The Intelligent Investor

BSE Sensex: (12962) the market cracked once again as expected and came down towards our target of 12787…looks like our target will be achieved as the market is not giving any signs of holding out.

The target for the Sensex is 12787-12434 and resistance to the up move at 13240. NSE Nifty: (3897) the support for the Nifty is at 3698 and resistance to the up move at 4000.

              

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The major averages finished mixed and the DJIA closed out the month with the worst performance for June in 78 years.

Stocks rallied early on some encouraging economic news, the June Chicago purchasing manager index was reported at 49.6, just shy of the 50 level, which indicates expanding manufacturing activity.

Helping the rally was oil prices pulling back to unchanged after being up as much as $3.50 a barrel and a knee-jerk bounce into the oversold market conditions.

The Dow was up as much as 90.80 points, but the breadth was very narrow and volume was light all session. The financial sector, especially banks and brokers were under attack the entire session.

The Dow finished +3.50, the S&P 500 +1.62 and the NASDAQ was under pressure, closing down almost 1%, as tech stocks came under attack in the afternoon. Selling accelerated late in the session and NYSE issues finished 3/2 negative and NASDAQ issues 2/1 negative.

The problems of the market are well known and many stocks have been beaten down. We do believe a tradable bottom is close in time and price, but probably not at the moment.

Today - Foreign markets were lower overnight. Stock futures are indicating a solidly lower opening after oil rose almost $2.50 a barrel after the International Energy Agency revived concerns about long-term supply shortages and tension between Israel and Iran raised fears about possible outages in the near term.

              

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Below we have listed a few common investor mistakes. Try to avoid making these mistakes with your investments.

1.
Falling in love with a position. An account has limited capital, so ask yourself if the position is the best one to be in here. Are you tying up capital that can be put to better use elsewhere? Don’t get sucked into the fundamental story—that is, don’t hold on to a stock whose technical picture has deteriorated just because you are intoxicated with the reasons for your choice.

2.
Buying the stock right, but forgetting to sell it right. There are two foul shots to make successfully with respect to investing. You must buy the stock right, and then you must sell the stock correctly. Therefore, once you buy a stock in stock market you must review it on a regular basis; don’t just forget about it. Attempt to sink both foul shots.

3.
Not having a game plan for investing. Investors will haphazardly, especially in a strong market, pick stocks to buy, thinking that the stock market is easy to beat. They fail to realize there is risk, not only reward. Therefore, it is essential to have a game plan that helps dictate what stocks to buy and when, and also tells you when to sell or play defense.

4.
Buying stocks that are extended. When you buy a stock that is up on a stem, it increases your risk and diminishes your potential reward. Rather, it is best to buy a stock when it pulls back closer to support, thereby increasing the potential upside reward, and diminishing the risk to the stop-loss point.

5.
Taking small gains, but not being willing to take small losses. Be willing to take small losses by adhering to your stop-loss points. Avoiding large losses will keep you in the game. You will not be right on every trade, so be willing to bail out and take the small loss when the technical picture so dictates.

6.
Buying a stock that is trending down, thinking that it is cheap, or a value. Often, these types of stocks become an even better value because they continue to fall in price. Ideally, it is best to stick to stocks that are in an overall uptrend, trading above their bullish support line and exhibiting positive relative strength. These are the stocks that are in demand and should be considered for purchase.

7.
Acting on poor advice, stock trading tips, and financial media hype. Many investors try to get rich quick without doing their homework. They rely on the TV or financial media to tell them what to buy. Instead, take the time to educate yourself, to arm yourself with a game plan. Then you will be able to make sound, informed decisions. Take responsibility for your own success. Don’t rely on get-rich-quick schemes and rumors. Do your own research.

8.
Getting emotional and not being able to stay objective. Any investor knows that emotions can be your worst enemy. Try to stay objective. The point and figure chart helps you accomplish this because a picture paints a thousand words. When looking at the chart, cover up the name of the stock. Make your decision on what the chart is telling you, therefore taking the emotion out of knowing the name of the stock.

              

Filed under: Trading Articles | 3 Comments »

After you have found a profitable stock trading system that you already back tested, how can you be sure that this system will produce the same gains in future?

Nobody can predict the future, your system can easily make losses in next years or can be no tradable.

There are some tests you must do before accepting a stock trading system, these tests swill show the robustness of your system and when passing these tests, it will be more likely to show gain in future.

Test 1

Make sure that you put liquidity rule, that your entry and exit prices are realizable.

Test 2

Examine again your stock trading systems and your rules (This is very important).
I made dozen of stock trading systems that showed great results but after more examination, it showed that i cannot follow them in real life.

Check if there is one stock that made very big gain, the system will maybe become no profitable without this stock.

Test 3

Change twice or 3 times the date of begin for the simulation, if it still show good results then it has passed the test 3.

Test 4

Change values of some parameters or variables you have in your trading system rules, you must change one value and then back-test, change another and then back-test.
If the results are not affected very badly then it passed the test 4.

Test 5

Try to restrict the system from buying 20% or more of stocks you previously bought when doing the back-test. Then re-run the back-test. To pass this test, system must show pretty the same results as before.

Test 6

Equity chart must have a good look, check some statistic values like sharpe ratio, sortino ratio, standard deviation, maximum drawdown, average day for gains recovery.

It depends on the risk you are willing to take but choose only stock trading systems that have higher sharpe ratio, higher sortino ratio, lower standard deviation, lower maximum drawdown.

Exclude systems that have very big max drawdown, standard deviation and average day for gains recovery.

The must important factor i think is average day for gains recovery. Its the average number of day that you must wait until your equity value will goes back to the same level before the drawdown happen.

Big values will let you wait for long times before recovering gains and for sure many traders will abandon their stock trading system, and thats the worse thing that can happen to a trader because just after that, the system will show excellent results. (Thats always happen)

Theses tests are very restrictive and you will reject maybe all your stock trading systems, but when stock trading you will put your money, real money, so i think you must be very selective to make all chance in your side.

              

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Most stocks are traded on exchanges, which are places where buyers and sellers meet and decide on a price. Some exchanges are physical locations where transactions are carried out on a trading floor. You’ve probably seen pictures of a trading floor, in which traders are wildly throwing their arms up, waving, yelling, and signaling to each other.

The other type of exchange is a virtual kind, composed of a network of computers where trades are made electronically. The purpose of a stock market is to facilitate the exchange of securities between buyers and sellers, thus reducing the risks of investing. Just imagine how difficult it would be to sell shares if you had to call around the neighborhood trying to find a buyer.

Really, a stock market is nothing more than a super-sophisticated farmers market linking buyers and sellers.

Before we go on, we should distinguish between the “primary” market and the “secondary” market. The primary market is where securities are created while, in the secondary market, investors trade previously-issued securities without the involvement of the issuing-companies.

The secondary market is what people are referring to when they talk about “the stock market.” It is important to understand that the trading of a company’s stock does not directly involve that company. To learn more about this, see our article entitled “Where Securities Are Traded.”

The New York Stock Exchange

The most prestigious exchange in the world is the New York Stock Exchange (NYSE). The NYSE is the first type of exchange, where much of the trading is done face-to-face on a trading floor. This is also referred to as a “listed” exchange. Orders come in through brokerage firms that are members of the exchange and flow down to floor brokers who go to a specific spot on the floor where the stock trades.

At this location, known as the stock trading post, there is a specific person known as the “specialist” whose job is to match buyers and sellers. Prices are determined using an auction method:

The current price is the highest amount any buyer is willing to pay and the lowest price at which someone is willing to sell. Once a trade has been made, the details are sent back to the brokerage firm, who then notifies the investor who placed the order. Although there is human contact in this process, don’t think that the NYSE is still in the Stone Age; computers do play a huge role in the process.

              

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Let me share a story with you -

This story is about two young men. Both of them graduated from the college on the same day. Both of them have a passion towards stock trading, both were intelligent, both of them were full of aspirations and wanted to become successful in the stock market.

Both of them started trading at the same time. They started trading with same capital, same type of trading software and tools along with the same type of trading system with the precise rules for entry and exit.

But after one month, there was a difference in the amount they have earned during that month trading stocks. After one month, one trader gone broke and other returned with 25% returns on his investment.

Any guess work??? What makes this kind of difference in their trading results? Do winning traders have some special talent

              

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It is said that stock trading is 85% psychological and 15% methodological. Does this then imply that regardless of Stock trading method, a trader that has control over their emotional issues will thus be a profitable trader, or will it be impossible to ever control emotions without the proficient implementation of method? The stock trading method point will suggest that not only are these statistics not the case - trading psychology does not exist.

Trading method will be the determinant of profitability, and this will be done through -

- the ability to understand the methods inherent strengths and weaknesses

- the ability to maximize these strengths and minimize the weaknesses.

Viewpoint OF Trading Method

Stock trading psychology has become so widely discussed and promoted through consultants and books that it has become a very convenient rationalization and excuse for losing. Why take the responsibility for a lack of work ethic and stock trading without any concept of plan, an honest assessment which would be a hit on the traders self-esteem when you can just blame it on trading psychology instead?

Stock trading psychology - that a trader creates from existing personality traits that are not initially related to trading, but surface from trading without method understanding. The outcome of course is fear, but wouldn’t this be the case when doing anything that was perceived as dangerous, and which was being done without the necessary understanding and skills?

Trading, with its inherent characteristic of accepting financial risk while participating in unknown outcomes, is certainly dangerous, and thus the more preparation and understanding that is needed.

Trading Scenario

Consider the a trading plan which has the following three setup types -

- initial which your intended trade entry

- first continuation which is used to enter a trade in case you have either missed your initial entry, or you decided that you wanted more confirmation because it was a counter direction trade

- second continuation which is intended as a trade addon setup, but is also one last chance to enter a trade.

You get an initial sell setup that triggers, but you do not take the trade = trade1.

The trade breaks cleanly and goes to what would have resulted in a partial profit, and then before price goes down further, it retraces back to the area where the sell was done. This price holds so the swing remains short, and from this hold of what is now resistance, you get the trigger of your first continuation setup.

BUT you don’t take this trade either = trade2.

Why wasn’t the trade taken? You decide that after missing the initial entry that you have missed the trade, your emotions and biases tell you that the move has gone too far. Again, this trade breaks cleanly, not only adding to the gains of trade1, but also giving a partial profit on trade2.

Price now consolidates between the lows and the price resistance that you would typically be using to stay short if you had taken either the initial trade, or the first continuation trade.

Instead of the swing reversing after consolidating, it continues down again, and with this continuation your second continuation setup triggers = trade3.

AND AGAIN - you dont take the trade. After all, if you didnt take either of the first two trades, how can you possibly take this trade; maybe you were wrong when you thought that the move had gone too far to take trade2, but certainly thats the case for trader3.

              

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Remove the loser and keep the winner

For many it is worse than having a tooth pulled to sell a stock for a price lower than what they paid for it. If you buy a stock for $20 and it drops to $10, so long as you don’t sell, then it can be referred to as an unrealized loss. In this case you can say to your spouse, Don’t worry, dear. It’s going to come back. Similarly, many can’t wait to sell as soon as they can see daylight between the purchase price and the current price. If the price has gone up be a few dollars, they want to sell and lock in the profit.

We referred to this as watering the weeds and pulling up the flowers. They are examples of what I call investor diseases. The disease of holding on to your losers I call get-evenitis. The disease of selling winners I call consolidatus profitus. We found that people tended to trade out of winners into stocks that performed less well. In the opposite direction, the study showed that the losers in their portfolio tended to continue to under perform. It was really the case that once a loser, always a loser.

We found that people would have been better to sell their losers and keep their winners. Instead, they did the opposite, namely keep their losers and sell their
winners.

Suppose two simple changes were made: the investors sold their losers and held on to their winners. On average, the study showed that their average annual performance would have gone up by almost five percent per year.

The difference between the two strategies is even more marked when taxes are taken into account. When you claim a loss you are getting a tax rebate and so you want this as early as possible. In contrast, with a profit you are paying tax so you want to delay this as long as possible. But, as we just learned, the average investor tends to take profits early and losses late ending up on the wrong side of the taxman.

This gives us confirmation of secret number eight: Remove the looser and keep the winner not the other way around. Of course, this is an oversimplification. There are times when it is better to keep a stock when the price has gone down. In fact, it may well make sense to buy more. At other times, it is better to sell a stock after it has gone up. Each case has to be treated on its own merits.

This leads to the question. Just when should you sell? A large survey carried out by the Australian Stock Exchange showed that investors found it much harder to know when to sell than when to buy. Similar results were found in a survey of nearly 300 investors that I carried out. Almost 50 percent said that they either regularly worry or constantly worry about when to sell their stocks.

The general rule which is full of common sense is - Sell only when you can be very confident that you can do significantly better with your money in another stock. The problem is to be able to determine when this is the case.

              

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