Saturday, October 30, 2010

The Seven Deadly Sins of Trading

Just in time for Halloween, here are the Seven Deadly Sins of Trading. It's some scary stuff, let me tell you. I may not be the world's greatest trader, but I am definitely an expert on this particular subject. I've made all of these mistakes myself at least once, some more than once, and I'm still working on one or two. Hopefully, someone else can learn from my sad experience. So without further ado, here they are:

1. Impatience

I put this first because impatience has cost me more money than the rest of them put together. I can't count the number of times where I've unloaded a stock because it wasn't performing and the next day it took off. Or bought too early - that's the classic "catching the falling knife". And the most irritating case is when I'm trying to get in on something and the price just keeps hovering right above my limit order. Every time I finally get tired of waiting and bump up my limit to meet the ask, two minutes later the price drops down to my original price - or lower. Patience above all else.

Oddly enough, the opposite of impatience, timidity, can be almost as bad. I've had lots of stocks just take off and run away from me while I was debating pulling the trigger. There's nothing like the feeling of being left standing in the dust as you watch the tail lights of the bus pulling away from you. That's one reason I like swing trading - this isn't as much of an issue there.

2. Sloth

This is also one of the "classical" seven deadly sins. Trading is hard work. Just because you're not swinging a pick axe or twisting wrenches doesn't mean it's not work. Forget all those stupid ads for automatic systems where all you have to do is hit buy or sell when some blinky thing lights up. You have to stay current with the news, both financial and general, and watch the charts. Every day.

3. Avarice

Another classical sin, aka greed. Now it's well known that greed and its companion opposite, fear, are what make the market go round, but that's no reason for you to join in. You don't have to trade without emotion like some sort of financial Mr. Spock, but fear and greed will kill you eventually. Fear is what leads you to leave profits on the table or worse yet, get out at the bottom. Greed is what keeps you from getting out at the top so you end up watching all your profits evaporate. Buy low, sell high. Fear and greed are what make you do it the other way around. Try to replace fear with respect and greed with gratitude. You need to respect the power of the market and be grateful when it hands you money.

4. Undercapitalization

I don't think the importance of this is sufficiently appreciated. I think way too many people decide they're going to trade for a living and start off with tiny account, like $5000, figuring they'll parlay that sum into riches of Bill Gatesean proportions. Ain't gonna happen. Too little capital means you are limited in how much heat you can take, and unless you enter every single trade exactly at the bottom and then it goes straight up, you're going to have to suffer through some unrealized losses at some point. Insufficient capital leads you to take excessive risks to generate returns you might think are reasonable (but are usually just a dream). The net result is that your account blows up and you're done.

So how much capital do you need to start trading? Well the SEC says you need a minimum of $25,000 just to get in the game if you want to day trade. But that becomes your floor so you really need at least 10% more in order to have room to maneuver. Even if you don't want to day trade, I'd say $25K is the bare minimum, and that number won't make you a living.

I started my first account with the laughable sum of $2000 (back in the days before the pattern day trading rule) because I was afraid if I had more I'd lose it (see avarice and fear above). But that wasn't enough money to be successful, so naturally I blew it all up. I think it took about four months. As Jim Cramer always likes to say, "you've got to stay in the game".

5. Ignorance

When I first started trading, I knew nothing, and I got my head handed to me. The problem was that I'd read a few books, did a bit of paper trading, and thought I had it all figured out. Bzzzt! After 10 years, I'm willing to admit that I now at least know what I don't know. But I'm far from an expert. Trading is a performance art, like skiing or playing the piano. To get good at it, you have to constantly practice, study, and learn all you can (see "sloth" above). This was a recurring theme in Dr. Brett Steenbarger's late, lamented TraderFeed blog right here on Blogspot. I highly recommend reading that over.

You also need to keep meticulous records. You absolutely need to keep a trading diary and a performance spreadsheet. Track everything. If you don't know what you're doing, you can't tell how well you're doing.

If you don't have the time or inclination for this, forget about trading. You're going up against armies of people who are smarter, stronger, and richer than you'll ever be. You don't show up to a gun fight with a knife. Don't trade until you are properly armed with a solid plan and all the time and capital you need to execute it.

6. Hubris

Oh my, another one of the classics. The sin of pride. If something doesn't go your way, just take your lumps and move on. The market is excellent at sniffing out know-it-alls and teaching them lessons. Don't let your errors get you mad (see TWM below). Revenge trading is about the worst thing you can do, and it is guaranteed you'll get your head handed to you.

7. Distraction

TWD - trading while distracted. And the results can be as deadly to your account as texting behind the wheel of your car can be to your life. You can't trade if there are kids screaming in the background, dogs barking, phones ringing, etc. You really have to concentrate. I have occasionally hit Buy when I meant Sell, or sold the wrong number of shares. This is the sort of behavior that ends with keyboards smashed on the table top and monitors thrown out the window. One time I even hit sell on the wrong row and accidentally sold one of my cherished holdings. Oddly enough, that stock tanked shortly afterwards proving once again that it's better to be lucky than good.

Also, obviously don't commit TWI (trading while intoxicated), the other TWI (trading wile ill - if you have the flu, take a sick day), TWM (trading while mad - at your spouse, at the market, or at life in general), or TWS (trading while stupid - see "ignorance" above).

Well there you have it - the seven awful, scary things you should never ever do when trading. Avoid these errors and you'll be a lot better off. I know. Happy trading!

Friday, October 29, 2010

October Monthly Review

Whew! October is finally over and despite its spooky reputation, we managed to escape pretty much unscathed. Since the month is over, we're going to take a series of progressively larger views to try and figure out what to expect next month.

Let's start by zooming in on the last few days of the action in the Dow, which proved to be most interesting. Yesterday, I called an end to the uptrend and started a new descending RTC line. Here is is. You can see that today's action took us to the right edge of the channel, since it's so steep, but I wouldn't really call it a bullish setup. Conceivably, Monday could mark the end of this short downtrend and in fact, today's narrow range doji suggests further indecision. However, I think we remain inside this new downtrend for the time being. I note also that historically, the first trading day of November is not so hot.

Pulling out to the weekly chart, this week's downturn barely registers and the whole week simply forms a doji candle, but that in iself, coupled with the highly overbought readings on all the indicators is enough to suggest a reversal. Compare the recent runup to the one last spring. There's a striking similarity there. So if the daily chart suggests the possibility of a limited downside, the weekly chart looks considerably weaker.

And since today also marks the end of the month, we might as well look at the monthly chart. As a swing trader I don't do this very often, but it can be quite instructive for strategic planning. Check it out:

Here's four whole years of the Dow, a month at a time. The whole sickening slide from the 2007 highs to the March 2009 lows and the bounce back. In this view, the troubles of the summer of 2010 look more like a stumble than a bear market and the indicators aren't overbought at all. This longer term view suggests considerable upside remains in the market. Note also that we will soon be entering a pre-presidential election year and that these historically significantly outperform other years in the four year election cycle.

So where does this all leave us? I'll be looking for a limited decline on Monday and Tuesday in anticipation of the election. I'm still betting we'll see a gain on Wednesday based on election results that may be given up by the end of the week. But I think the month as a whole will end higher. November is traditionally a good month and I'm not hearing enough bad economic news to warrant any major declines at this point. We'll see.


The Dow ended up today a paltry 4.5 points. I was down 0.12% on the day, down 0.09% on the week but still up a respectable 1.32% on the month, compared to the Dow's 3.04% gain for the month. Though it's disappointing to have underperformed the Dow on a monthly basis, this still leaves me 21.82% up YTD, compared to the Dow which is up only 6.62%, so I can't complain. My little low price/high yield sub-portfolio continues to do well, gaining from 0.22% to 2.57% today, with the exception of AOD that lost 0.71%. However, all are still in a profit position, even though I'm only owning them for the dividend.

Today, I added a new name to it: DHY, Credit Suisse High Yield Bond Fund, buying an experimental 200 shares at 2.94. It closed at 2.92. It's trading at the lower end of its recent range and looks poised to go higher next week. It is currently yielding an attractive 10.89%.

I did not take any short positions today but I'm also holding cash in reserve. I see a number of names that are becoming more attractive lately, but not enough to pull the trigger just yet. And I'm wishing I'd execercised a bit more patience and held on to my AUY from the beginning of hte week. Oh well.

It's Over

Finally. It's official - the uptrend is over. We have now (finally) broken the RTC daily uptrend in the Dow extending back to the end of August. Tuesday's doji was the top, yesterday was the bearish setup and today's 12 point decline, finishing well below the lower RTC line was the trigger. I think we can now look forward to at least a few days of lower prices. There are several minor support levels on the way down, corresponding to the steps the Dow took on the way up - at 10,970 and 10,825. The lower Bollinger band stands nearby at 10,820, suggesting a possible stopping point. Then there's a stronger support level at 10,685, corresponding to the August highs.

This is followed by the 50% Fibonnaci retracement level at 10,571, a 5% correction at 10,558, and the 200 day MA at 10,525. The close proximity of those three numbers suggest strong support there too. In the meantime, we will now start charting a new descending RTC channel starting from two days ago and watching for an upward break out of it. My guess would be that might happen next Wednesday, the first trading day after Election Day. I know everyone says the election results are already "baked in", but I do think the immediate realization of a Republican victory should provide at least a temporary bounce to the markets.

Finally I note that the excllent Quantifiable Edges blog here did a historical analysis today and reached the conclusion that "the stats seem to suggest a possible downside edge over the next 1-3 days." We'll see.

I made no trades today. I'm now over 50% in cash and considering taking a position in SDS tomorrow as a short proxy. I'm also pleased to see that AMD, which I mentioned on Monday when it closed at 7.26, was up 3.81% today on a lackluster day overall to close at 7.63.

Wednesday, October 27, 2010

A puzzler

OK, here's today's action in the Dow. I have to say, I'm stumped. You tell me what this means. The Dow closed dead on the lower RTC line, exactly where it did on October 19th. And the next day, the Dow rallied furiously. However, unlike then, today's candle is a classic Hanging Man and that's never a good sign. On the other hand, the rally off the lows at 1:20 PM suggest an absence of true selling pressure. We actually had more extreme high TICK readings today than lows.

So we have a bearish setup but not a trigger. In a way, it's simple. If the Dow is lower tomorrow or fails to close above 11,175. then we have a sell signal. Otherwise,we cannot really say the trend is broken. Which way will it go? Who knows.

I'm playing it safe. No trades today but I have also not yet gone short. I'm waiting for some confirmation that we're headed lower and I'm willing to take the heat until I get it. However, I do have to say that intuitively, I think the uptrend is over.

Waiting for Godot

I swear, waiting for the end of this uptrend is like waiting for Godot. Every time I think the turn is at hand, it isn't. Even today's meager five point advance in the Dow still kept us inside the rising daily RTC channel. However we are now in the lower half of the channel, and have been there for the last six sessions straight, as opposed to the entire earlier segment of the current uptrend. A decline tomorrow of just 25 points will cause a trend reversal setup once again, like we got on the 19th.

But that one did not trigger and if the market falls tomorrow, I'd need to see a second day of declines to declare it time to go short. But for now, I still can't go short.

In the meantime, today's action formed a long doji candle, indicating the considerable uncertainty in the market. The resistance of the April highs continues to be formidable. No doubt many of the people who rode the summer roller coaster from there all the way to the bottom on July 2nd are just so glad to finally have made back their losses that they're cutting and running.

So what to do? I'm mostly just sitting back and watching right now. I did sell my position in SD today at 5.76; it closed at 5.66. It's RTC does not quite indicate it's time to sell, but all the rest of the indicators do. I also bought some more CIM at 4.08 after it took a 5.58% dive on a 2 cent miss; that closed at 4.06. But those are just tiny trades. I want to see how tomorrow pans out before doing much else. For what it's worth, the ES futures are not looking too happy right now (1:15 AM), down 525 after having been up by 575 earlier this evening. Patience is the key.

Tuesday, October 26, 2010

Still no downturn

Today's 34 point gain in the Dow kept us inside the rising RTC channel, but the small size of the increase moved us closer to the lower edge. In fact the last nine sessions have more or less been just consolidation rather than consistent gains. We're really just stuck at April resistance level of 11,200. Upwards from there, there's no meaningful resistance until 11,500 which is the "summer shelf" going way back to 2008.

In the meantime I'm hearing a lot of conflicting opinions on how much further this rally has to go. There's a lot of noise about how a Republican victory is now "baked into" the market and won't do much to help the rally. My personal feeling is that this is wrong. I expect the market to post some significant gains, at least short term, following the elections. It just might be the push to get us through the 11,200 level.

But for the time being, one just has to sit tight and watch the RTC. And there is still no sell signal there.

Political Aside

Personally, I don't think it's going to make much difference who wins. As far as I'm concerned, the Demicans and the Republicrats are just two sides of the same tarnished coin. Our choice at the polls is basically a choice between Jack L. Johnson and John L. Jackson. To quote those astute political analysts, The Who, "Meet the new boss, same as the old boss". Even worse, nearly half the races on our own local ballot are going completely uncontested this year. We have become like the old Soviet Union - one party, no choice.


I got tired of waiting for AUY to perform and dumped it today for a whopping 2 cent profit. It's just floundering around right now and I'm out of patience. See ya.

I could find nothing else to replace it with but I did notice something interesting in AMD. Check out this daily chart. Notice how on September 27th, AMD broke out of a declining RTC going all the way back to April and has been in a horizontal channel since then. It made two attempts, one last month and one this month to top 7.46. After that double top and a 5.37% gain today, it seems like it's about to make another run at it.

But here's the interesting part. Note how the indicators now are much less overbought than the last run (blue arrow). There has also apparently been a lot of call action in AMD recently on news of some new product (from a tehnical analysis point of view, it doesn't even matter what this product is). I think AMD could be poised to break out on this attempt. Note also the increased volume. I'll bet something's up here. Disclaimer - I am long AMD (though still underwater).