Trading - Lessons from Stock Wizards

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graphrix_IHB

graphrix_IHB

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There has been a lot of discussion on trading here at the forums, and there is a certain mental aspect to it, which many fear. These are not tips for those who park there funds. BTW, there is nothing wrong with that, and that may be best for you. This is for those who do trade, daily, or at least often. The mental aspect of it can make, or break you. I have made many mistakes, and this list would have prevented many of them. So, <a href="http://bigpicture.typepad.com/comments/2007/11/lessons-from-st.html">here is Barry's list</a>.





I ordered <a href="http://www.amazon.com/gp/product/0066620597/104-9868463-2355906">Stock Market Wizards</a>, as well as <a href="http://www.amazon.com/gp/product/0735201447/104-9868463-2355906">Trading in the Zone</a>. It would be interesting to hear from others, who have read these books. Trading in the Zone, has been highly recommended to me by many respected traders, including IrvineRenter.





Even with having taken investment principles at the Stern school of business, there is nothing like reading from the street side of it.
 
graphrix et al.,



A few times over the past year and a half or so I've considered what it might be like if I concentrated fulltime on making a living as trader. Comparitively speaking, how disadvantaged is a person who doesn't have a statistical background with one who does? Or maybe a better question would be, what percentage of effort is spent performing heavy statistical analysis when developing a trading plan? Could a trader make a living making only a few trades per day or week? Finally, I wonder if my personality would be well suited to such endeavors. According to Myers-Briggs, I'm a text book INTP.



Thanks in advance for any sage advice and patience for the rapid fire questions.
 
Adam,





I have been trading for 8 years now. I have traded many different securities on many timeframes. I have come to the conclusion that trading is about 50% technical and 50% psychological, and if you don't have both, you will lose money. No amount of technical analysis can overcome psychological problems relating to money. There are people who are afraid to lose it, and there are people who are afraid to make it (I know that sounds crazy, but it is true). When your own money is on the line, it is very difficult to trade in a disciplined manner and stick to your trading plan. Also, there is no substitute for experience. The trick is not to lose all of your money while you are learning. You learn the markets through watching and trading, and in the process, you learn about yourself.
 
How do you get started? I mean don't you need something like $1M to make $100k per year (that's assuming you make 10%). Isn't it like the chicken and the egg?





Adam, I doubt you make more money trading your money than trading other's money.
 
My $0.02





98% of the time, no amount of "paper trading" will fully prepare a person for when his/her real money is on the line.





I've been trading a little stocks on the side for fun since 1990's, and I still have many of the psychological fear problems with having real money on the table. But since I limit myself to an amount that I could afford to lose, I don't blink too hard anymore when the stock dips by few grand.





Look at it this way, buying stocks is usually a better bet than playing slot machines. Yet people don't think twice before they pour dollars into the one arm bandit. Yet when they hold a stock that dips by 20%, they panic and sell. It's all mental.
 
I agree with Irvinerenter. I have also been trading for about 8 years. I started in 99, made 500% like everyone else, then lost it all. That was the best education I could've ever had.



There's no system or books that will teach you how to trade successfully. You just have to go out and watch the market, learn how the market reacts to different situations and how YOU react to situations(especially when you are losing money). Some people will get better as time goes on, but most will go bankrupt. My advice is, if you don't have a large bankroll, and you have a good job, don't bother trading. It's a tough way to make a living.
 
A futures floor trader friend of mine once had to teach a class, and I sat in on it. He mentioned 5 things (2 of which I forgot):





#1 - never bet the farm. as long as you're in the game, you can come back.


#2 - accept losses as an integral part of trading.


#3 - stay disciplined to your trading plan.





my problem has always been #3. so now i work harder to maximize my return (salary), park my money with safe funds, and get my gambling kicks from fantasy football!
 
I agree with IrvineRenter. But, I will emphasize the psychological aspect, and how important that 50% is. Risk aversion is something that increases greatly, when it is your money. I have made so may what if trades, that if they were real, I don't know if I would be rich or broke. But, I remember the great ideas more than I remember the bad. An INTP personality would be great for the technical side, but I am not sure how it will effect the psychological side. Just as the psychological side can make you fail, it can be what makes you successful. According to Myers-Briggs I am an INFJ, and it is fairly accurate. I think, that the emotional side, at least for me, plays an important role. In fact, I privately mentioned a trade to a few here. It is a pure gut trade. We, will see if I do it first, as it depends on how it opens tomorrow, and we can see how it does.





I got started not knowing crap, but I jumped in. I have learned a lot over the years, and you can't replicate that by any "paper" trading. I understand the technicals better, and continue to learn more. I understand the psychological side better, and continue to learn more.





Is it possible to make a living doing it? Sure, if I had $100k to play with, that I had no fear of losing, I could do well enough to live comfortably. The technical aspect is 50%, but that 50% psychological aspect is all on you. If I had $100k that I am depending on, well, I would probably fail. Read up on Kahneman and risk aversion. People deviate from their plans, when they depend on that money.
 
<p>I agree with most of what has been said above, but my percentages are different. I thing successful trading is 20% fundamentals and technicals and 80% emotional and knowing yourself.</p>

<p>I just read something third hand that is attributed to James Sinclair. Paraphrased: It seems 99% of folks who want to trade are unable to buy a stock at a price that is higher than what they sold it at. They will wait forever for the stock to be cheaper than what they sold at, no matter how what the signals are telling them.</p>
 
awgee,





I struggled with throwing out percentages. I agree that your assessment of 80% psychology may be more accurate.





When I really think about it, the reason I said 50% technical is because without technicals, you really can't even play the game. It is a basic skill you must have. However, once you have a certain level of technical proficiency, psychology completely takes over. It is as if at the beginning it is 80% technical and 20% psychological, and by the time you get better at it, it changes to 20% technical and 80% psychological.





I think the best analogy would be professional golf. The guys on the pro tour all have fantastic technical skills which were prerequisite for getting their tour card. It is the ones who have mastery over their own psychology that go on to be truly successful.
 
Yeah, and I think I should have been more specific in that <strong>successful </strong>trading is 80% emotional for <strong>me</strong>. It seems each successful trader has their own method that works for them. If I plan my exit strategy with my emotions in mind before I make the trade, the discipline is much easier, and at times natural. The trade with the most potential profit and least risk may not work for me if it is something I don't understand or have a feel for.
 
Yes, psychology plays a big part. We have seen this over and over. Whenever there's bad news without any validity. The herd mentality kicks in and move the Market.
 
Yup psychology plays a huge role, and that's why having a big bankroll and money management will help tremendously. It allows you to ride out the paper losses and avoid selling out of fear.
 
What about the role of luck, boys?



An article in the Journal of Business analyzed CFTC reports in nine markets. The empirical investigation concluded that, "...the fortunes of individual futures traders are determined by luck, not forecast ability." The study further finds that, "...there are fewer participants with significantly superior skill than expected if participants trade randomly, there are more traders exhibiting no skill than expected if particiapnts trade randomly, and forecast ability is not correlated over time--superior forecasters in the early period are only average forecasters in the later period. Therefore, it is luck that determines trader performance."



Michael L. Hartzmark. 1991. "Luck versus Forecast Ability: Determinants of Trader Performance in Futures Markets." Journal of Business. 64(1):49
 
profette - I disagree completely with the luck theory. Just because a trader does well for awhile and doesn't do well another time has nothing to do with luck. Sometimes a trader is trading per their discipline and with what they know and sometimes they don't. The only folks who think successful trading to be determined by luck are those who do not trade successfully. Babe Ruth struck out more often than he hit home runs, but luck had absolutely nothing to do with his home run success.
 
One lesson that it took me a long time to learn is that being too active can be a very bad thing. Just so there is no confusion, I'm not saying that short term trades should be avoided. In fact, though I do invest with long term horizons, I like to trade in the short term as well. But for me, one of the keys to success has been to learn to be patient and look for the right setups. While having exit strategies and using stop orders and trailing stop orders are a very good idea, all pale in comparison to maximizing your opportunity for success by buying during periods of oversold conditions (or individual stocks that are oversold) and selling and entering short positions during overbought conditions. You shouldn't be 100% invested all the time, and margin should only be used sparingly on rare occasions.
 
If all traders had no real skill, and you put 1024 of them to work investing over 10 years, at the end of 10 years you would expect one of them to have had a perfect record of 10 up years. Try a million people with no skills, and you get a thousand who will pass the 10-year test, and 1 who would pass a 20-year test. With many millions of people trying their luck at investing at one time or another, you should get one person with a Warren Buffett record. So seeing a few people who are very successful over long periods doesn't automatically mean they are skilled. They might be, but the evidence might be weaker than you expect.
 
<p>Okay boys, it seems you don't like the "luck" theory. How about the weather? </p>

<p>"Psychological evidence and casual intuition predict that sunny weather is associated with upbeat mood. This paper examines the relationship between morning sunshine in the city of a country’s leading stock exchange and daily market index returns across 26 countries…Sunshine is strongly significantly correlated with stock returns. After controlling for sunshine, rain and snow are unrelated to returns. Substantial use of weather-based strategies was optimal for a trader with very low transaction costs. However, because these strategies involve frequent trades, fairly modest costs eliminate the gains. These findings are difficult to reconcile with fully rational price setting." </p>

<p>David Hirshleifer and Tyler Shumway. 2003. “Good Day Sunshine: Stock Returns and the Weather.” The Journal of Finance. LVIII (3).</p>

<p>Listen to <a href="http://uk.youtube.com/watch?v=Ehnp2a2m774&feature=related">this</a>, while you ponder...</p>
 
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