Finance and Stuff

Thoughts on finance and other stuff by Johan Lindén

Tag: Trading

My Ideal Scenario

It is said be many, and I agree, that the stock market is rigged so that as many people as possible will be wrong as often as possible. This contrarian thinking is also backed by many studies which show that strategies that work are counter-intuitive.

So far it worked well for me trying to figure out the route of the market since I got active analyzing the market again last fall.

Let us take a look at my favorite scenario that I think will fool most people getting in the stock market at the worst time.

The facts are as follows:

  • Since last fall we have had many difficulties all over the world
  •  The stock market has risen a lot
  • Most people have been afraid of getting in the market
  • Most ways of measuring the trend is pointing up, which is what many people like to see before entering the market
  • The last movement up has been almost without any big draw-downs.

So most people now are noticing that the trend is up, they also read all the positive things happening in the economy (the bad things aren’t shown so much in media when the stock market is going up). So now people are looking at a time to enter the market. Every big draw-down now will likely attract a lot of money.

When the market finally enters a multi year high, just 2% up from where we are now, then they will throw their last dollars in desperation not trying to miss the rally. They do not even realize that they just missed a 25% move from the bottom. When that happens I think we reached a new multi-year high, maybe for many years to come.

This is just an ideal scenario that I would like to see. Of course there could be other similar scenarios or I could be totally wrong, but this would fit my expectation of the psychology and knowledge of the market.

Also note that I will short the market at a time when most of the traditional type of technical analysis would scream buy.

bear bull trap stock market top

Negative Interest Rate in Swiss Franc… Again

Switzerland is now charging interest (or call it a tax if you want) if you want to lend the country your money! That is right, for every franc you want to lend them they will give you less back.

No matter how crazy this might sound, this is actually for the second time period in history that Switzerland charge investors to give them money. The first period where Switzerland had negative interest rate was in the 1970’s and that initially lead to a decline of 27% before the appreciation continued. Switzerland sure seem like a country who knows how to take care of its currency. Maybe something other countries could learn from.

Today you have to pay 0,82 Swiss Franc for a U.S. Dollar. The facts above indicates that the market sentiment is a bit stretched to say the least, and if the pattern from the 1970’s repeats, then there seem to be a good risk/reward to buy U.S Dollar with Swiss Franc. 0,7765 is where I put the stop loss for this idea, which is 5,3% below current value.

US Dollar Swiss Franc USD CHF

Beware! Be sure to understand money management and the risk of trading before attempting any trades. For instance, in the example above, if you only want to risk 1% of your trading capital you need to invest a fifth of your capital. There will be a risk and money management article coming up in later posts.

Bernanke Speaking at Jackson Hole

FED director Mr Bernanke is now starting his speech in the Jackson Hole FED-bank conference.

bernanke jackson hole stock market

The market participants are now waiting for news about the economy. Last year a big rally started in the stock market that lasted until this summer.

This time people do not seem that optimistic about the things Bernanke has left to offer. A Quantitative Easing number 3 is what many hopes for to help inject money into the markets. But even if that comes that is no guarantee for a raising stock market.

The positive side, I think, is that so many are negative now and not many believe in a strong stock market. That is the only, but very important, tell that we might enjoy some strength in the market.

But beware of volatility. Always take smaller trade sizes during times of high volatility. More about trade sizing in later posts.

S&P 500 is at this time down 1,3% to 1144.

POST-MEETING UPDATE 16:48 CET

No specific information about quantitative easing was given as most had expected.  But Bernanke said that the U.S. Federal Reserve will do what is necessary to support the economic recovery. — Suprise suprise!

The recovery in the U.S. economy remains modest. The recovery is slower than the Fed had hoped for, but the Fed continues to expect better growth in the second half of 2011. — I think you should change the world “expect” for “hope for”. What they or any expert expect is rarely what happens.

While noted a significant growth in the global economy and America’s banking sector is generally in much better shape now, says Bernanke, and I believe him, but it is not now I am worried about. It is tomorrow or next year. Warren Buffet also seems to believe in the American banking system. Google Buffet + BAC for more info about his latest investment.

The Federal Reserve has a number of tools that could be used to provide additional monetary stimulus. We discussed the relative merits and costs of such tools at our August meeting. — They might have the holy grail but they have not used it yet and do not want to tell us about it.

Their next meeting is in one month.

S&P 500 is at this time down 0,7% to 1152.

Regulating Short-Selling is Ridiculous

As always when the stock market is running bad there is this discussion among authorities to forbid short-selling* of stocks. This time is no different as I could read yesterday that several authorities are talking about banning short-selling of stocks.

So, it must be good for the market if we forbid short-selling right? No, wrong.

  1. There is no evidence whatsoever that it will be better for the financial markets. Show me proof and I will surrender!
  2. Why keep up prices if market participants want them lower? Prices will always end up where they belong sooner or later. The sooner a stock shows its real value, the better for an effective stock market.
  3. Restricting the market makes the market less liquid and effective, which leads to lower prices. Not really what the authorities had in mind I guess.
  4. There are ways to get around this ban by using futures and options. So as usual, the ones that lose are the average Joes who do not have access to those instruments while the sharks prosper as usual. Or maybe we should forbid those instruments too? Why not forbid the whole stock market to avoid turbulence?

The most important point though, is why there is only talk about trying to lower the downward swings. If the market have not gone so high to begin with it would not have gone so deep now. Why ban short-selling? If we instead had ban people from over-investing and buying on the margin we might not have gotten these swings.

Check out the chart below for how the market did the last time we did when banning short-selling in 2008.

short-selling ban 2008

Edit: 28th of September. Adding a video from Bloomberg below.

*For those who do not know what short-selling is, it is when you are speculating in a falling price and sell something you do not have. So instead of owning 100 shares of XYZ, you are owing 100 of XYZ, meaning you have a total of minus 100 shares of that stock in your account and thus prosper when the stock is going down and you later buy it back cheaper.

 

Trading vs. Poker

Having been a full-time poker player for a few years before I started my recent venture in finance, I have found many similarities between the two occupations.

trading poker

When I read the book Poker Wizards, a book interviewing some of the best poker players of all time, I found it very interesting to see how the poker professionals reasoned and how it was related to the financial markets.

Let us look at what Daniel Negreanu, one of the most acclaimed and well-known poker players of all time, has to say about the traits of successful poker player:

  1. The one quality that I think is definitely the most important in being a successful player is having good people skills.
  2. The second most important quality is an aggressive personality.
  3. Third is discipline.
  4. The last quality is having a fundamental knowledge of the game, which is the easiest part.

I could not have agreed more about this list of qualities that makes a successful player. The interesting part though, is that the same thing goes for the players in the stock market or other financial markets. So let us look at these four qualities one by one when it comes to being a successful trader.

People Skills

Most definitely one of the most important qualities! A good poker player knows that when the table is tight and people hold onto their money he should be more involved and putting his money in the pot more often. But if many players are involved most of the time, then he plays fewer hands.

The same thing goes for the stock market. When everyone talks about how good it is to invest in stocks and you hear stock tips just by visiting your local coffee shop, you better stay out. But when people loathe the thought of owning stocks, that is a good time to own stocks.
stock market psychology behavioral economic

Another way of seeing why you need good people skill is to understand what drives the stock prices. In the long-run it is the earnings of a company that leads the way for stock prices, but in the long-run we might have gotten broke already.

In the short-run it is the hope and fear of people who decides where the stock prices moves. This is what we call market psychology or behavioral economics. Instead of fundamental analysis of the company itself, many successful traders try to measure and use people’s behaviour when analysing the outcome of a trade.

An Aggressive Personality

I prefer to call it an unafraid personality. If you assessed the risk of your strategy you must be willing to follow through your plan and not change it just because you are currently losing. When people panic they often take the wrong decision.

Discipline

Even if you have the best trading plan in the world and make money 95% av the time, you might lose all those winnings in the last 5% of your trades if you trade inconsistently. You must also have discipline and routines to look over your trading on a regular basis to optimize results, but also take care of your well-being to not lose focus due to stress and other factors.

Another very important aspect that many people fail to follow is the discipline of game selection. Both poker players and traders alike love their game so much so they often join a game where they do not have an edge instead of waiting for the right opportunity. To sit out and not take a position is many times the right decision. Or to put it another way, to not get involved in losing games makes you a winner in the long-run.

Fundamental Knowledge of the Game

It is easy to get a fundamental knowledge of poker. Anyone can get it by reading a few good poker books. In the stock market this is much harder since there is not much scientific evidence about doing the right investment. Are value companies better than growth companies? Is it better to buy a stock with a low P/E? Many people have an opinion but if you ask them for some statistical evidence they think you are a donkey not taking their word for granted.

It is a big leak for a trader or investor who is using his common sense to take decisions instead of finding a scientific measurable edge. But just as in poker, those bad traders might win in the short-run and complain about being unlucky in the long-run. Do not become one of those people!

Differences between Trading  and Poker

Finally I would like to point out two differences between trading and poker. In poker, many go with their gut-feeling when taking hard decisions. They might see something in their opponent, a tell, that looks suspicious, and take actions according to that. That is fine! People have had millions of years to evolve skills in reading other people’s subtle expressions. But traders usually do best in avoiding that gut-feeling that usually comes from fear or greed instead of the body language of their opponent.

The similarity, however, is that you should try switching of your emotional senses in both poker and trading to avoid taking emotionally driven decisions. So much money has been lost in both poker tables and in the stock market for those emotionally driven decision. But your own emotions are one of the toughest challenges to master no matter if you are a trader or poker player.

My last point regarding the dissimilarities between poker and trading is that trading and the financial markets is much tougher to master than poker. It is much harder to find an edge in trading than in poker. If you have two aces and get your money in before the flop, you are making a good investment. That is a fact. In trading you rarely find those facts.

I want to finish of with a quote:

“Poker is like sex. Everyone thinks they are the best, but most people don’t know what they are doing.” -Dutch Boyd

I hope you enjoyed this article. Feel free to comment!

Related posts:
Ten Characteristics of Successful Traders
Quotes of Market Wizards

Quotes of Market Wizards

I will open this blog with a recommendation to all people serious about trading or financial markets to read the book Market Wizards by Jack D Schwager. This is surely a must-read or as I refer to it as the Bible of trading.

trading quotes market wizardsThe whole book is just a series of interviews with the most successful traders of the 1980’s and is very easy and entertaining to read. It was interesting to read that all traders was very successful using totally different strategies. However, looking back at the book, I found one common trait they all shared while making their millions or billions. They were all risk avert. That might be something to think about before you double your position during your next unsuccessful trade.

I will most certainly get back to this book later on, but today I will share some thoughtful advise given by these Market Wizards. Enjoy!

The most important rule of investing is to play great defense, not great offense. Every day I assume every position I have is wrong. Always question yourself and your ability. Don’t ever feel that you are very good. The second you do, you are dead. Always maintain your sense of confidence, but keep it in check.
-Paul Tudor Jones

Place your stops at a point that, if reached, will reasonably indicate that the trade is wrong, not at a point determined primarily by the maximum dollar amount you are willing to lose.
-Bruce Kovner

Many people actually want to lose on a subconscious level.
-Dr. Van K. Tharp

The realization that you are responsible for your results is the key to successful investing. Winners know they are responsible for their results; losers think they are not.
-Dr. Van K. Tharp

My Marine training helps in investing. They teach you never to freeze when you are under attack.
-Marty Schwartz

Investing is like poker. You should only play the good hands, and drop out of the poor hands, forfeiting the ante.
-Gary Biefeldt

Fundamentals that you read about are typically useless as the market has already discounted the price. I call them funny-mentals. However, if you catch on early, before others believe, then you might have valuable surprise-a-mentals.
-Ed Seykota

If you make 50% two years in a row and then lose 50% in the third year, you would actually be worse off than if you just put your money in a money market fund. Wait for something to come along that you know is right. Then take your profit, put it back in the money fund, and just wait again. You will come out way ahead of everybody else.
-James B. Rogers, Jr.

Most traders who fail have large egos and can’t admit that they are wrong. Even those who are willing to admit that they are wrong early in their career can’t admit it later on! Also, some traders fail because they are too worried about losing. I’m not afraid to lose. When you start being afraid to lose, you’re finished.
-Brian Gelber

I hope you enjoyed some of these quotes from the book. Even if you learn only one thing from these masters, it may make the difference whether you will become a winner or loser in the end.

If you have not checked out “Are You a New Reader?” please do that and send me some feedback. Thanks!

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