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~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ 4 October 2006 Table of Contents (1) Quote on Fear (2) Article - The Problem with Selling - Part 2 (3) Trading Plan Workshop (4) ATAA Presentation - Melbourne - 26 October 2006 (5) Website Update ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Stay up to date with all that is happening at Trading Plan, by subscribing to our 'Trading Blog' (no email address necessary). I am continually adding content and every update of this site is announced here, including minor content updates, page additions, and product releases. So stay plugged in by subscribing to this site's RSS feed. Copy and paste the address below into your RSS reader to receive the Trading Plan RSS feed... http://www.trading-plan.com/Trading-Plan.xml Not sure what RSS is? ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Previous Issues Only just joined the mailing list? That's OK - you can read all of the previous issues of the Trading-Plan ezine. Visit http://www.trading-plan.com/ezines_previous.html to access the archive. ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Online Trading Forum Do you want to learn from the experiences of others in a friendly online trading forum? I now frequent and contribute to the online trading forum called Stock Meeting Place. Membership is easy and free. You can come along and ask any trading question in one of the numerous sections of the forum and receive a helpful response from one of the many members (approximately 2000). This forum is the only place online where you will also find Daryl Guppy, the well known trader and author. Remember, there is no such thing as a silly question so visit, sign up and ask a question. Visit http://www.trading-plan.com/trading_forum.html for more information. ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ -- 1 -- Quote on Fear "I have learned over the years that when one's mind is made up, this diminishes fear; knowing what must be done does away with fear." Rosa Parks (1913 - 2005). -- 2 -- The Problem with Selling - Part 2 Pressure from Ourselves ‘We have met the enemy and he is us’, The Need for Control We have looked at some emotional conditions which cause difficulties with selling, but there are two particular attitudes for which all investors seem to be hard-wired. The first is the need ‘to be in control’. The reason why Tattslotto quickly supplanted the purchase of ordinary lottery tickets was that lotto systems enabled the purchaser to choose their own numbers. While this does virtually nothing to improve the odds of winning, the gambler feels that he or she now has some control over the process. The same attitude prevails in most forms of gambling in which, through a variety of (usually meaningless) beliefs, objects or actions, the punter feels that they are somehow able to control the outcome. When operating in the share market, in which there are never any guarantees, the investor or trader looks for similar mechanisms which they believe will provide them with the necessary control. These range from astrological signs (Gann), generalised theories of market behaviour (Elliott, Dow, MPT, Black-Scholes, random walks and others), pundits and gurus (Buffett, Graham, Tharp, Guppy, Bedford and hundreds more), computer-generated indicators (probably thousands) and many, many others. This is not to say that these mechanisms aren’t useful (except perhaps astrology!) but that they do not of themselves provide any control over outcomes. In the last analysis, the investor is completely responsible for his own decisions, his own rules and his own discipline to take action to limit the moves of the market against him. This is again the use of the SL and the discipline to take action. The Need to be Right The second attitude is the need ‘to be right’. There is a natural human tendency to want the majority of attempts at anything to result in success. We all want to be right more often than we are wrong. For many of us it was this attitude to life which, over time, enabled us to succeed financially and acquire enough capital to be able to either invest or trade. We made more right decisions than wrong ones when faced with our share of life’s vicissitudes. So when we choose a share, we want our choice to be right. To see it go against us, and have to sell it, will prove us ‘wrong’. And as we don’t like to be wrong, we don’t like to sell. However, trading or investing in the market, is (surprise!) different. If our winning number of positions is, say, 40%, our losing positions represent 60% of our trading or investing effort. Instinctively, most people would discount the possibility that this series of trades could be profitable. After all, we are losing more often than we win. What this fails to account for is the size of the typical win and the size of the typical loss. Suppose that for each position we take that goes in our favour, we make $1500 and every time a position goes against us and we sell, we lose $500. In this case, a 40% win rate is more than sufficient to bring in impressive profits. As counter-intuitive as it may seem, while most of our trades are losers, the average trade in this example results in a profit of $300. This figure is determined a simple arithmetical formula, and is known as ‘expectancy’ (further discussion on expectancy is outside the scope of this paper, although we will return to it briefly later). You don’t have to be right more times than you are wrong. You can be wrong many more times than you are right and still be a winner by keeping your losses small (though many of them) and letting your (few) big winners run. This is the exact opposite of the disposition effect, and is one of the more difficult perceptions for investors and traders to come to terms with. Unfortunately, many investors and traders want to be right far more than they want to be profitable. It is ironic that many professional advisors of one type or another are also most subject to both the ‘need for control’ and the ‘need to be right’ syndrome. To convince both their prospective and existing clients (and themselves), they talk a good talk which demonstrates that they are somehow in control of market events, and strongly push the line that ‘buy and hold’ is the safest possible course – usually citing Warren Buffett. And, of course, it probably is for them as, inter alia, it obviates having to recommend a sell and thus to be proven ‘wrong’. Becoming Better Investors ‘Never buy at the bottom, and always sell too soon’ Possible Actions Warren Buffett or not, while ‘buy and hold’ (also known as BHP, or buy, hold and pray) is possibly the best tactic for some – e.g. superannuants in the distribution phase – it is an inefficient application of capital for those SMSF investors who are still accumulating. They usually need to make their money work as hard as possible; to ‘sweat their capital’, consistent with effective risk management. They can best do that by determinedly and quickly selling out of positions that move against them and taking another position in something else. As an expression has it, ‘You must learn to be wrong, fast!’. This requires an intelligent application of the SL. The use of the SL has to be axiomatic. Even a poor SL is better than none. My portfolio management software won’t accept an entry unless the price-paid is accompanied by a SL figure. If you feel uncertain about setting stop losses, read up on the subject and try different approaches until you get comfortable with at least one method. As you gain confidence, you will be more inclined to manage the trade closely until you decide to close it. This may be well before it hits your SL, and there are a number of techniques to achieve this effectively. However, you must be willing to pull the trigger when necessary, and to accept any loss that goes with this. These losses can be regarded simply as one of the overheads (like brokerage) that you have to meet with trading or investing. Another technique includes recording and analysing your emotions if you find that you are having difficulty in selling when you should. The Motley Fools recommend putting all sold stocks in a separate folder and re-visiting them after three months. The Fools then award notional gradings on their subsequent performance relative to the major index. This not only treats the matter lightly but provides an indication as to how well or otherwise their overall stock picks have run, and to also avoid the mental accounting effect. A Better Way While these actions should alleviate the problem, if you have a reasonable amount of experience in the market, a more satisfactory approach is to cut through the clutter of conflicting information and pressures and (if you have not done so previously) ascertain your personal market philosophy. Each one of us should strive to determine a set of core beliefs; a coherent way of thinking on how we each personally believe the market operates. It doesn’t matter if others agree or disagree with our conclusions, it is about our belief in what the market is and what it offers as it affects us individually. An example. For some time, I could not make up my mind as to whether I was an investor or a trader. I had always assumed that the length of time that a stock was held was the determinant. However, I saw a definition which indicated that intent is the difference. An investor buys an item with the intention of holding it ‘forever’ with no intention of ever selling it e.g. a beach house, artworks, companies and value stocks (the Buffett/Graham approach). A trader buys shares with the intention of selling it at some time in the future. Therefore, I am a trader. A core belief for me now is that I buy a stock solely to sell it later, even if this is years later. As buying and selling are now either side of the same coin for me, I have no problems with selling. This simple difference focussed my attitude to charting and fundamental analysis and other considerations to create an integrated trading strategy. I have now defined my core beliefs – there are only eight – and engage with the market accordingly. Do you agree with the definition of trading above? It doesn’t matter whether you do or not. The point is that it is my belief and it helps me. If you can define your own core beliefs, it will similarly assist you. If you lack a philosophy (‘a rudder’) you will be continuing prey for buying pressures, conflicting strategies and arguments, as well as the charlatans and pretenders, which each claiming to have a ‘magic bullet’ to beat the market. You may also care to further investigate the vital importance of money management in trading and investing and become more familiar with the notions of positive expectancy, risk-based management and the range of position-sizing methods. You need to have a reasonable number of trades behind you (around 30) to provide statistical validity, but it will greatly assist your longer-term profitability. Owen Richards is a member of the Australian Investors Association (www.investors.asn.au) and this article first appeared in the AIA Equities Bulletin in May 2006.
-- 3 -- Trading Plan Workshop With anything in life, preparation is a key to success. Trading is no exception and time spent on developing your trading plan is time and effort well invested. "Give me six hours to chop down a tree and I will spend the first four sharpening the axe." The Trading Plan Workshop - an online course which leads you through the mindset, money and method to develop a trading plan - a must if you want trade profitably over the long term. "The questions so far tackled seem to be of paramount importance to a successful trading future. I am very happy with the material so far covered." In 'The New Market Wizards' by Jack Schwager, Howard Seidler said it best when he stated, "In regards to being successful in the markets, I think the single most important element is having a plan." This course goes for almost 3 months with over 40 messages sent every two days. You are able to send me your answers along the way for a personal review and comments. At $197 USD, this is most likely less than your next losing trade. I have been humbled by and appreciative of the comments I have received from people working through it, which include: "There is an absence of hype. In working through it there is a sense of integrity; one of its biggest appeals for me is that there are no outlandish claims. It takes a practical commonsense approach, carefully explaining every step along the way; providing sufficient links to provide greater detail and explanation on the major concepts and topics." "Indecision, fear, lack of confidence & so on; you have named them all & in your workshop plan have set forth means of rectifying them." "This workshop is not about any GRQ scheme - as far from it as you can get actually. What it does is teaches you the most important aspects that will allow you to survive and then thrive in the markets." Please visit http://www.trading-plan.com/trading_plan_workshop.html for more information. -- 4 -- ATAA Presentation - Melbourne - 26 October 2006 I will be presenting at the monthly Australian Technical Analysts Association meeting in Melbourne on 26 October 2006. The topic of my presentation will be 'Developing a Trading Plan', and further details are available at www.ataa.com.au This is available to members only, however non-members are invited to attend a monthly meeting before joining - with no obligation to join. -- 5 -- Website Update Over the last couple of weeks new information has been added on trading options. Visit http://www.trading-plan.com/options_general.html to view the new options section. If there is anything you want to learn about specifically with regards to trading, do not hesitate to contact me. Contact details are at http://www.trading-plan.com/contact_us.html ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
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