President Obama, U.S. Dollar and Stocks

Knowing that I risk alienating a fair amount of my readership with this statement I will go ahead and say it anyway. Yes We Can! Yes We Did! GOBAMA!

Also, although I rarely give my opinion on macro economics I will indulge myself here and talk a little bit about what I see as some potential impacts of the new presidency on the U.S. dollar and stock markets.

Right now, we are in a bear market (for stocks and bull for U.S. $ and Yen) as Jesse Livermore would say. The new presidency won't change that. However, what we will likely see in the near term for the dollar is a second test of the highs and either a bounce or continuation. My guess is that at least for the short-term we haven't seen the final high yet for the U.S. (or for the Yen for that matter). Why you ask? There are a number of reasons, but most importantly I think there has been a long-term overvaluation of the Euro that is now being questioned world-wide as we see banks struggle in Europe as well as the U.S. So why is the U.S $ benefiting from this? Although people have not held much esteem in recent years for the $ they do for U.S. treasuries. The recent strength of the Yen has been much discussed and again there are many reasons for this most notably the unwinding of the carry trade.

So what about U.S. and worldwide stocks? As I said earlier, we are in a bear market. Even Mr. Change Obama can't fix that. Although he and Bernake will try their darnest. What I see for stocks right now is that we are bouncing off the lows (looking at the DJIA) in a retracement. Why a retracement and not a recovery? Why son, this is a Bear market like I told you. It ain't over yet. Also, if you look at the two times that we tested the lows of around 8000 it was on relatively light volume. I want to see that there are truly no more sellers in the market before I'm convinced we've come anywhere near the bottom.

We've talked a lot about the short-term implications of our new President on the markets and now its time for some real speculation :) Our new president, despite some concerns, appears to be a rational man willing to listen to both sides of the parties. His economic policies are largely centered around helping the middle class to get back on their feet (something we haven't seen in awhile). At the same time he's shown that he supports protecting big business as well by supporting the bailout. What is more important than his policies is how he makes people feel. The middle class and poor have felt left out of the loop for the last 8 years (at least that's how the polls speak in my mind). This is also the largest and most important group of consumers. Regaining their confidence and ensuring their sense of security is something Obama has shown a great capacity for. Since consumer confidence is the key consumer spending and hence the health of the markets, it is my belief that the new president will help setup the next bull market in stocks. That being said - this is a bear market, son. And its going to take at least 3 to 4 years before we see any sort of real change for the marketplace.

LT

Lessons from "Reminiscences of a Stock Operator"

This morning I received a copy of the typical "Doom and Gloom" article that has been floating around recently from a fellow friend and trader. The article was filled with the typical economist bleating regarding how we are going to enter a prolonged economic contraction (i.e. another Great Depression) etc., etc. and that the world has never experienced the level of greed that we have seen in recent years on Wall Street and that the world as we know it will end.

Good grief people! Read your history. Just this morning I was re-reading "Reminiscences of a Stock Operator" by Edwin Lefevre for about the 100th time. Why? Because there is nothing new under the sun when it comes to the markets. It doesn't matter if the year is 2008 or 1908 or 1858.

A great example of this is when Livingston (a fictional character based on the true stock operator Livermore) is discussing his involvement with the manipulation of the Consolidated Stove stock. In this scenario, a number of uninteresting and not particularly profitable stove companies are consolidated into one stock to be marketed and hyped on the general market and sold for more than their current value. Gee, I say to myself, this sounds a lot like a CDO! And this type of activity was rampant in the 1920's bull market. Livermore also goes on about the weak moral fiber of his associates (not to mention his own sordid manipulation of the stock). Sounds just like Wall Street today, doesn't it!

So for all of you out there, including my good friend, please take heart. The more that the economists and general public are saying that this is the end of the world the more convinced I am this bear market (for stocks) is reaching the end of the line. We aren't there yet, in my humble opinion. I am still waiting to hear from the general masses that a) they will never buy stocks again, b) the U.S. will declare bankruptcy any minute. When I start hearing this type of talk "from the shoeshine boy" as Livingston would put it, then I will know that it is time to be a bull again. Until then, I continue to listen to the market, not the hype. I strongly suggest you do the same.

LT

Setting Trading Goals

After talking with many beginning traders, I've seen a common theme that often limits them from their full potential. Unrealistic or undefined goals.

Now one of the reasons for this is that most beginning traders want to make money the same way they do at their day job. Make $X per day, every day. Or they have a $500 account and want to turn it into $10k.

Well I'm here to tell you that the above situations aren't very realistic. Are they achievable? I won't argue that. But what I will say is that they aren't probable. And in trading that is the name of the game. Probability.

When I meet with traders beginning their trading path I tell them, look wouldn't you like to start with a challenging but achievable goal? Like beating the top CTA's in the world? And they say that sounds pretty tough. And I say yes, tough, but achievable. All you need to do is make 30% per year with a maximum intraday drawdown of no more than 25%. And these new traders look at me like I'm crazy. "30% is that all?" they say. No way they tell me. I want to make $500 a day or turn this $500 account into $10k. So I ask them, what type of drawdown do you intend to have while doing that? They look at me like a space alien, "drawdown, no I don't want any of that". So basically, they are telling me that they want to make like 2000% per year with a 0% intraday drawdown. Put in those terms it sounds pretty looney, right? But, seriously, this is what they tell me.

I am here to tell you that you need to start with realistic achievable goals. Imagine as a beginning golfer you tell yourself and others that not only do you want to beat Tiger Woods, but you want to beat him by a ratio of 100:1. And you want to do it every day, day in, and day out. You'd be a laughing stock. No one could possibly take you seriously.

I understand that most beginning traders are undercapitalized. I understand that you "need to make money now", but these are the very weaknesses that will destroy you. It isn't the market or the evil speculators doing it to you. It's you doing it to yourself. If you are undercapitalized the best thing you can do for yourself is to not trade until you are well capitalized. Go get a second job, save your pennies, or start a small business on the side. If you don't have the discipline and drive to make those things happen then you won't have the discipline and drive to stick through a bad trading month, or quarter, or year.

Do yourself a favor and set realistic trading goals and recognize that making money everyday isn't how this business works and that you aren't going to beat Tiger Woods by a ratio of 100:1.

LT

P.S. "Typically 3 months make my entire year. 3 months I lose, 6 months are small winners to breakeven. But those 3 months make it all worthwhile." Loosely paraphrased from Phil McGrew.

Waiting for the other shoe to drop...

After the last couple weeks I'm just waiting for the other shoe to drop. To give you an idea, a typical month for this trading method averages about 15-20% with these risk numbers. So we're a bit above the curve to say the least.

Paper Trading = Waste of Time?

Jules has recently posted an excellent thread regarding the controversy of paper trading vs. real trading. Too many times I have heard other traders state that simulated or paper trading is worthless.

Essentially, these folks are telling us that aspiring surgeons should just go operate on someone without dissecting a frog brain first. Or that an aspiring pilot should just hop on a 747 and learn while endangering hundreds of passengers. Or that an engineer shouldn’t prototype a new design of spacecraft. I think you get the point. Doing this sort of thing is madness.

And yet people really think that trading a live account with no defined edge and no experience will yield different results. That somehow these aspiring traders won’t blow up their account? What exactly are these folks thinking? I guess they aren’t.

Also, I would like to differentiate the people who utilize simulated and paper trading as a training tool and those who are playing around. Obviously anyone can cut open a dead frog. However, only in a training environment and with the proper dedication can one learn anything valuable out of cutting open a dead frog. If I just go in there and use a meat cleaver and don’t really identify what I’m cutting open and haven’t read my biology text book then I would learn exactly nothing. Similarly, I could go into a simulated account/paper account and trade at 100:1 leverage, average my losers and essentially “play around” with my paper account. This is significantly different than researching a definable, quantitative edge, challenging all of my assumptions, and testing that edge in a controlled and realistic environment while practicing sound money management and risk principles.

Lastly, I would like to state that yes there are definite differences between paper/simulated trading and live trading. Psychology does play a role. However, I don’t care if you have the psychological prowess of a Zen Master – if you can’t quantify and test what you are doing then you have no chance in trading well - None.

Given the recent economic climate, it should be pretty obvious that there are a lot of so called Masters of Wallstreet that do not know what they are doing. Maybe they should have done some realistic simulations/paper trading before taking their accounts live?

The Real Reason 95% of Traders Fail

You’ve all seen this statistics that are anecdotally given out at trading forums, seminars and the like. And I’ve always thought to myself, wow, is it really that bad? I mean I’m not that smart and I don’t work that hard that I should be in the top 5% right?

This Saturday I had an interesting discussion with a fellow trader who’s been successfully trading the markets for longer than I have. He told me that he’s had guys come to him for help before (having heard that he knows how to trade) and he will ask them to please read a certain trading book. The next time that person talks to him they tell him that they purchased the trading book and are reading it. And so he asks them, “Do you have the book right in front of you?” When they invariably say yes he says, “So on page 114 paragraph 2 what does it say?” 9 times out of 10 they log off IM and he never hears from them again.

To me this is an incredible story. The “average trader” doesn’t have the commitment to go purchase and read a book that is $15 and then has the audacity to lie about it. What does this say about the “average trader”? In my mind they are a total joke. No wonder 95% fail if this is the pool of “average traders” that exists. I mean how is that trader going to actually test a methodology if they can’t commit to something so simple? How will they ever endure the painful and psychologically debilitating process that is a prolonged drawdown? The answer, I believe, is that they cannot. And that is why 95% fail.

But for those of you who are capable of the blood, sweat, and tears that are required to learn about, create, and test trading systems I feel very confident that 95% of you will succeed. Where did I get this statistic from? I just made it up. But seriously, I have never met a trader that has done his homework for 3-5 years who hasn’t been successful. Thus, in my mind the only trader that I ever have to really compete against are the 5% that can actually do their homework.

For myself I have my own litmus test as to the longevity of a potential trader. Can you commit to testing your trading idea (either candle by candle, backtest, or forward test) for at least 60 trades? If you cannot do this simple exercise then quit now, for you will never succeed. If you can then congratulations! Welcome to the 5% club.

LT

Trading Wife

No I’m not trading in my wife. (She’s irreplaceable). She’s expressed an interest in learning to trade. All these years I thought she was absolutely uninterested in trading, but actually she was interested yet worried about taking over “my thing”. I guess I understand that. But trading isn’t exactly like a bachelor’s party…

So I’m having her start off learning the important things (many of which I did learn in the early years), without all the fluff and snake oil (which is almost impossible to avoid). I’m having her start with Forex because it was what I started with and because I still think in many ways it’s the easiest to trade (yes I’m sure some of you disagree with that statement). Also it has the advantage of having its best trading hours during the late P.M. early A.M. our time which is most conducive to her schedule (since she is still working during the day). We will split the trading duties into roughly 4 hour blocks and basically trade from about 12:00 a.m. our time to about 8:00 a.m.

We’re going to trade an old favorite of mine – Phil McGrew’s dots. And for the first time in a long time I’ll (actually we’ll) be able to trade on the 15 minute timeframe (which is what Phil himself trades). I’ve not been able to juggle this and trade other markets like the eminis so it had been put aside for the last couple years (which is too bad since it is a great methodology). I think this system will be a good one for her to learn on since it is not entirely mechanical or discretionary but a little bit of both. It’s mechanical enough that someone new to the markets isn’t overwhelmed with information, but discretionary enough to take advantage of intelligent insight.

So for the next 4-6 months I’m having her learn the basics plus get familiar with the dots (Phil has a wonderful 100 page + manual that I deeply admire). Also during that time I’ll have her start testing the system the same way I do (candle by candle) to gain confidence in trading it and understand how drawdowns work. After that we’ll have her start with a demo account for another 3 months to understand mechanical execution, and then we’ll start with a small account trading live and see where things go from there.

The best part about all of this? I can talk about trading with her now and not receive the glassy eyed look. Priceless :)

LT

PS The picture is of a week I traded the 15 min dots back in April 2006. Good then, still good now. That's a robust system IMHO.