and discuss the future of AAPL, GE, CITI, S, FB ...etc! This was and is not healthy and it was bound to crash and it did in 2008/2009 without any real warning and took most of us, "experts" and novice like me, by COMPLETE surprise.

How do we protect ourselves against such crashes and such uncertainty, is the "million dollar" question and the holy grail of trading (or investment).

Personally, I have a large long-term equity portfolio which suffered well over %60 loss during the fallout of 2008/2009 even though I was invested in excellent world-renowned funds run by "expert" economists and financiers and in "safe" funds designed to maintain my fortunes and provide some nice returns for my retirement, no high-risk quick-buck funds!

Look where I am now!

I have completely lost trust in all the financial institutes I have dealt with, and they were a few, I now believe that all financiers and economists know as much as I do about markets, basically NOTHING! No one can predict the markets and no one ever will.

There is now so much "sentiment" driven trades world-wide of such a large variety of people with institutional investing seemingly holding a minor share in the overall market, and that is the recipe for disaster! Again?

This is what I "feel", and as I said, I know NOTHING.

Anyway, both posts emphasized the "risk management" aspect of trading and recommends we all do it and make it our priority, GREAT. We must all do it.

Now, what the heck is it? How do we do it?

Can you guys please give us a detailed example of how one manages the risk of his trades and his whole portfolio and protects against bad trades and bad market moves? I understand that I must have a risk management policy and I must abide by it, but I have no idea how to set one up.

Please do not tell me to Google it , so far I got to a point where I am trusting both of you, your know-how is apparently vast and the way you trade is evidently safe, systematic and cautious enough for me to want to follow you guys and grasp your advices and learn from you. So, please guide me.

Bless you all.

Edited August 18, 2012 by ammarmalhas

[Guest listolyman]

I suggest that you read the book "Super Trader" by Van Tharp to begin your understanding of risk management and position sizing. It's on the recommended reading list.

[Kim 7,475]

Ammar,

You are absolutely right that things are not simple. Anyone who tells you that you can just follow him and make money in 10 minutes per day (an hour per week/month etc.) simply doesn't tell the truth.

Here is the problem: people have unrealistic expectations about their trading. To become an Engineer, you need to study 4 years. To become a doctor, 7 years. That's before practice. Why people expect it to be different in trading? Trading is a hard work and to succeed, you need to devote time to it.

Every second reader on Seeking Alpha thinks that AAPL should be a $1,000 stock today. What does he know that others don't to make that statement?

I had couple of articles about Mutual Funds:

http://seekingalpha....-won-t-tell-you

http://seekingalpha....-their-own-game

I think they can tell you why Mutual Funds might be a bad idea.

2008 crisis was what caused me to adapt the no-directional trading. I simply don't want to rely on what the markets are doing. The 2008 will come again, it's only matter of time.

What is risk management? We are trying to teach it every day here. It is not an easy concept, and it definitely cannot be described in one post. We have dozens of posts about it. Van Tharp books are an excellent start. I don't think I can do it better than him.

I have a shelf full of trading/investing book. Over 50 of them. Probably another 50 that I took from the local library. This is how I reached my style. This is what works for me. Everyone has to decide what works for him - this is the most important thing.

[cwelsh 1,497]

You are correct most of that information is for day traders with technical analysis. However, the risk management is not. Kim wants me writing more here anyways, I'll make it a project to put together a risk management post this week (try to anyways).

Van Tharp is a great place to start, and here's a neat website that lists tons of resources:

http://www.tradermike.net/2005/07/position_sizing/

And here is a good overview of why it is important and the basics of it:

http://www.vantharp.com/tharp-concepts/position-sizing.asp

[ammarmalhas 5]

I suggest that you read the book "Super Trader" by Van Tharp to begin your understanding of risk management and position sizing. It's on the recommended reading list.

I just started, thank you for the tip. It is however, 200 something pages long and a few tips from the masters here will help.

[ammarmalhas 5]

Kim & Chris,

You two are great. Simple fact.

I am starting to read and I know it will take me a long time, I am not sure I have the energy to go through all this, but I will try.

I am stuck invested in long term equity in C, GE, ALU, FNMA and also have a fairly large options positions (leaps) on these and on BAC, FB, S ...etc. I am starting to think I probably should liquidate (slowly) and put my money in land and development, which is what i know best!

I am staying put, and I am reading and reading and looking forward to all your comments. i will keep trading the SO way and I hope for the best.

Whatever happened to "long-term" investment in good companies? GE, Citi, BAC, ALU, S, FNMA where among the best that ever was, they are in trouble now as is the whole market, but is "long-term" investment dead? Are Warren Buffet's views on buying good companies and holding on to them an "old fashioned" style that no longer works?

Bless your heart guys, it is GREAT to know you are out there supporting us.

[Kim 7,475]

I think long term investment is dead for me, and probably for most retail investors like us. It might not be dead for people like Warren Buffet who simply have much more information and can better protect themselves.

I mean, Apple is a great company, but does anyone seriously believe that AAPL stock will be immune in the next 2008 like crisis? I don't.

[ammarmalhas 5]

Can you guide me to a newsletter or site that keeps track of the general trend of the market on a daily basis. I want to be informed on what the markets are trending technically. Thanks.

[Kelly Park 10]

I am starting to read and I know it will take me a long time, I am not sure I have the energy to go through all this, but I will try.

I am stuck invested in long term equity in C, GE, ALU, FNMA and also have a fairly large options positions (leaps) on these and on BAC, FB, S ...etc. I am starting to think I probably should liquidate (slowly) and put my money in land and development, which is what i know best!

Well, the 2008 market meltdown may have been fueled by highly correlated, automated trading, but the fire was lit by a massive mortgage writing frenzy and the resulting land and development bubble. I know land and development better than the market too, but I'm still sitting on beautiful coastal lots in Florida that are worth less than a quarter of what I still owe on them!

[ammarmalhas 5]

Kelly, I am sorry to hear that but I believe things will normalize soon; soon being a couple of years or so. It was bad on all of us. My 2008 loss was almost 70% of my worth! I still have properties here in Jordan, prices are holding but there are no buyers!

What I do not understand with the US government and immigration is why don't they offer a program for immigration to the US for those who buy houses and maintain (of a certain size)? They must have thought of this! I did! This can surely cause a HUGE demand and may help resolve some of this mortgage and housing problem that destroyed the world, not just the US!

Think of it! If they offer this, I believe they will have at least a million applicants willing to buy housing in the US and this will drive the market up and solve many problems. I am not sure of the size of the housing problem (quantities of foreclosures and houses with bad mortgages), but it could be a beginning. Furthermore, those who can afford to buy housing in the US will not be a burden on the social security, welfare and medical systems already in slight trouble.

Just a thought! (By the way, I am one person willing to do this wholeheartedly)

We are gearing away from the topic of the forum, sorry!

[cwelsh 1,497]

Well they have a program CLOSE to that, it's called the EB-5 visa program. If you're looking to start a business involved in purchasing, maintaining, and selling real estate, its a definite possible route (I have worked on an EB-5 project before). Many foreign entities love these programs.

There is also a bill winding through congress called the VISIT USA act, which would permit individuals to buy real estate in exchange for visas. However, it has not passed yet, and with the upcoming elections, is likely stalled until after February.

[ammarmalhas 5]

Yes I have read all about the EB5 program but in the end it is investing $500k in an non-guaranteed investment that needs to show the creation of 10 permanent jobs in two years.

There can be no security or guarantee that the money will be refunded nor the jobs created. The US government does not guarantee anything and one can lose all or some of the invested sums.

If the project fails and/or does not to prove the creation of 10 jobs (per investor) then the temporary residency (Green Card) will be revoked and the investor will have suffered tremendous losses.

To me this is a too risky, especially since the housing and development market in the US is still showing weakness and uncertainty.

[cwelsh 1,497]

Yes I have read all about the EB5 program but in the end it is investing $500k in an non-guaranteed investment that needs to show the creation of 10 permanent jobs in two years.

There can be no security or guarantee that the money will be refunded nor the jobs created. The US government does not guarantee anything and one can lose all or some of the invested sums.

If the project fails and/or does not to prove the creation of 10 jobs (per investor) then the temporary residency (Green Card) will be revoked and the investor will have suffered tremendous losses.

To me this is a too risky, especially since the housing and development market in the US is still showing weakness and uncertainty.

I completely understand that opinion. I do know though (as I personally have been involved in it), that outside (Chinese with me) groups have succesfully used the EB-5 program to start a real estate investment/rental business here. However, not at the $500K level -- it was closer to $15m, which allowed them to purchase dozens of residential homes, rent them out, and hire landscaping crews (7 jobs), handymen for the rental homes (4-5 jobs), a rental agent (1 job), and a project manager (1 job), and clear a very nice profit.

Like any business, you need to make sure you're adequately capitalized, have experience, and have the right contacts on the ground.

I certainly would not recomend the program for a $500K investment.

[cwerdna 12]

This was and is not healthy and it was bound to crash and it did in 2008/2009 without any real warning and took most of us, "experts" and novice like me, by COMPLETE surprise.

How do we protect ourselves against such crashes and such uncertainty, is the "million dollar" question and the holy grail of trading (or investment).

Personally, I have a large long-term equity portfolio which suffered well over %60 loss during the fallout of 2008/2009 even though I was invested in excellent world-renowned funds run by "expert" economists and financiers and in "safe" funds designed to maintain my fortunes and provide some nice returns for my retirement, no high-risk quick-buck funds!

Look where I am now!

I don't have great answers for you on risk management even though I've been investing in stocks since 97, I still consider myself to be not that much better than an amateur. I've made a lot of mistakes over time.

I don't have much time to write about this right now, but I had a debate/discussion w/some other people on a non-investing forum about "buy and hold" being a terrible idea. I basically asserted that one can find better times to enter and exit the market. It's near impossible to find the top or bottom, but still.

To quote from my post there:

For you guys, if nothing else, look to the 200 day SMA (http://www.usatoday....g-average_N.htm and http://www.usatoday....g-average_N.htm) of SPY or the S&P 500 as to when to get in or out of the broader market. I looked at SPY (S&P 500 SPDR) going back to 97 and w/a couple extra rules, it's turns out to be a pretty good signal as to when to get in/out. If you don't want to use it as a get in/out signal, at least use to it as a signal as to when to buy more/less aggressively.

In the back of http://www.amazon.co...e/dp/1416558853, he lists some mutual funds he likes but you might not be able to choose them and the manager may have changed. Essentially I agree w/part of his reasoning that if you're going to pick mutual funds, pick ones that lose less than the market when the market's down. Try to find funds that meet this criteria.

It's better to have ones that are more consistent winners (even if underperforming the market that year) than to have it wiped out by say a 50% loss. To make up for a 50% loss, you need a 100% gain. That's tough.

This isn't a recommendation (and not in Cramer's book either) but I found http://finance.yahoo...pm?s=merfx&ql=1 (MERFX) has generally small gains but very tiny losses.

and from a later post (made on June 1, 2012):

Sell in May and go away is totally separate from SMA calculations. However, it sure seems like that adage is holding true this year, so far.

Well, it is under the 200 D SMA now. Unfortunately, watching the S&P vs. the 200 D SMA is not at all good for finding a market bottom.

However, it seems like when the market crosses back above it and stays that way for a few days, that generally precedes an uptrend, sometimes a strong and long lasting one.

If you have a decent trading platform (e.g. Thinkorswim) or know of some good charting web site that lets you plot the 200 D SMA and zoom in, zoom out and scroll around on different points of a chart easily, you'll see what I'm talking about.

Since it was hard to illustrate, I ended up making these YouTube videos (on June 1st, 2012).

And I said:

You only really need to watch part 1 to see what I mean about the 200 D SMA.

I recommend that you click on the YouTube logo to open it in a new window, click on the gear to watch in 720p or 1080p, then go full screen via the button in the lower right of the video.

I really wish I knew about the 200 D SMA as being a decent indicator about the broader market YEARS ago and I wish I knew about TOS when I started investing. It would've saved me a LOT of pain.

I recently did look at the 200 D SMA a bit more vs. a few shorter duration moving averages (e.g. 30 or 50 day). Perhaps a decent rule could be something like this?

Enter the S&P 500 (e.g. via SPY) when it crosses above 200 D SMA but take some off the table after a long run up if it starts crossing below the 30 or 50 day and exit completely when it crosses below and stick to the rules.

This shorter MAs really hadn't occurred to me until more recently. If I had only stuck to my guns about the 200 D SMA rule, I'd be better off. Take a look the attached chart. S&P 500 crossed above the 200 D SMA (red line) on 6/6/12.

Back to funds, here are some examples (not recommendations) of funds that didn't do so horribly in 08 and in down years. Be careful, some of them have changed managers.

http://finance.yahoo...FSX Performance

http://finance.yahoo...pm?s=BERWX&ql=1

http://finance.yahoo...pm?s=FBRVX&ql=1

http://finance.yahoo...CKX Performance

Since Yahoo Finance doesn't include 2011 performance yet (for some reason), you might want use Morningstar instead (http://performance.m...A&culture=en-US, click on Expanded View).

Whatever happened to "long-term" investment in good companies? GE, Citi, BAC, ALU, S, FNMA where among the best that ever was, they are in trouble now as is the whole market, but is "long-term" investment dead?

Yeah, I've made big mistakes on names like C where when I bought them, I thought "this is one of the biggest banks in the world. They've got to be doing something right." Boy, instead I'm sitting on a huge % loss as I didn't sell.

Edited August 29, 2012 by cwerdna

[Guest listolyman]

I believe that anybody in long term investing in mutual funds, etf's, or individual stocks should considering limiting their losses and letting the profits run by setting trailing stops on their accounts. Every brokerage offers this feature but i had never heard of it until a few months ago. I have invested with Edward Jones, Fidelity, JP Morgan, and individual advisors but nobody mentioned this feature was available. I also had major losses in 2001 and 2008.

[ammarmalhas 5]

cwerdna, Thank u for the detailed and informative post, I appreciate it.

listolyman, can you elaborate more on "setting trailing stops"? Why and how?

[cwerdna 12]

I believe that anybody in long term investing in mutual funds, etf's, or individual stocks should considering limiting their losses and letting the profits run by setting trailing stops on their accounts. Every brokerage offers this feature but i had never heard of it until a few months ago. I have invested with Edward Jones, Fidelity, JP Morgan, and individual advisors but nobody mentioned this feature was available. I also had major losses in 2001 and 2008.

Not all brokerages have always let you set trailing stops. I started w/Datek in 1997 and after a bunch of buyouts/mergers, it became TD Ameritrade. I'm pretty sure that before 2000 or maybe even as late as 2004, they didn't have trailing stops.

I haven't had a chance to look at all the posts in detail, but I feel http://www.vantharp....tion-sizing.asp is worth a look. I didn't totally understand position sizing and risk until I went to a free TD Ameritrade seminar (partly intended to suck you into paying for pricey Investools training). I agree w/those principles there (even though, I admit I should be following them more strictly).

At the free seminar I went to, they advocated something like this: if you buy a stock, set a stop loss order for 20% loss. So, for example, if you buy $1000 of stock, set a stop loss order for $800. That way, your max risk is $200, not $1000. Of course, there's always the danger that you end up buying high, selling low, and have the stock rebound later. Those losses can add up.

However, it keeps you from riding a stock all the way down (I've had some companies go bankrupt or have MASSIVE losses due to the .com crash, and still haven't returned). It also keeps you from selling once you've incurred a big loss (say 50 or 60%) and decide to throw in the towel.

I'm not saying you should do this, but keep it in mind.

listolyman, can you elaborate more on "setting trailing stops"? Why and how?

There's a good tutorial on TD AM's web site on trailing stops. Unfortunately, you need to have an account to see the page (https://wwws.ameritr...StopBasics.html). I attached a bitmap of the relevant part.

The only problem w/trailing stops is those activation points aren't based on any technical analysis, just a fixed % or point value away from the highest bid price. You could get stopped out too early. And, of course, there's still the danger of buying high and selling low(er), if you buy and the stock does nothing but go down from where you bought it at.

[cwerdna 12]

I recently did look at the 200 D SMA a bit more vs. a few shorter duration moving averages (e.g. 30 or 50 day). Perhaps a decent rule could be something like this?

Enter the S&P 500 (e.g. via SPY) when it crosses above 200 D SMA but take some off the table after a long run up if it starts crossing below the 30 or 50 day and exit completely when it crosses below and stick to the rules.

This shorter MAs really hadn't occurred to me until more recently. If I had only stuck to my guns about the 200 D SMA rule, I'd be better off. Take a look the attached chart. S&P 500 crossed above the 200 D SMA (red line) on 6/6/12.

Back to this point, I've attached a 2 year chart of the S&P 500 w/30, 50, and 200 D SMAs (blue, green, red lines). MA_BS(30) == Moving Average with breakout signals (30 days).

If you have TOS or some other good charting platform, you can explore how well this works (or doesn't work) further back.

If you look at the far left, at ~Sept 2010 and entered when the S&P crossed above 200 D SMA (red line), rode it all the way up and didn't exit until it crossed below at ~August 2011, you'd have lost some of your gains. If you look at some of the points where it crossed the shorter MAs (30 or 50 day) perhaps you could've taken some gains there and saved yourself some of the downside of waiting until the 200 D SMA crossover.

The same thing is if you entered at ~December 2011 and got partly out at mid-April 2012, instead of waiting all the way until the cross below at June 2012.

Again, this is much easier to see using the TOS app, since you can zoom in/out, move the crosshairs around, change time periods, etc.

[ammarmalhas 5]

cwerdna, looking at $DJI, SPX, RUT and NDX (in TOS) and using your 200 day SMA and the 30 & 50 SMAs, it appears that all indices (the market as a whole) are on an upwards roll with no indications of any turning down soon.

Now, if I have read these charts correctly, everyone is saying that a correction is overdue and that the charts and technical indicators show that the markets are overbought and a downward movement is expected. Who should I believe?

This is confusing. What are others looking at to say that a correction is over due?

Another question, please, does the 200/30/50 SMA analysis work for individual stocks? I mean can I chart say C and analyze it as you did SPX?

Thank you.

[Kim 7,475]

The problem with corrections is they don't come when everyone expects them. They come when the complacency is at the highest levels and people think that everything is perfect.

[cwerdna 12]

cwerdna, looking at $DJI, SPX, RUT and NDX (in TOS) and using your 200 day SMA and the 30 & 50 SMAs, it appears that all indices (the market as a whole) are on an upwards roll with no indications of any turning down soon.

Now, if I have read these charts correctly, everyone is saying that a correction is overdue and that the charts and technical indicators show that the markets are overbought and a downward movement is expected. Who should I believe?

This is confusing. What are others looking at to say that a correction is over due?

Another question, please, does the 200/30/50 SMA analysis work for individual stocks? I mean can I chart say C and analyze it as you did SPX?

Thank you.

I can't speak to whether a correction is overdue and all that, based on technicals. I'm a total amateur at technical analysis (huge subject: see http://www.investope...rsity/technical, for example) and am trying to get better at it. Some people use RSI (http://www.investope...p#axzz25gRdKH93) to determine overbought/oversold. Some people can see something in a chart that others miss/disagree with. Support and resistance are pretty clear cut and easy to draw on certain stocks, as are channels.

Problem w/depending on support/resistance, is you could buy on what looks like a support bounce, but then it could fall and fall below support. You could sell at resistance, only to have it break thru (higher)...

I don't think there's a 100% accurate silver bullet/holy grail indicator. But, as you can see, looking at 200 D SMA for S&P 500 seems to work pretty well for picking decent entry times and ok for exit.

You can try to look at the SMAs for stocks and see how well they work for the stock in question. My technical analysis and options guru friend feels 200 D SMA is too slow for stocks. As a side note, I sell way OTM naked puts for income. He suggested I only do it on stocks that are above their 200 D SMA, essentially as a sign of strength of the stock.

FWIW, Investools (at least in their teaser training) tries to pitch their "3 green/red arrows" strategy (

). You can actually duplicate these studies exactly in TOS w/o paying for anything from Investools. They also advocate some other methdologies, right or wrong. However, from what I understand, as you go thru more Investools training, it further diverges from their 3 green/red arrows strategy + other tools (e.g. Phase 1 and 2 scores, Big Charts). From talking to my friend (same guy), who went thru their "PhD" program, he confirmed that. He also couldn't care less about fundamentals or phase 1, 2 scores and most of Investools' tools (which aren't free).

Sorry, I disgress. I only threw out the 3 green/red arrows strategy as an example of techniques some use.

If you want more of a flavor of technical analysis, watch some of Jim Cramer's "Off the Charts" segments he does on Mad Money. He's not a technician and doesn't believe in technical analysis (some of it sounds like BS, to non-believers in TA), but he knows some of the basic patterns (e.g. head and shoulders, cup and handle) and basically explains what technicians have showed him.

[artie 1]

I actually wouldn't call this market terribly overbought. It only seems that way. Market can go way higher(irrationally of course, as the world economy is crap).

Please see the current Oscillator chart. We've seen WAY higher levels. This is a good technical indicator.

[Kelly Park 10]

I believe that anybody in long term investing in mutual funds, etf's, or individual stocks should considering limiting their losses and letting the profits run by setting trailing stops on their accounts. Every brokerage offers this feature but i had never heard of it until a few months ago. I have invested with Edward Jones, Fidelity, JP Morgan, and individual advisors but nobody mentioned this feature was available. I also had major losses in 2001 and 2008.

I haven't tried this myself, but I recently read a pretty comprehensive analysis of profit target/stop loss settings for S&P 500 stocks. The study found the optimum return with a 7% stop loss and 20% profit target settings. Baically, the strategy recommended by the anlysis was to use some fundamental analysis to choose stocks, some technical analysis to choose entry points (what kind was not the point of the article), then set 7% loss and 20% gain sell orders when the stock is bought. I would think that a 7% trailing stop would be at least as good and potentially better.

[tjlocke99 18]

I actually wouldn't call this market terribly overbought. It only seems that way. Market can go way higher(irrationally of course, as the world economy is crap).

Please see the current Oscillator chart. We've seen WAY higher levels. This is a good technical indicator.

Thank you Artie? How did you generate this? Does this Mc. Oscillator use bollinger bands?

[artie 1]

Thank you Artie? How did you generate this? Does this Mc. Oscillator use bollinger bands?

I use TC2000 for charting (basic is free). the ticker for the McClellan Oscillator is T2106. I have actually included bollinger bands in the chart I attached(that's the shaded region).

See the below description as to how its calculated - http://en.wikipedia.org/wiki/McClellan_oscillator

[tjlocke99 18]

I can't speak to whether a correction is overdue and all that, based on technicals. I'm a total amateur at technical analysis (huge subject: see http://www.investope...rsity/technical, for example) and am trying to get better at it. Some people use RSI (http://www.investope...p#axzz25gRdKH93) to determine overbought/oversold. Some people can see something in a chart that others miss/disagree with. Support and resistance are pretty clear cut and easy to draw on certain stocks, as are channels.

Problem w/depending on support/resistance, is you could buy on what looks like a support bounce, but then it could fall and fall below support. You could sell at resistance, only to have it break thru (higher)...

I don't think there's a 100% accurate silver bullet/holy grail indicator. But, as you can see, looking at 200 D SMA for S&P 500 seems to work pretty well for picking decent entry times and ok for exit.

You can try to look at the SMAs for stocks and see how well they work for the stock in question. My technical analysis and options guru friend feels 200 D SMA is too slow for stocks. As a side note, I sell way OTM naked puts for income. He suggested I only do it on stocks that are above their 200 D SMA, essentially as a sign of strength of the stock.

FWIW, Investools (at least in their teaser training) tries to pitch their "3 green/red arrows" strategy (

). You can actually duplicate these studies exactly in TOS w/o paying for anything from Investools. They also advocate some other methdologies, right or wrong. However, from what I understand, as you go thru more Investools training, it further diverges from their 3 green/red arrows strategy + other tools (e.g. Phase 1 and 2 scores, Big Charts). From talking to my friend (same guy), who went thru their "PhD" program, he confirmed that. He also couldn't care less about fundamentals or phase 1, 2 scores and most of Investools' tools (which aren't free).

Sorry, I disgress. I only threw out the 3 green/red arrows strategy as an example of techniques some use.

If you want more of a flavor of technical analysis, watch some of Jim Cramer's "Off the Charts" segments he does on Mad Money. He's not a technician and doesn't believe in technical analysis (some of it sounds like BS, to non-believers in TA), but he knows some of the basic patterns (e.g. head and shoulders, cup and handle) and basically explains what technicians have showed him.

Human minds love to find patterns. However TA seems to be adding a pattern to things that have already occurred and sometimes reading tea leaves. You can make a pattern out of anything in the past. However I don't think this tells us much about the future.

I love Jeff Augen's discussions on this. He says once a strategy has hit a common broker tool,any alpha that was available from that strategy is now gone.