The Gulmohar Tree

Billionaire Traders

2010-02-21T12:47:00.026+05:30

Mentioned here are some professional traders, who are still rocking.

John D. Arnold (age 35) made his first billion $ within 5 years. Made 1.5$ billion in 2008.
http://en.wikipedia.org/wiki/John_D._Arnold
NYMag Interview

Paul Tudor Jones, started as a clerk on a trading floor.
http://en.wikipedia.org/wiki/Paul_Tudor_Jones
MarketFolly Interview
"Today, I want to talk to you about the dirtiest word that any of you 9th graders know. It’s a word that is so terrible that your parents won’t talk about it; your teachers won’t talk about it; and you certainly don’t ever want to dwell on it. But this is a preparatory school, and you need to be prepared to deal with this phenomenon because you will experience it. That is a guarantee. Every single one of you will experience it not once but multiple times, and every adult in this room has had to deal with this in its many forms and manifestations. It’s the “F” word...."
Full Article

Louis Bacon is by far the biggest of the daredevil managers who are still placing big directional bets on stocks, bonds, currencies and commodities at a time when such bold trading has come under withering scrutiny.
http://www.turtletrader.com/bacon.html
http://marquezcomelab.com/blog/?p=497
http://www.iimagazinerankings.com/...

Carl Icahn
http://en.wikipedia.org/wiki/Carl_Icahn
http://money.cnn.com/magazines/...
"To 'meet with triumph and disaster' and to 'treat those two impostors just the same.'
So if you're doing great, don't think you're a genius and
If you're doing badly, don't think the world comes to an end.
If you work hard and don't let your ego get ahead of you,
(which so many people do when you're doing well),
And if you don't let yourself become
too despondent if you're not doing well for awhile.
And have faith in your ability,
And really work hard at whatever you do.
If you can do all that, I think, chances are good
You're going to hit a lucky streak.
Luck comes and goes. Realize that
When you're doing really well, it's not just you
And when you're not, it's not just you either." Full Story

Steven Cohen, the Trading God.
http://en.wikipedia.org/wiki/Steven_A._Cohen
BW Article

David Tepper is another former Goldman Sachs employee who turned into a hedge fund manager. His hedge-fund firm has racked up about $7 billion of profit so far this year—with Mr. Tepper on track to earn more than $2.5 billion for himself.
Recent 7$ billiob bet
David Tepper - Wikipedia, the free encyclopedia
http://www.gurufocus.com/forum/read.php?1,77148

John Paulson began his career at Boston Consulting Group before leaving to join Odyssey Partners, working under Leon Levy. Shot into limelight in 2007 after making around $15 billion speculating on US Housing Crisis. Cited by some as the biggest trade ever made, outshining Livermore's 1929 one.
John Paulson - Wikipedia, the free encyclopedia
The Best Trade of 2007 – John Paulson Overtakes Oprah Winfrey
John Paulson: Hedge Fund Manager MVP 2007-08, Congress Testimony Video
Paulson May Have Made $45.3 Million on Detour Gold (Update1)

Back in 1965, a penniless refugee named Thomas Peterffy, was destined to revolutionize the global trading industry.
http://www.iinews.com/site/pdfs/IIMa...s_Nov_2005.pdf
http://people.forbes.com/profile/thomas-peterffy/44384
http://individuals.interactivebroker...?ib_entity=llc

Ace Greenberg, started as a clerk in the oil department at GS. Since 2001 he is head of the executive committee of the same and the company's capital base grew from $500 million to $26 billion.
http://www.forbes.com/2008/10/10/Onl...Greenberg.html
http://www.tradersmagazine.com/issue...inter_friendly

James Simons, a mathematician from MIT manages more than 25$ billion, with great success.
http://en.wikipedia.org/wiki/James_Harris_Simons
Interview mentioned on abacus and seedmagazine

T. Boone Pickens, "“My IQ is the gas price. At $3 I’m a genius. At $1.50 I’m a moron. Don’t talk to me too fast; it’s at $1.53 today.”
Wikipedia Page, Frontline Interview, Fox news Interview

Bruce Kovner's first trade was for $3000 borrowed against his MasterCard.
Wikipedia Page
CNN Money Interview

Edward S. "Eddie" Lampert's current networth is estimated at 1.5$ billion.
Wikipedia Page
http://www.streetstories.com/Bruce_Kovner.htm

David E. Shaw is a computer scientist and computational biochemist who founded D.E. Shaw & Co. The capital under management in his firm has shrunk from 40$ billion to 29$ billion in recent meltdown.
Wikipedia Page
MarketFolly Interview

Louis Bacon is another self-made billionaire, considered by some among top traders of 20th century.
Wikipedia Page AR Interview
Forbes Entry

Advice For Struggling Traders

2009-12-17T16:43:00.004+05:30

Do not keep opinions. No opinions about strategies, people or your ability to make it in trading. If you see people losing money horribly in market, ignore them. If you see highly successful traders, try to interact with them. But keep away from opinions... they lead into generalizations which can be very dangerous.
Listen more and talk less- particularly applicable to people visiting forums and chatrooms. Okay, you like talking for hours to your girlfriend or school buds but this is goddamned business. You need to be precise and sharp. You still haven't made it big and if you start talking, you do the oppsite of being precise and sharp. It's not just about social interaction, effects your psyche as well.
Do not make generalizations. Nothing can be as bad in trading as generalizations. Example: fundamental analysis does not work, technical analysis works better on daily charts, quant traders make most consistent money, trading is an art, big traders do not share anything about business to budding traders...

Precarious Prediction

2009-10-15T22:09:00.002+05:30

"Everything that can be invented has been invented."
Charles H. Duell, Director of U.S. Patent Office, 1899

"Who the hell wants to hear actors talk?“
Harry Warner, Warner Bros. Pictures, c. 1927

"Sensible and responsible women do not want to vote."
Grover Cleveland, 1905

"There is no likelihood man can ever tap the power of the atom."
Robert Milliken, Nobel Prize in Physics, 1923

"Heavier than air flying machines are impossible."
Lord Kelvin, President, Royal Society, c.1895.

"A late-1970's market research study commissioned by Bell Labs .. predicted a (cell phone) subscriber base of only 800,000 by (the year) 2000, and concluded there was no market at any price.'" "...by next year (2000) there were in fact be an estimated 80,000,000 subscribers in the U.S. alone.."

"In 1876, a Western Union internal memo predicted, this 'telephone" has too many shortcomings to be seriously considered as a means of communication." Magazine, January 2000, page 64

"Stocks have reached what looks like a permanently high plateau."
Irving Fischer, Yale Economics Prof., 1929

"I think there is a world market for maybe five computers."
Watson Sr., President of IBM, 1943

""With over 50 foreign cars already on sale here, the Japanese auto industry isn't likely to carve out a big slice of the US market."
Business Week, August 2, 1968.

"We are probably nearing the limit of all we can know about astronomy."
Simon Newcomb, astronomer, 1888.

Hope and Faith

2009-10-04T04:01:00.002+05:30

“Hope is itself a species of happiness, and, perhaps, the chief happiness which this world affords: but like all other pleasures immoderately enjoyed, the excess of hope must be expiated by pain; and expectations improperly indulged must end in disappointment.”
Samuel Johnson (1709-84)

Ernie on low volume stocks

2009-07-02T21:47:00.003+05:30

There are a lot of thinly traded stocks, so that is one area where big funds will not trade. Because of low liquidity, the big funds are unable to take advantage of them. They need to make money on a $10 million portfolio, and yet the stock may have a daily trading volume, in terms of dollars, maybe only $100,000. So there is no way this would interest the major institutional investor. But thinly traded stocks are something the independent trader can take advantage of.

Another area is low-priced stocks. I worked in numerous places where there is a strict prohibition against buying stocks less than $2, for example. There is no particular reason that rule was imposed except for possibly transaction costs. If you trade in a size suitable for an independent trader, however, there is no reason why you should not be able to buy these kinds of low-priced stocks.

There are also strategies that trade once a year, once a quarter, or once a month. These are strategies that do not interest a lot of hedge funds because they need to make a profit practically every month, if not every week. So if you have a strategy proven to be profitable once a year, you can be assured it is not something the institutions want to engage in. As an independent trader you have no such concern, so you can go right ahead with these strategies... (continue reading)

Reference Post: Why trade illiquid stocks...

Why outliers can be important...

2009-05-22T21:04:00.006+05:30

Reference Post: Price movements which are random, ineffective, manipulative etc.
CGRB Buyout: http://www.reuters.com/

Huh, so what is trading?

2009-05-21T13:51:00.001+05:30

Trading is a search problem; buyers search for sellers and sellers search for buyers. Buyers seek sellers willing to sell at low prices, and sellers seek buyers willing to buy at high prices. Traders must also find other traders who are willing to trade the quantities or sizes they desire.

The following axioms may appear as common sense:

Markets exist to facilitate trading. It provides opportunity to someone at all instants.
Trading takes most properties of a zero sum game. Some traders will always be manipulative to others.
They dynamic interaction between buyers and sellers, or supply and demand, is expressed through prices. Thus prices are a tool of discovery.
Prices also change to reflect new information arriving in the market.
The goal of a trader is to be spontaneous with the market.
The feedback loop process among traders indicates the spontaneous direction of market. Positive feedback occurs when higher prices attract more buyers, and lower prices attract more sellers; vice-versa for negative feedback.
Future prices cannot be predicted owing to the dynamic extraneous information entering in the market. Probabilities in the market are never absolute unlike in a game of cards.
Extreme events or once-in-a-generation-outliers may occur every couple of years.

The Morning Prayer

2009-05-21T13:49:00.001+05:30

God, grant me the sensitivity to be tolerant of all people.

Help me always to remember that issues of race, culture, gender, and sexuality transcend all other things; even common sense. Especially common sense.

Lord, please help me shun logic and reason to accommodate vogue and fashion.

And if I ever become so open-minded, Lord, that my brain falleth out, all I ask is that it not hit anyone on the way down. Especially the Scholars.

Generous Lord, obliterate my identity and help me become a scintillating part of the System.

Amen.

SOES Banditry and NSE’s DMA

2009-03-21T19:29:00.002+05:30

In the 1990s, SOES bandits were traders who used the Nasdaq Small Order Execution System(SOES) to submit orders designed to profit from very short-term price changes, similar to the generic scalping. The losers generally were the Nasdaq dealers who adjusted their quotes slower than few seconds. These high-speed trading strategies ultimately caused spreads to widen because dealers and other traders had to recover from other traders what they lost to the SOES bandits.

Nasdaq protected its dealers by restricting the access of bandits to the SOES system by classifying them as professional short-term traders. The issue is now forgotten, however, the new losers are public limit order traders. High frequency proprietary traders undoubtedly exploit these traders when prices change quickly, but unlike Nasdaq dealers these traders are not organized to complain about it.

NSE is considering providing Direct Market Access(DMA) and it will be worth watching how it protects the low end retail traders.

Being A Professional Trader

2009-03-21T19:27:00.000+05:30

A Professional is a person supposed to be an expert on the subject he is dealing with for earning a livelihood. The inner work process of professionals is likely to differ. But they are adaptable, easy to get along with, open to change and great note takers. Their approach is holistic; rather than harping on a certain method since it is the sum of parts that is more important. Technical expertise comes naturally as they work for satisfaction and not merely for money. Research is a prized instrumental value which enables the development of more fundamental values, such as autonomy. A professional learns from his mistakes and utilizes them to bring more perfection to his trading. Their comments are realistic and precise but never abstract. Since Trading is a zero sum gain, most people in the industry from Investors to Analysts to Brokers find it tough to accommodate with professionals.

A professional can give bad name to his profession if he does something unethical or against his profession. Hence he follows strict ethical standards. Ethics are a part of practical, professional decision making. If they are willing to help newcomers, good; it will be a comprehensive mentoring. If they're not; it will be a simple silence or blatant 'no'. This is why most pro traders shy away from publicity and like to operate secretively.

The Guru

2009-03-21T19:24:00.000+05:30

Whoa! Here comes the suave, fast-talking, obsessive and ofcourse knowledgeable Guru. He has a unique way of getting a word in edge ways. He can stand up and talk about any method and any indicator and any market condition.

Before you start wondering how the hell he manages to know so much about so many different things, he’s got a secret. OK here is his secret. Ofcourse he doesn’t know anything except the psychology of his ‘clients’. The hidden flaws in any method, the cause of all losses and the cause of all failures; he knows inside out. He advises the budding trader how the tough the profession is and the great mental stamina and right psychological mindset essential for getting their feet wet. His ambition in life is to lay bare this terrible truth.

The first day he went close to the market, the losers befriended him. The guy who made loss on the moving average is well known to him; then there is the one who lost on classical chart patterns; loss from momentum indicators, from oscillators, from gann wheels, from haramis and butterflies; from data mining based systems and implementing Fourier time series; you name it and he can guide you in detail how such things can cause terrible looses and carrier failures. He isn’t just skeptic but sometimes sarcastic as well.

Yikes, you cannot ask him how to make profits. The bad Guru will shoot instantly his coaching fees. But there is the good Guru as well. He will answer in abstract and cryptic language, which will be totally vague, to be precise. If you seek more knowledge there will be another vague answer. After the second interaction you are expected to ‘enroll’ for his mentoring. What, you still aren’t unwilling to pay? You seek a free lunch? Seek more knowledge again and you are sure to be shooed away as a dumb/lazy student for bad manners.

For goodness sake, don’t ask where to find The Guru. You search for generic terms like ‘learn forex trading’, ‘learn day trading’ and you know his website tops the search results. Internet media is important these days. Even in financials newspapers/magazines his advertisement is most interesting.

Nature’s Epitaph

2009-03-21T19:21:00.000+05:30

By William Herbert.

Who knows where the graveyard is
Where the fox and the eagle lie?
Who has seen the obsequies
Of the red deer when they die?
With death they steal away
Out of the sight of the sun;
Out of the sight of the living, they
Pay the debt and are done.
No marble marks the place;
The common forest brown
Covers them over with Quaker grace
Just where they laid them down.
But a few years, if you see
In summer a deeper green
Here and there, it is like to be
The spot where their bones have been.
Thus, not more, to the poor dead year:
No grave, nor ghostly stone,
But a greener life and a warmer cheer
Be the only sign that he's gone.

Current Wallpaper

2009-01-20T10:53:00.002+05:30

The next few months may suggest major changes for the next few years. Prepared to adapt.

Why trade illiquid stocks...

2008-11-18T16:19:00.003+05:30

First and foremost, it is easier to become a surrogate specialist in a thinly traded stock than it is for a active stock where big boys are in play. One can have a fair idea about who is filling one's limit orders.
Secondly, the considerable money that Value Traders lose as execution costs can go well in your pocket. Several authors quote that illiquid stocks earn higher investment returns, presumably to compensate for the higher costs of transacting. For the tape reaader it simply means bigger catchable moves. Reference:

Amihud, Yakov, 2002, "Illiquidity and Stock Returns: Cross-Section and Time-Series Effects," Journal of Financial Markets, 5, 31-56.
Brennan, Michael J. and Avanidhar Subrahmanyam, 1996, "Market Microstructure and Asset Pricing: On the Compensation for Illiquidity in Stock Returns," Journal of Financial Economics, 41, 441-464.
Pastor, Lubos and Robert F. Stambaugh, 2002, "Liquidity Risk and Expected Stock Returns," Journal of Political Economy.

Reference post: 6 Rules for Trading by the Tape, Rule#1

My Favorite Fraud

2008-09-22T03:24:00.002+05:30

By Larry Harris

The following scheme is illegal. Do not use it. I present it only so that you can better appreciate the sample selection bias, and so that you can avoid falling for this scheme should a man ever try to target you.

Buy a mailing list of 20,480 wealthy and gullible people. Send them a letter in which you explain that you are a very successful trader who has more money than you can spend. Boast about how you correctly predicted what direction prices would move during nine of the last ten months. Tell some fascinating story how you did it. Then tell them now you crave their recognition for being a market genius, since money is no longer very useful to you. Give them their prediction for the next month.

Divide your names into two equal groups. To first group, predict that the market will rise. To the second group, predict that it will fall.

One month later, write a letter to the 10,240 people for who you correctly predicted the market. Continue boasting and remind them that you correctly picked the market for them. Tell them how much money they could have made if they had traded on your recommendation. Then give them another pick. Of course, you predict an increase to one half and a decrease for the other half.

Repeat this for ten months until 20 people have seen you correctly predict the market 10 times in a row ( 20 = 20480/2^10). If they are not aware of your scheme, they will be convinced that you have correctly picked the market 10 times for them, and they will be prepared to believe that you did indeed do it correctly in nine of the ten months before you started to correspond with them. Such results are extremely unlikely to occur at random. They will swear that you are a genius.

You now have these people wrapped around your finger. If they are gullible you may be able to abuse their trust.

If you also send letters to people for whom you incorrectly predict he market, you can increase your yield. Simply tell them you are only human and cannot get it right every time. You will have 200 people for whom you have correctly called the market nine times and another 900 for whom you have correctly called the market exactly eight times. You probably will not want to continue corresponding with those for whom you failed to call the market three or more times.

The “lucky” ones for whom you correctly predicted the market cannot possibly make the proper inference about your skill without knowing your scheme.

Q&A: How can you tell a Quant from a Trader?

2008-07-26T23:55:00.001+05:30

Two guys walk into a room and find a bag of cash under the table...

The first guy thinks: This is crazy. Anyone could walk in here and take this money.

The second guy says to himself: Cool. What's the worst thing that could happen if I just took this money?

Which guy is a Quant and which Trader?

The first guy is a Quant. By training he wouldn't think of taking the money if it wasn't compensation for hard labor and sweat. The second guy is a Trader. The situation is simply an opportunity with possible consequences.

Lots more of interesting stuff at: Working [Wall $treet] $mart

Old Wall Street Sayings

2008-06-03T00:23:00.002+05:30

Mentioned here are some words being passed generation after generation.

"A stock and a company are not always the same thing."
"Money follows earnings."
"The market indices have correctly predicted nine of the last four recessions."
"After a sharp fall money returns to its rightful owners."
“In the stock market, as in warfare, it is well to keep in mind the difference between strategy and tactics.”
"If you are going to panic, panic early."
"The first loss is the best."
"Nothing has a straight line up or down."
"When you rob a whorehouse, take the piano player, too, because no one is entirely innocent."
"Never meet a margin call."
"Sell down to the sleeping point."
"A bullish market is born amid pessimism, grows up under skepticism, matures with optimism and dies with euphoria. "
"In times of crisis, always blame the one who isn't in the room."
"If somethings worth doing, it's worth doing for money."
"Have the best hand, the best draw, or get out."
"Don’t get mad, get even."
"Buy when there is blood on the streets."
"There’s no free lunch on wallstreet."
"Don’t fight the tape"
"When volatility turns higher, it usually does do on the downside."
"Inevitably, compression gives way to dispersion."
"Trends test the line successfully, but eventually they breakthrough."
“The market is always with us.”

Learning to Day Trade

2008-06-02T23:45:00.003+05:30

Of course there are numerous methods to make money from the markets, but few have been known to work across different markets and different generations. The approach being described here remains secretive to training module of some proprietary firms. The chief reason it did not become popular was 1. Less commercial gains for the person promoting it 2. It requires absolute focus and hard work, rather than a ready-made formula to be spoon fed. It rather assures that a person *learns* tape reading.

Only a very brief summary is given here, please note how the course emphasizes on trading versus market analysis. There are three stages to work out, and passing the first one leads to the next.

Stage I- The Clueless Trader

Benefits: Allows the student to know what is meant by tape and tape reading. Learns the concept of auction, supply and demand. Appreciates market risk, his time frames and their limitations.

Time required: Three to eight weeks.

Preparation: First a watchlist of about 30 stocks is prepared. These should be the one which are thinly traded or with decent volumes, but certainly not high volume stocks like YHOO or C. Also they should make intraday range of more than 2%.
Before market open the time of all vital announcements should be noted. Only the time of announcement is important. For eg., if Wholesales Inventory data will be released at 10:00 am the student does not bothers about the expected figures or the anticipated impact on prices. He assumes the tape to tell about the impact, though the time is important for his trades.
The student needs plain line charts, updated tick by tick, that’s all. No technical studies, or even volumes on the chart. Also no access to live news feed.

Methodology: Important levels are marked in a notebook, day in and day out, like day's high etc. Watching the tape and charts all day long the students starts trying to anticipate the current trend of prices. He observes few patterns like when a stock trips 50 cents in half a minute, and feels like betting real money. Simulation trades get in handy. The student shall learn now the difference between scalping and tape reading, and starts to appreciate his holding period... which usually the market decides… and can be anything from few seconds to few hours. He notes how a 60$ stock may give a bigger (catchable) move than a 120$ stock.

Stage II- The Struggling Trader

Benefits: Allows the trader to survive in the markets... that is not loosing. Discovers his primary trading style, develops an understanding of the markets and focus for sizing (scaling). Old Wall Street sayings now don’t sound like granny’s words but start running with blood.

Time required: Three to eight months.

Preparation: The trader is now allowed to use candlestick/bar chart with volumes, as per his wish, but no other technical studies. Again no access to live news feed. He may now include or exclude tickers to his original watch list of 30 stocks at the end of each weekend, with no restriction on the category of stock.

Methodology: Now trading with real money, the trader learns about the functioning of the markets, and the reactionary behavioral patterns of various market participants. He develops tape reading skills, and few consistent patterns, which take care of his mistakes so that the trader has some money to take home each month.

Stage III- The Consistent Trader

Benefits: Allows the trader to discover his ‘edge’ in the market and define his system.

Time required: Four months to two year.

Preparation: The trader shall now have access to full computer power, again as per his wish. He may use any technical/quantitative studies to assist his trading. He has access to live news feed to use at his discretion. Of course the cost of technology equipment shall not outweigh monthly P/L.

Methodology: The trader shall quantify his decisions and many observations. He starts working towards system development by defining goals, expectancy and downside risk. He learns when to play on intuition versus counter-intuitive trading. The trader understands very well his risk appetite and trading style, and so shall be in peace with the markets. Done.

The Wonderful World of Event Driven Trading

2008-06-02T23:42:00.002+05:30

Event Driven Trading is any strategy that seeks to exploit pricing inefficiencies; that could be due to scheduled events like takeovers, restructures (including share buy-backs, spin-offs and capital returns.) and release of economic numbers and corporate announcements. Unscheduled events include exogenous political and environmental events. The legendary trader Livermore did not agonize over unexpected events, but rather chalks them up as an unavoidable fact of trading: "Normal business hazards are no worse than the risks a man runs when he goes out of his house into the street or sets out on a railroad journey."

Traders, who follow event driven strategies, attempt to anticipate the outcome of a particular corporate event on the security price as well as the optimal time to commit capital. For example the MSFT-YHOO takeover drama provided many opportunities even in the extended sessions.

Considering no two trading styles can be exclusive, every trader faces such scenario. On one extreme side traders look for merger arbitrague while on the other side there are scalpers trying to exploit liquidity crunch. There have been several papers published about the microstructure as the market stabilizes after a price shock.

One peculiarity about event trading is it gives more importance to the speed at which market reacts to information. That is how the inefficiency is identified and exploited in real time. Hence the development of elementized event news processing systems.

What is Stock Analysis?

2008-03-19T20:31:00.013+05:30

Stock Analysis should include these components:

1. From the chart: trend and momentum from price indexes, breadth, volume, relative strength, sentiment & supply/demand patterns/indicators.

2. Perception of traders: options data, put/call ratios, put/call ratios on volume, put/call ratios on premiums; Consensus, Inc. polls, Investor’s Intelligence polls (traders make tops).

3. Perception of Investors: corporate buy backs, new equity financing, results which impact price valuation (investors make bottoms).

4. Intermarket Analysis. Relationship of the commodity with its pairs, like airlines and crude prices, Goldcorp Inc. and USD.

There goes a saying among tape readers, “Have a bigger picture in your mind… and forget it when you sit on your terminal”. The bigger picture refers to analysis.

Stock Earnings and Preannouncements

2008-03-19T20:31:00.008+05:30

"We find that firms are more likey to prenounce earning if the consensus of analysts' forecast is very difeerent from actual earnings, if the dispersion in theese forecasts is high, or the firm has negative news. Further, we document that there is a systematic pattern in the amount managers preanounce. On average, firms release only some of their positive news at the preanouncement date, thereby creating a predictable surprise at the earnings anouncement date. Given that preanouncements occur very close to the actual earnings anouncement date, it is likely that managers know the actual earnings amount with a high degree of certainity. Therefore, our results suggest that managers strategically withhold some of the positive earnings surprise. We show that earnings surprise is more persisitent for firms that preanounce positive news for firms that do not. "
Soffer, Leonard C., Thiagarajan, S. Ramu and Walther, Beverly R., "Earnings Preannouncements" (September 1997)

"We find a strong – economically and statistically – negative price reaction to aggregate earnings news. This finding suggests that unexpectedly high earnings are associated with higher discount rates, at least over the fairly short horizons we study. Aggregate earnings are strongly correlated with macroeconomic conditions, including measures of real activity and proxies for discount rates (Tbill rates, the term spread, and the default premium). However, the discount-rate proxies only partially explain the market’s negative reaction to earnings news. Thus, the results suggest that discount-rate shocks not captured by our proxies explain a significant fraction of returns."
Lewellen, Jonathan W., Kothari, S.P. and Warner, Jerold B., "Stock Returns, Aggregate Earnings Surprises, and Behavioral Finance" (February 2003)

"Further, upgraded stocks bought by herds initially outperform, then underperform their size, book-to-market, and momentum benchmarks, while downgraded stocks that are heavily sold exhibit the opposite pattern."
Brown, Nerissa C., Wei, Kelsey D. and Wermers, Russ R., "Analyst Recommendations, Mutual Fund Herding, and Overreaction in Stock Prices" (February 13, 2008).

“The one thing that everyone, from the most uninformed layperson to the most erudite professor knows about the stock market is that earnings determine returns. Chapter 1 of every finance text book, lecture 1 of every investment class and every news dispatch all agree:
1) Earnings and markets move up and down together
2) The greater the earnings increases, the higher the market return.
3) When earnings are up, it is time to buy stocks, and when earnings are down, it is time to sell stocks.
4) When the market’s price/earnings ratio is high, it is time to sell.
Analysis of each of these hypothesis’ would invalidate each and every one of them as false. Contradictorily, each is completely opposite to the actual empirical relations. Almost everything investors are taught about in relation to the earnings and stock markets returns, whether in business schools or on the stock market pages of the newspaper is wrong.Shrewd articles know that they will not get far in life by relying on the conventional explanation of market moves. But the great majority of investors are deceived on both the big and the small aspects of this relation.Firstly, it is necessary to examine the actual relations between earnings and the market returns. There are many different leads, lags and ratios to be tested. The best way to reveal these relationships is with a scatter diagram. If these data tend to life close to the line of best fit, then there is a strong relation. If the data tends to appear to lie In a shapeless mass around the line, then there is little or no relation. Each of the charts uses earnings data from S&P securities price index record, updated with current figures and returns data from London Business School’s comprehensive database of global markets.According to the induction, stocks are supposed to go down when earnings are down and go up when earnings are up. In fact, they don’t and the opposite relation holds good.1) If reported S&P 500 earnings rise in a year, the S&P 500 is likely to perform worse than average that year.2) If the reported earnings fall in a year, the S&P 500 is likely to perform better than average that year.The inverse relationship is shown in the above figure. Notice how the line of best fit slopes gently from the northwest quadrant to the south east. This is the hall mark of what statisticians call negative correlation. Regression analysis is used to calculate an equation that expresses this slightly inverse relation between earnings and next year’s market return as a line of best fit: S&P 500 return = 9.6 percent minus one fifth of the annual percentage change in the S&P earnings. The equation explains some 5% of the total variation in stock prices from normal. Another way of saying this is that if a person new nothing about earnings change in a year, the best forecast of S&P 500 returns in 2002 would be 9.6%. Knowledge of the earnings would increase the predictive ability of the analyst by only 5%”
Niderhoffer in Practical Speculation

Case Study: Bear Stearns
"Bear Stearns's balance sheet, liquidity and capital remain strong,'' Chief Executive Officer Alan Schwartz said in the company's statement. Alan ``Ace'' Greenberg, the former Bear Stearns chief executive officer and current board member, told CNBC that the liquidity rumors were "totally ridiculous.''
”Credit-default swaps protecting against a default by Bear Stearns for the next two years soared to 900 basis points, according to broker Phoenix Partners Group in New York. That's up from 514 basis points last week, CMA Datavision prices show.”
News headlines on 12th March.

Premarket BSC starts trading up 10% after the financing news came out on 14th March. See Chart:

What happened thereafter is well known.

The Russian Roulette

2008-03-19T20:31:00.000+05:30

Anyone who has been in the profession of stock market trading for a while must have noted the high mortality rate in the business. Many wipe out in the first few years. More important than that, there are countless others who make huge money for (say) three years and then loose most of it in the next two months (click here). There are even those who get blown out after ten years in business that includes fund managers as well.

Visualize a middle-class teenager and a bored businessman. The businessman places one cartridge among the several chambers of a revolver and rotates its cylinder so that the location of the cartridge is unknown. The teenager is asked to shoot himself at his head. The cruelty of the game: if he survives he gets ten million dollar cash. This game is called the Russian roulette.

Here the probability of winning is specific. Now what if the revolver has a thousand chambers and the prize money is ten thousand dollars? The participant will have a false sense of security after few consecutive wins. There was a breed of Moving Average based traders in the 70s. There was a breed of breakouts based traders in the mid 80s. There were many day traders who made consistent money using only order book until NYSE became hybrid. There are currently many algo traders who make consistently with their trend exhaustion based strategies.

That is exactly the reason why it pays to differ between Strategies and Tactics.

Trading as a Career or Trading for a Living

2008-02-09T19:18:00.000+05:30

Here goes the story of Rahul, a 19 year old, college freshman. He is extremely passionate about the stock market and tries to read every relevant book that he can get his hands on. And so Rahul gets some money from his Dad and opens a trading account.

To begin with, he had seen several times ads in the newspaper, CNBC etc. about Gurus who give training for stock market trading. He signs up for such a seminar.

His instructor starts with the general talk about where trading can take a man, and about trading instruments and time frames like swing, intraday etc. He quotes about the risky nature of daytrading and how futures trading is akin to war. And so the Guru’s emphasis on why so many get blown out of the market in their first trading year itself. Rahul asks for a excuse, looks straight in his eyes and asks, “Is there a quantitave study ever being done that suggests 90% of people fade out?”; and then,” Do you mean that the chances of success of a person who wants to be a trader is 10%?”; and still,” What are the chances of an average, positive thinking, well educated, totally driven person to succeed as a trader?”

Rahul leaves the seminar unsatisfied by the answers and conducts himself some study.

Most people enter the market with information from the snake-oil vendor society.
Most of then are happy to get their hands on some analysis software or in-fashion downloadable e-book; i.e. they bother about excess information rather that knowledge.
Still those who escape the above two get stuck in technical analysis/fundamental analysis hubblaboo rather than bothering to understand the functioning of the market.
Then there are the worst type who think that life’s all about luck and one needs luck and gambling instincts to succeed in stock market trading.

And so his study concludes that the 10% who succeed are perhaps those who have at least an average I.Q., well educated, positive thinking, highly motivated and do not come in the above categories.

Rarely do any of us grow up learning how to operate in an arena that allows for complete freedom of creative expression, with no external structure to restrict it in any way. In the trading environment, you will have to make up your own rules and then have the discipline to abide by them.

The problem is, price movement is fluid, always in motion, quite unlike the highly structured events that most of us are accustomed to. In the market environment, the decisions that confront you are as endless as the price movements you intend to take advantage of. You don't just have to decide to participate, you also have to decide when to enter, how long to stay in, and under what conditions to get out.

There is no beginning, middle, or end - only what you create in your own mind.

-- Jesse Livermore

What was the last thing you traded? Look at its 1 year, 6 month, 1 month, and 3-5 day charts. Can you see all the opportunities where you could have made a profit? Should have gone long there, shorted here . . .. You're assessing "opportunity" based on price activity subsequent to the point at which you believe the opportunity existed, which means that you're working backward to identify that point of opportunity.

While trading, these are the very opportunities a trader is aiming to spot. This and the desire to make trades will often drive the inexperienced trader to "see" opportunity where there is none, simply because the trader can easily envision the price pattern moving in any given direction. If his predisposition or any of his analysis makes him inclined to forecast a certain direction, he can quickly envision the movement of price in the direction that will yield profits. By envisioning such price pattern formations, it's often the case that the trader will mentally emulate what he has previously viewed on historical charts, and perhaps even had a desire to experience. And this psychology is made even more complex when the trader begins to find "evidence" in current price activity that supports his forecast/vision and ignores any information that contradicts it, thereby providing a false justification to make the trade.

This type of thinking will cause a trader to make trades when no real opportunity exists. The fundamental problem is that the reason for action is based on a forecast/vision, and not on what has happened and what is happening right now. Given the fact that forecasts and visions are not realities and that historical and current activities are, decisions that are based on the proper interpretation of what has happened and is happening will be correct far more often. It's critical to avoid mentally creating opportunities and to know when to stay out of a trade.

Looking at the charts again, try to identify forward-looking opportunities, where you consider only each price point and the price patterns before it. You'll find that it's now far more difficult to spot the winners, but those are the opportunities that you need to identify and then appropriately act on in order to be a successful trader.

Any experienced and successful trader will agree that it's very important not to trade until there's a true opportunity.

-- Innerworth

To keep experiencing the novelty and freshness of the market, and to keep from being trapped by your preconceptions, it's important to keep distinguishing between the tape and your interpretations of the tape. View as neutral both the events and your inclination to impose your interpretations on them. You enter the market without expectations, surrendering to it rather than struggling with it for personal gain. Ultimately, you are able to fine-tune your responses.

-- Ari Kiev

Consider everything that appears on the tape as an evidence of support and lifting power, or pressure and selling power. Continually compare the strength of these forces. Use all the judgment and reasoning power at your command. Endeavor to improve your judgment by constant study and practice. Strive to lift your judgment from commonplace to good; from good to better; from better to excellent.

-- Richard Wyckoff

Until the lens of experience focuses information, it does almost no good. No matter how much the marketing machines of the Information Age would have us think otherwise, information by itself isn't power: knowledge is. And turning information into knowledge requires more time, experience, and effort than an afternoon spent starting at a screen full of facts.

Information is passive. To make it knowledge, you need to assimilate it. Put it in context. Understand it. Knowledge streamlines and focuses our relationship with information. Knowledge helps us avoid information we don't want or need and leaves us with the stuff we can use.

In an age in which endless amounts of bits and bytes are always available, it's a daunting task to spot the worthwhile stuff. It's easy for the Net to overwhelm us or lull us into the misconception that simply having access to something is as good as knowing it.

-- Michael Penwarden

Consider that you are going on a trip one fall morning and need to formulate an idea about the weather conditions prior to packing your luggage. If you expect the temperature to be 60 degrees, plus or minus 10 degrees (say in Arizona), then you would take no snow clothes and no portable electric fan. Now what if you were going to Chicago, where you are told that the weather, while being 60 degrees, will nevertheless vary by about 30 degrees? You would have to pack winter and summer clothes. Here the expectation of the temperature carries little importance concerning the choice of clothing; it is the variance that matters. Your decision to pack is markedly different now that you are told that the variability would be around 30 degrees. Now let us push the point further; what if you were going to a planet where the expectation is also going to be around 60 degrees, but plus or minus 500 degrees? What would you pack?

We can see that my activity in the market depends far less on where I think the market is going so much as it does on the degree of error I allow around such a confidence level.

--Naseem Taleb

Price movements which are random, ineffective, manipulative etc.

2008-02-04T17:59:00.001+05:30

The adjective "random" is perhaps the most misused word pertaining to stock market. Although it is rarely the definition given, it is indeed something "made, done, happening, or chosen without method or conscious decision".

Carl Menger begins his introduction to economics by: "All things are subject to the law of cause and effect. This great principle knows no exception, and we would search in vain in the realm of experience for an example to the contrary. Human progress has no tendency to cast it in doubt, but rather the effect of confirming it and of always further widening knowledge of the scope of its validity."

Stock prices move up and down because people keep buying/shorting in hope to sell/buy at a better price. Several sciences study the causes of purposeful human action; so, it would be hard to argue any human action is uncaused.

If the actions of market participants cause price movements, and past price movements are a partial cause of the actions of traders, then past price movements must partially cause future price movements.

Hence even though people find price moves (of any time duration, intraday or weekly) as unpredictable, random, ineffective, and manipulative or in a nutshell, "surprising"; it follows that the "ineffectiveness" is in the predictive methodology of a trader, rather than the stock. As a trader develops a higher and higher understanding of the stocks, he categorizes fewer and fewer price moves with such adjectives.

However whatever be a trader's level in the market (click here to read more about levels in the market…) there are always such type of moves which he categorizes as random. Professional trading is about understanding acutely such useless moves in which the risk is unidentifiable.

This is all actually scientific. In science, we are willing to pretend there are random events, even though we know there must not be random events ("God does not plays dice with the universe") . In math, we are willing to pretend zero is a number, even though we know it must not be a number. A model with random events is useful. In most circumstances, a refusal to allow for random events would be harmful rather than helpful. The model with random events is simpler and more workable. The situation is much the same with zero. It isn't a number. To include zero as a number, one would have to put aside the principles of arithmetic. So, we don't do that. In school, we were taught that zero is a number, but that there are certain things we must never do with zero. We accepted that, because it was a simple, workable model. One should adopt the most useful model not the most honest model.

People never loose money because of the randomness in price behavior. What can be the "randomness" in one's trading methodology? Here are few unfortunate examples:
1.Trading on tips from one's broker, friend etc.
2.Hiring an investment advisor without thoroughly testing his past performance.
3.Trying to predict stock prices on impact from news like a company' quarterly earnings, CEO's statement etc.
4.Borrowed wisdom: assuming a set of premise to work in all market conditions.
5.Giving importance to price derivative rather than price behavior, like if indicator X moves beyond such value the stock is bullish.
6.Generalizing a premise like if GS has sharp volatile cycles than all NYSE finance stocks have similar cycles.
………..

Post Edits

2008-01-12T14:52:00.000+05:30

Words do matter. There have been minor edits in all previous posts and a major edit in 6 Rules for trading by the tape.

By Chinese calendar, 2008 is the year of the rat!

The Full Service Trading Throne

2007-11-23T15:34:00.000+05:30

Components Of Strategic Thinking

2007-10-21T11:13:00.000+05:30

(This post is intended to be a run-up for an upcoming post on strategic development in trading)

To begin with, the process for solving a problem takes two types of steps; initially Divergent - The generation of many options, alternatives, or responses to an open-ended question, then Convergent - To narrow down or select from many options. Here are the components of the thinking process, which might be helpful for traders:

Categorization: A problem, however ill-structured it may be, should be documented and categorized.
Goals: The goal or objective should be measurable, specific, documented and deadline oriented.
Consequences and Sequels: This helps to probe the side benefits, associated problems and costs associated with the process.
Challenge: As one of the most fundamental techniques, persuade individuals to refuse to accept things as they are or that the current way is necessarily the best way.
Creative Pause: It is an interruption in the smooth flow of any routine in order to once again pay deliberate attention. This is likely to park alternatives in the thought process and give attention to something that may be useful later.
Focus: One does not generate ideas with focus, yet should be willing to note a point as a potential focus for creative effort. Once a focus has been defined, it can there be treated as a real problem. It isolates Red Herring. An enhanced technique involves considering multiple foci/ alternatives definition of same focus.
Alternatives: It involves the willingness to seek out alternatives even though the next step seems to be logical and available.
Concept: It is important to 'pull back' from any idea to discover the concept behind the idea. Once the concept is extracted, work can be done to strengthen the concept, change the concept, or find better ideas with which to put the concept into action.
Resource Utilization: This involves talking to competent person/reading subject literature for generation and flow of ideas
Fractionation: it seeks to provide a complete breakdown of a situation into component parts and then reassemble them. It works with the premise that smaller parts are more manageable.
Facilitation: process control and facilitation should be carried out throughout. Also emotions, feelings and intuition should be ventilated and considered through out the process.
Factual: it emphasizes that at each step of the process, the facts should be kept aloof from the opinions. It also identifies and secludes bias and stereotypes.
Anticipatory Troubleshooting: Room should be left for possible exogenous, unforeseen events; as they may play spoilsport in the pattern of trader’s behavior.

A Game Of Chance?

2007-10-19T13:13:00.001+05:30

The harder I work, the more luck I have.
-- Thomas Jefferson

Day Trading Strategy

2007-10-08T15:59:00.002+05:30

"All men can see those tactics whereby I conquer, but what none can see is the strategy out of which victory is involved."
"Strategy without tactics is the slowest route to victory. Tactics without strategy is the noise before defeat."
---Sun Tzu

Day trading should incorporate these:
1. Helps to focus on your understanding of the markets
2. Takes into consideration your motivation for trading
3. Establishes a clear, precise plan of action
4. Creates a point of focus
5. Is automatic and effortless in its implementation
6. Manages risk and assumes losses
7. Gives you room for patience and calmness
8. Allows you to produce consistent results
9. Gives you a distinctive edge over other market participants
10. Allows you to trade to win

Each day trader, during the course of his experience develops his own set of trading tactics (ideas/system). One set of tactics might not be followed profitably alike by 10 traders; however, for 10 successful traders the underlying strategy is likely to be the same.
The reason that there are so few charts/stocks discussed on this webpage is its shift in focus on strategies rather than tactics.

BTW here are links to some day traders blogs :
CreditViolet
ADD Trader
Blonde Money
Clueless Q
Dinosaur Trader
DummySpots
Fallond Picks
Green on the Screen
High Probability Trading
M.A.S. Trader
Move the Markets
Mr. Doji
NotReallySure
Online Stock Trading
OONR7
PinoyTrader
Simon Super Trader
Slot Monkey
Stocktickr Blog
The Denarii Trader
The Dogwood Report
The Miseducated DayTrader
The Sports Trader
Trader Bubs
Trader Eyal
Trader Tim
Trading for the Masses
Tyro Trader
Ugly Chart
Wall St. Warrior

6 Rules for Trading by the Tape

2007-07-11T14:59:00.000+05:30

Trading has to do with reality, and that’s precisely the prices. To drive the price up or down there can only be two factors: supply and demand. Seasoned traders look exactly for that.

Furthermore, we cannot precisely know any circumstance surrounding stock movements, apart from the aforesaid, about what owners plan to do with them. They might want to sell for reasons that have nothing to do with current company situation. For instance, a fund needs free money for another operation and we see selling when nobody expected it at all. Or maybe there is less competition for them to sell their portfolio at this level versus a higher level as they see it.

Unfortunately most people have false notions about what moves the market, like news, data-release or certain chart pattern.

Please note that demand has to with accumulation (active and passive), or overreaction of a crowd (momentum). Similarly for distribution.

Tape reading is not about staring at the Time & Sales window. As stressed before it’s about reading the basic fundamentals of supply and demand. Original tape readers of times of Jesse Livermore used those principles, and they work today just as fine. They are applicable in any time frame, and longer time frames would require a broader view of stock/sector/commodity/market trend.

Tape reading, as it is, absolutely lethal and unbeatable. Chart guys just don’t have a matching edge. Pit traders know this from the very beginning, since they're never subjected to all the vendor-hype and snakeoil society. However, few people have to privilege to start off as a pit trader.

1. Big money comes from thinly traded stocks. There it is easier to recognize patterns of buying and selling Eg. WPO (NYSE) or ANSALINFRA (NSE).

2. The ‘flow’ is determined by the prints. The ‘levels’ are determined by the price at which block prints (major volumes) occur. Add to this how other traders react to the block prints whenever they occur.

3. Point no.2 describes 90% of the price behaviour.

4. Markets such as NASDAQ, AMEX etc. where we can see who is moving the stock (MMs, ECNs) are easier to trade by the tape then the Indian markets. Eg. ADAM is a strong bull in USNA (NASDAQ). It’s good to go long when ADAM comes, and to go short when ADAM is taken off (as on july, 2007).

5. The sensex is always a good indicator. Eg. If the sensex is strong and a stock is weak, just a dip in sensex will make the stock crash (see sketch).

6. It does well if you can add news analysis to your tape reading. It does better if you can add technical analysis to your tape reading.

Books:

So many blogs on trading..

2007-06-06T18:03:00.000+05:30

There has been a spurt in the growth of blogs on trading/market action, each fighting for attention.

Would like to post one of my favourite quotes:

"When trading, no blogging. When blogging, no trading."

Becoming the Person You Know You Can Be

2007-06-06T18:01:00.000+05:30

This is one of my shortest articles, and it may be one of my most important. In bodybuilding, there is a principle known as "train-to-failure" (TTF). The idea is that you lift that amount of weight that permits you at least ten repetitions, but continue the lifting to the point of failure: the point at which you can no longer sustain the repetitions. Such a heavy-duty program, as outlined by the late Michael Mentzer, is low force (to minimize injuries) and high intensity (drawing upon the body's full reserves). This program also contradicts usual practice, which has athletes lifting every day. Mentzer, a world class bodybuilder, found that a limited number of repetitions to failure were sufficient to stimulate muscle growth, as long as there was an adequate period of recovery following the training stimulus. When first espoused, the idea of doing a limited number of intense repetitions and then staying out of the gym during the recovery phase was heretical. Now it is the backbone of many successful approaches to bodybuilding and strength training.

As Mentzer noted, the idea of TTF is itself a reflection of a principle in exercise physiology called SAID: Specific Adaptation to Imposed Demands. The body, according to SAID, will develop along the lines of the demands imposed upon it. If you impose intensive demands upon a muscle set, that set will develop more than others that have not been challenged. The opposite of SAID is deconditioning: the absence of demand upon the musculoskeletal system. Astronauts in space for a considerable period of weightlessness lose body mass due to deconditioning and, at times, have had to be carried from their spacecrafts due to a loss of strength. Their bodies adapted to the absence of demand.

The vast majority of people live their lives the way uninformed athletes train: they take on too many demands, none of which are sufficiently intense to take them to failure. Theirs is the equivalent of lifting a twenty-pound barbell for hours on end. They become tired, but not strong. By the time they get old, they are chronically tired, and then retire from all demands. For many, retirement is an exercise in mental, physical, and spiritual deconditioning.

Truly great people live their lives on a TTF basis. They challenge themselves until they fail, and that provides new challenges. They ultimately succeed, because the challenges that produce failure also build their adaptive capacity. Their minds and their personalities exhibit SAID: they adapt to imposed demands.
Now ask yourself: If you trained in the weight room as hard and as smart as you train for trading success, how strong would you be?

The reality is that few traders train at all, and those that do rarely impose demands on themselves that require growth and adaptation. The bodybuilder knows that effort is a friend, a stimulus to development. You push yourself to your limits, and then you adapt to those imposed demands. In simulated trading--and in the practice that comes from trading small size--it is not enough to concentrate and focus: you develop the capacity to operate in "the zone" by testing the limits of your mental stamina. Similarly, don't just follow your trading ideas; test them until they break. Then you'll be able to figure out where they are weak and how you can fix them. We cannot know our limits unless we are willing to venture beyond them.

Mentzer realized that, to become the person you know you can be, you have to do more than you think you can do. Paradoxically, you will find your greatest freedom, in the gym and in life, in the imposition of your most stringent demands.
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Brett Steenbarger, Ph.D., does not offer commercial services to traders, but maintains an archive of articles and a trading blog at www.brettsteenbarger.com.

How Traders Can Become Their Own Therapists

2007-06-06T17:56:00.000+05:30

In recent years, brief therapies have demonstrated their effectiveness for dealing with a number of normal life challenges. Unlike traditional psychotherapies, which may take months or even years to show results, these short-term techniques often help people change persistent problem patterns in as few as several sessions. Even more interestingly, these therapies can be learned by the motivated layperson, allowing individuals to become their own therapists. This is particularly useful for traders of futures and options, for whom time is the essence.

In the October, 2002 issue of SFO Magazine, I presented a brief, intensive method for overcoming anxiety and impulsive behavior patterns known as exposure-based therapy. In this article, we will turn the tables and explore a set of methods used to cultivate positive trading behaviors. Known as solution-focused therapy, it is one of the briefest and most powerful of the “therapies for the mentally well”.

How Problems Are Constructed
A cornerstone of the solution-focused method is the idea that problems are constructed by the human mind: they represent ways in which we view ourselves. An example might help illustrate this somewhat unusual idea:
John is a trader of S&P e-mini futures contracts. He has had several losing days in a row and on two occasions failed to honor his stops, wiping out several weeks of profit. The night before his last busted trade his sleep had been fitful, and he attributed his lapse in discipline that next day to fatigue. The next evening he vowed to get good sleep, but found himself mulling over the day’s poor trading. As a result, he could not fall asleep and woke up even more fatigued than the previous morning. Fortified by coffee, he vowed not to make the same errors, but now found himself hesitant in taking his normal trades. Cursing his “sleep problem”, he decided he would take an over-the-counter sleeping aid and go to bed early that night. When he still found himself replaying the day’s missed opportunities in his head, however, he started to worry that he would never recover his sleep. Frantically, the next day he called his doctor and asked for help with his insomnia.

The problem, from a solution-focused vantage point, is not simply that John cannot sleep. Rather, he has drawn a conclusion in his mind that he is an insomniac; that he has a sleep problem. This construction of a problem-based identity helps to maintain many negative patterns of thinking, feeling, and acting. Once people label themselves as “bad traders”, “insomniacs”, or “depressed”, they tend to react more to the label than to their initial difficulties. John begins with a normal sleep disruption that, sadly, contributes to a lapse in his trading discipline. Instead, however, of viewing his problem as one of trading—leaving his stops too discretionary, so that fatigue affects their implementation—he defines the problem as one of sleep. Once he constructs this sleep problem, it now becomes an object of worry and threat. Even normal difficulty getting to sleep becomes viewed as evidence of “my insomnia”, further convincing him that he has a problem that will undermine his trading.

Solution-focused therapists emphasize that many life difficulties possess this self-reinforcing quality. A statistically normal, but nonetheless upsetting string of negative events is viewed as a new problem, which sets off an emotional chain reaction of anxiety and depression, and further reinforcement of “the problem”. Active traders of futures and options are very familiar with this phenomenon when they experience streaks of wins or losses. Even random trading results are apt to show runs of consecutive wins or losses, yet traders—like gamblers—become convinced that they have a hot hand or a cold one. Once they construct the notion of being hot or cold, they alter their trading accordingly, perhaps by raising or lowering their position size or by taking trades they normally would not. This shifts them from their time- and experience-tested strategies, raising the likelihood that their equity curves will suffer.

Another way in which constructed problems become self-reinforcing is the notion of “trends”. A short-term futures trader takes a long position in the SP after a seeming price breakout and then observes the market move one, two, three bars in the opposite direction. At some point, the trader concludes that the countermovement is evidence of a new, downward trend—despite the fact that the market is moving in a range not distinguishable from random motion. Now emotionally reacting to this constructed “trend change”, the trader bails out of his long position, only to see the market spike higher after its consolidation of the prior breakout.

The important idea offered by the solution-focused therapists is that many problems that bring people for help do not exist in reality. They are byproducts of the mind’s ceaseless search for meaning in events. Even random occurrences can be taken as meaningful, leading us to believe that problems are present when nothing meaningful has actually changed. As we shall see, this tendency of the mind to construct problems out of randomness creates pitfalls for therapists and traders alike.

Why Self-Help Techniques Often Don’t Work
Traders of futures and options typically work with a high degree of leverage and recognize the need to always be on top of their game. They are all too aware of the ways in which emotional interference can create lapses in discipline and distortions in perception, resulting in trading losses. As a result, many traders are interested in psychology and self-help methods that can assist them in maintaining their focus.

To be sure, there are many such self-help methods that can be useful additions to the trader’s toolkit. Indeed, I recently wrote a book (“The Psychology of Trading”; Wiley, January, 2003) that details many of these methods, and I employ them religiously in my own trading (see www.greatspeculations.com/Brett.htm for specific applications). From a solution-focused vantage point, however, traditional self-help methods often make trading difficulties worse, not better. Let’s explore why.

Returning to our trader John, who is bemoaning his insomnia and its impact on his trading, let us imagine that a psychologist recommends a relaxation exercise before he gets to sleep as a way of winding down and becoming sufficiently drowsy to fall asleep. Perhaps a psychiatrist might also prescribe a short-term course of a sleeping aid to help John return to his sleep cycle. Although these are sensible courses of action, many times they will backfire. John will return to his counselor or physician with continued sleep difficulty and an even greater sense that he has an intractable problem.

The reason for this backfire is subtle, but important. By offering aid for John’s sleep, the helpers are unwittingly buying into his initial premise that he does have a problem. The more they talk about his “sleep problem”, the more they reinforce the notion that this is, indeed, a real problem that exists independent of John’s meaning-making mind. This is especially problematic in longer-term therapies, where exhaustive discussions of the person’s past conflicts helps cement the idea that the person is, indeed, conflicted and troubled. After all, why would your therapist treat you for a problem unless you really had a problem?

Let’s bring the issue a bit closer to trading. Suppose a trading coach offers assistance for their client’s “cold streaks”. The coach may advice about unique money management strategies, protective stops, trading methods, or self-help techniques to cope with these streaks. All of this assistance, however, simply reinforces the underlying idea that these streaks exist, that they are a problem, and that trading needs to be adjusted to deal with them. Like the trader who exits a long position too early following a couple of adverse bars, the trader who experiences several consecutive losses is all too likely to abandon a worthwhile system at the worst possible time. From a solution-focused vantage point, any help that you seek for a problem is apt to reinforce that problem in your mind, making it worse. Many problems begin in random ways, but—ironically—are maintained by the very things we do to eradicate them. (See Table One at the end of this article).

So what is a trader, therapist, or trading coach to do? The example of streak trading offers perhaps the clearest illustration of an alternate strategy. Instead of addressing the “cold streaks”, the coach could aid the trader in backtesting his trading methods. This would identify expectable runs of losses based upon real market data. Armed with a concrete set of expectations regarding normal drawdowns, flat equity periods, and consecutive losers, the trader would be inoculated against the tendency to overinterpret events. Random adverse outcomes would be less apt to be taken for more than what they are.

Finding the Solutions: An Alternate Strategy
Solution-focused therapy avoids the pitfalls noted above by redefining the aims of the helping process. When traders seek psychological advice, they typically frame their request as, “Can you help me get rid of X?”, where X is a problem pattern in trading. Their aim is to eradicate a conflict, habit, or mood state, which they have interpreted as their problem. Solution-focused work does not seek to eliminate such negatives. Rather, it identifies people’s goals—the positives they wish to attain—and the ways in which they are already achieving these, even in limited fashion. The idea is not to do less of problem X, but to do more of solution Y.

Once again, an example will prove helpful. A couple comes to counseling indicating that they have “communication problems” and are considering a legal separation. They indicate that they are arguing frequently and that they seem to have grown apart. The wife indicates that her husband spends too much time working on his trading, ignoring family responsibilities. The husband says that his wife continually nags him to do things around the home, leading him to retreat to his study. During the session, the wife bursts out in frustration, “You never listen to me!” The husband, in turn, replies, “You never support my work!”

Clearly the couple has constructed the notion that they are on the ropes. The idea of “never”—that he never pays attention to her or that she never supports him—reinforces the idea that this is a dysfunctional relationship. If the other party never behaves in a manner that is conducive to a good marriage, little wonder that separation seems to be the only option.

The solution-focused counselor will not fall into the trap of exploring the couple’s conflicts. Discussing their problems—especially airing them in the meeting—will only further convince the couple that things are hopeless, that they cannot avoid being swamped by their difficulties even in the therapist’s office. Instead, the solution-focused counselor asks each member of the couple to describe exceptions to their problems. “I’m sure you don’t argue 24 hours a day, 7 days a week,” the counselor might point out. “Tell me what you’re doing when you’re not arguing.” Or, even better, the counselor could point out that there might be times when the couple feels just a little bit closer to each other than during the fighting times. “What are you doing differently during these closer times?” might be the question.

Beneath the counselor’s inquiries is a key assumption: During the exceptions to presenting problem patterns, the couple is doing something different and is doing something right. Very, very few people are wholly dysfunctional. The key is to identify what they are doing when they are more functional—and then to construct this as a solution. Instead of doing less of the problem, the idea is to keep doing more of the behaviors that bring them toward their goals.
The couple, for instance, may report that they feel closer when they act as a team, citing an occasion when they had to cooperate to get the house ready for a family reunion. From that recognition might come homework exercises that involve a high degree of teamwork toward shared goals, such as jointly planning a vacation or researching investments. In the process of performing these exercises, the couple finds out that they can, indeed, enjoy each other’s company, undermining the construction that they have a “bad relationship” and “never” care for each other. Indeed, the new experiences allow them to construct a more positive identity for themselves, creating a solution out of the exceptions to the initial problem.
When traders become mired in problems, the solution-focused approach is to search for the exceptions. “Let’s take a look at what you’re doing when you’re trading well,” is what I said to a troubled trader who complained of a fear of “pulling the trigger” on trades. “Instead of assuming that you ‘never’ trade well, let’s look at your successful trades and find the kernel of an effective trader. Let’s find out what that kernel is all about and then develop it. The goal is not to eliminate a trading problem, but to become more of the trader you have always been when you’re at your best.”

With trader John’s insomnia problem, for example, the solution-focused counselor might ask, “What kind of trading are you doing when you sleep well?” Out of this is likely to emerge a set of healthy trading practices that, once reinforced and extended, will allow John to sleep naturally, of his own accord. The key to the solution-focused method is to identify what people are doing that brings them closer to their goals—and then have them do more of it.

Applying the Solution Focus to Trading
In my personal trading, I have made an annual ritual out of conducting an audit of the trades made during the past year, focusing on the winners as well as the losers. From the audit of the winners, I try to identify what I did right: what was working for me during the past year. These become the basis for “trading solutions” that I consciously attempt to implement in the coming year (See Table Two at the end of this article for a sample list of trading solutions from my personal trading). The idea is to create my own model of trading success, but to build the model from my own experience rather than borrow it from a trading guru. Before each trading day, I rehearse elements of this model in my trading diary, which I maintain as an online weblog (www.brettsteenbarger.com/weblog.htm). This consistent rehearsal helps me to internalize the trading solutions so that they become an automatic part of the trading arsenal.

The solution-focused method appears to work for much the same reason that evolution works. When there are random mutations within a gene pool, some of these prove highly adaptive and improve a species’ survival rate. Over time, this selective pressure increases the representation of the mutation within the gene pool, until it becomes dominant. Similarly, we can view our trades as a set of mutations within the total pool of our trading behaviors. By emphasizing the successful trades and paying particular attention to these—constructing them as solutions—we exercise our own selective pressure and increase the representation of those behaviors in our repertoires. Conversely, when we are problem focused—paying more attention to our deficient behaviors than our successful ones—we unwittingly reinforce these and create a kind of devolution.

Recently, I extended the trading audit concept to daily preparation by identifying a single “trade of the day” for each past day’s trading. The trade of the day, which is part of the daily weblog, is not necessarily the most profitable trade one could have made, but it is the highest probability successful trade either that I did make—or should have made—given my trading systems and data. For instance, if the market emerges from an oversold condition and rises on a breakout number of stocks making short term new highs and a breakout level of positive TICK, the odds of continuation of the upside move are favorable. Entering on the long side of such a breakout, perhaps on the first pullback in the Dow TICK, might constitute my trade of the day. By identifying “best trading practices” each day, I cement in my mind the way I want to be trading, reinforcing solutions rather than spinning my wheels over problems.

To be sure, solution focused methods are not the answer to all trading challenges. Sometimes people do experience emotional disorders that interfere with their success, and these can require ongoing attention and treatment. Auditing worst trades can also be useful, especially in eliminating those few trades that often create a large share of one’s annual losses. Among helping approaches, however, solution-focused work is unique in its ability to help traders become their own therapists. By requiring market participants to find their own successes and create models built on these, the solution focus makes each person his or her own guru, empowering traders rather than fostering an unhealthy dependence on others.

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Brett N. Steenbarger, Ph.D., maintains an archive of trading psychology articles and daily trading strategies on his website, www.brettsteenbarger.com.

Table One
Trading Problems: A Solution-Focused Perspective

1. Many problems begin as a string of negative events or as a single, powerful negative event that capture the trader’s attention.
2. While a string of negative events or single, powerful negative events can occur through chance alone, people tend to search for meaning in events and look for explanations and patterns.
3. Once traders notice a problem, focus on it, and create explanations for it, they alter their behavior in an attempt to eradicate it.
4. Attempts to analyze and eliminate problems generally reinforce these problems and their consequences, creating a vicious cycle.
5. Over time, a problem focus becomes internalized, leading traders to experience themselves negatively, undercutting confidence.
6. By the time most traders seek help for trading problems, they have already internalized a problem-based identity, which further interferes with the information processing needed for successful trading.

Table Two
Sample Trading Solutions: Patterns From an Audit of Successful Trades

• Keeping each trade small, removing the pressure associated with any particular trade (emotional stoploss)
• Keeping trade size constant, with each trade like every other, making trading automatic
• Limiting trades to one or two intraday swings on the SP or ND, entering markets only when tested patterns show a significant directional bias
• Limiting breakout trades to those in which the breakout is qualified by a breakout level in the NYSE TICK and/or a breakout in the number of stocks making intraday new highs or new lows
• Exiting overbought or oversold markets when the five minute volume in the ES or NQ contract spikes higher by three or more standard deviations, compared with the normal volume for that five minute period (blowoff moves)
• Entering trades only when price and the cumulative normalized TICK and TIKI lines have already moved in the direction of the anticipated move, using the most recent lows/highs in these values as a stop-loss for long/short trades.

Real Trading

2007-05-19T17:47:00.000+05:30

"---economics is not an exact science; it contains merely of laws of probability. The most prudent investor, therefore, is one who pursues only a general course of action which is 'normally right' and who avoids acts and policies which are 'normally wrong'."
--L.L.B. Angas

Mathematic Model For Trading

2007-02-19T13:25:00.000+05:30

"As far as the laws of mathematics refer to reality, they are not certain;
and as far as they are certain, they do not refer to reality."
--Albert Einstein

Simple Line Chart With No Indicators

2007-01-14T20:53:00.000+05:30

A month back I met a swing trader who uses plain line charts( on closing price) with volumes and no indicators at all; his reasoning been that line chart gives the best view of 'flow', pivots, and patterns. He trades metals and crude on MCX. I was struck, for I could see him pulling good money consistently out of the markets. Of course he's a good friend now.
Also I am reminded of a acquaintance who's been trading nifty futures intraday for years sitting by a quote machine and making money consistently without ever learning a single word of technical jargon.

Haha... they're a kinda shame to people doing research in 100 candlestick patterns, ichomoku, equivolumes, points & figures etc. etc.

(4)You use oscillator divergence?

2006-12-31T15:37:00.000+05:30

ROC(14)and CCI(14) are plotted on the chart above

(3)You use oscillator divergence?

2006-12-29T01:49:00.000+05:30

TRIX(standard) is plotted on the chart above

(2) You use oscillator divergence?

2006-12-29T01:45:00.001+05:30

Stoch(5,3,3) and rsi(14) are plotted on above

Bucks By Bollinger Bands

2006-12-25T13:44:00.000+05:30

Many friends who have just started or about to start trading using Technical Analysis, look for setups which are likely to be safest and simple. One such setup uses Bollinger Bands(BB) alone.

BB alone can generate signals using either of the two criteria:
Condition1. If the last candlestick has a long upper/lower wick, and the wick goes outside the BB while the body lies inside.
Condition2. If previous trading bar goes outside the BB while today's bar lies inside.

If theese signals are tallied with support/resistance levels it is easy to achieve a good success rate.

The conditions can be tuned with trailing stop loss and stop loss for exit.
Please Note while using auto generated signals from software. Quite sometimes the OHLC values are skewed by freak (anomalous) trades/ bad prints.

The said strategy can be used to enter/exit in a trend at the earliest, eg. RSI(14) and MACD(9) are plotted on the chart above.

The default parameters (20,2,Simple) work good. However the s.d can be adjusted between 1.8-2

(1)You use oscillator divergence?

2006-12-24T12:23:00.000+05:30

rsi(14) and macd( with 9-ema) are plotted on the above chart.

Understanding Chart Patterns

2006-12-10T14:04:00.000+05:30

In adolescence, I had visited a TA Seminar where a man in expensive blazer told the audience "pattern study means identifying certain shapes like penants, double tops etc. for profitable trades". Now when I recall that have my guts out laughing.

Pattern Study means identifying periods of accumulation/distribution and high/low volatility, and levels of high supply-demand tussle. Nothing more, nothing less.

Yes, Elliott Waves (EW) and Gann Tools are a sibling of pattern study. The difference between orthodox pattern study and EW is that EW uses Fibonacci ratios also to anticipate the levels of support/resistance. Gann tools use maths somewhat associated with planetary movements.

Pattern Study is illustrated on all the charts posted on this blog.

(1)You use Dual MA Crossover?

2006-12-08T16:02:00.000+05:30

Breakdown of Dual MA Crossover: They make you wait until a trend is confirmed and disciplined enough to bear the noise as prices move. EMA 5-20 are plotted above.
First chart in the series of 100s... will scrutinize all popular 'systems'.

Oriental Bank of Commerce

2006-12-06T18:59:00.000+05:30

TITAN: Bear's Paradise

2006-12-06T12:39:00.000+05:30

Syndicate Bank

2006-12-06T00:12:00.000+05:30

hmmm.. I gotta trade this one

Most Important about Elliott Waves

2006-12-06T00:00:00.000+05:30

The most important thing about Elliott Waves is on which instrument's chart u apply them and when u apply them...
rather than the dumb know-how how to apply them
yes thats a million dollar question...

SWOT on Daytrading

2006-12-05T13:02:00.000+05:30

Strengths:
--There is little systematic risk, n little overnight risk.
--Margin Trading: Brokers allow u to take as much exposure on ur margin money as u dont loose it.
--A daytraders job is over once his targets are achieved, that sometimes may be in a small time(even 1hr), and then he can leave the terminal for a movie

Weakness
--Not for newbies, screaming with fear and greed.
--Slippage costs often bite daytraders unlike those taking deleveries.
--Requires split personality: At times patient and dormant like a recluse, then in a wink charging like a bull. As such may not suit temperament of some.
--Requires focus all the time. Trading in more than two stocks at a time is not advisable.
--One misses the chances of sitting and riding profits, like in swing positions

Oppurtunities:
--Huge profits that too in a while.
--Some Professionals(especially those using mechanical systems) find that profits from daytrading are more consistent than those from Swing trading.

Threats:
--Big losses may come in just as profits. I have seen ppl get numb due to strangulation(while covering) or if prices start moving in countertrend just when one enters.

MURUDCERA

2006-12-05T10:00:00.000+05:30

unfortunately many thought of it as a breakout on friday

Sugar Stocks

2006-12-05T08:40:00.000+05:30

many sugar stocks spiked yesterday.. n for almost all of them the spike was over by 3pm

First Post

2006-12-05T08:34:00.000+05:30

Hey guys... starting a new project... keep visiting.