Picking Tops or Bottoms

For the next few days, I am going to review and summarize parts of Ari Kiev's amazing book "Trading in the Zone."  This is perhaps the best book ever written for traders working for long-short hedge funds. 

On picking tops or bottoms. 

The Master Trader controls the impulse to do the impossible, which is picking tops or bottoms.  Instead, he bases his trades on information and strategy instead of emotional guesses. He will wait until a falling stock begins moving up before buying or a rising stock turns down before shorting. Even if he misses the first move, at least he trades on the actual movement of the stock. 

Patience, not emotions. 

Trading correctly requires a willingness to be uncomfortable. 

The master trader buys more if his positions are working and gets out when his positions aren't working. 

Success requires discipline and the ability to tolerate anxiety and uncertainty. 

Taking Losses. Being Strong.

The best traders in the world take losses.

They also focus on longer term records, not on daily performance.

Of course, daily performance matters because days add up to weeks, then months, and years.

One of the best, strongest traders is Bruce Berkowitz.  There is a good lesson for today's trader ten minutes in his recent setback in the Fannie/Freddie case.

Berkowitz lost 9.6% in one day on the Fannie/Freddie bet, losing all gains back to July 2013.

His fund spokesman responded:

     “The Fairholme Fund has the aim of achieving long-term growth of capital through investing in a focused portfolio of securities. This strategy can lead to higher near-term volatility than more diversified funds. As a result, our focus is on performance over longer time periods rather than on any single day.”

This is not a mere marketing statement.  Berkowitz, one of the best traders of all time, lives this!

He has produced 12% annual returns since 12/99 vs 4% for the SPX. Lost 32% in 2011.  Made 36% in 2012, 2013, putting him in the top 2 and 4% of investors.

"We are focused," he said. "We want to pick the best investments.  We don't want to buy the number ten investment if we can buy more of number one."

What a lesson in being focused on the right time frame.  And what an example of strength.  It brings to mind when P. T. Jones says in his video biography "The Trader," when describing another trader who had just experienced horrific losses:

"I couldn't believe he could be so strong!"

Handling Emotions

The rest of the world thinks we traders are a stoic bunch.  We are cold, ruthless, with ice in our veins.  We silently handle huge personal financial losses with alacrity and grace.

This is not true at all.  I think the career of trader is much harder than mere physical work, and even harder than so-called "mental work."  

For example:

1.  Construction worker.  Hard on the back.  Exhausting.  But when the shift is over, you go home and drink a bunch of beer and watch TV, free from concerns.

2.  "Knowledge worker."  Lawyer, app developer, coder, copy writer.  Harder yet, and yes, you take some of the work home with you because you are never "done."  Also your mind is not your own during the work day because you have to actually THINK.  White collar sweatshop.

3.  Trader.  Hardest yet.  It requires thinking; mental work all day.  But more important, and much more difficult, it requires you to HANDLE your emotions.  I don't say "control" emotions, because that is impossible. 

Ari Kiev, in "Mental Strategies of Top Traders" makes some good points about the subject of emotions, which I paraphrase and summarize here.

Handling emotions.  A process.

First, recognize the problem so that you don’t perpetuate it.  Own the problem.  Don’t try to rationalize or justify your actions. Simply admit the facts.  This is what happened. This is what I did.  When you are too busy trying to defend yourself, you are not open to instruction from the past or from peers.  Then, make a conscious decision not to act impulsively or automatically in an effort to eliminate feelings of discomfort.  Notice the feelings.  Recognize that they are not pleasant but move forward with determination and a clear presence of mind, reacting to the events at hand- not to the feelings you have conjured up as a result of the events.  Don’t waste time trying to change how you feel.  Just notice them, let them pass; learn to stay centered in the present moment.  Keep coming back to the present moment.  Keep coming back to your plan of action, what you know, not what you feel, away from the off-kilter thoughts which impel you to become distracted by negative impulses. 

Keeping a log of your trades and how you felt and how those feelings affected your actions and decisions in the trade can be very useful.

Developing the trader’s edge requires staying calm and managing risk in periods of great market volatility. The toughest lesson for most PMs is to cut losses and to get out of trades that aren’t working, especially during periods of drawdowns.

This is one of my favorite books on trading.  Available on Amazon here: http://www.amazon.com/Mental-Strategies-Top-Traders-Psychological-ebook/dp/B002XGICBI/ref=sr_1_1?ie=UTF8&qid=1412171544&sr=8-1&keywords=ari+kiev+mental+strategies

"Stock Market Wizards Take Losses."

"Market Wizards" by Jack Schwager is probably the best book on trading that I have ever read.  It has had the most influence on my development as a trader.

I feel so strongly about this book that I would probably not hire someone to work for me that had not read this book.  So today for my "Trader Ten Minutes" I simply browsed my old paper copy of the book and re-read my brief notes from the book.

WIZARD LESSONS:

1. There is no single true path. 
2. The universal trait is discipline.
3. Trade your personality.
4. Failure and perseverance are part of every successful trader's life.
5. Great traders are flexible.
6. It takes time to become a successful trader.
7. Keep a record of your market observations.
8. Develop a trading philosophy.
9. What is your edge?  Big picture tech, change, on the cusp, understand big trend before others, shifts.
10. Confidence is important, and you build it from hard work.
11. Hard work.
12. Obsessiveness.
13. Market wizards are innovators, not followers.
14. To be a winner you have to be willing to take a loss!
15. Risk control.  Stop-loss, or reducing position size, limit initial position size, short selling.
16. You can’t be afraid of risk
17. Some limit downside by focusing on undervalued stocks. (but still can drop.)
18. Value alone is not enough.  Need catalysts.
19. The importance of catalysts.
20. Focus not only on when to get in, but when to get out

What really surprised me when reading the book was that each trader in the book had a very different philosophy and method of trading, but they almost all cited the importance of taking losses.  They all were rather quick to cut losses and focused a lot on controlling risks when trades went bad.

This one idea has really stuck with me.

The book is available on Amazon in a variety of formats. (It's also available in a bootlegged free PDF copy on the web if you want to cheat Schwager out of his royalty for writing this masterpiece. You decide.)

http://www.amazon.com/Market-Wizards-Updated-Interviews-Traders/dp/1118273052/ref=sr_1_2?ie=UTF8&qid=1412086240&sr=8-2&keywords=stock+market+wizards+by+jack+schwager

"We Ride the Tiger With Our Fingers Crossed."

“We ride the tiger with our fingers crossed.” – B. Biggs.

I think keeping a trader diary and a spreadsheet of trades made, when, and most important, why, is absolutely essential for a trader. (No, tweeting trades doesn't count).  I especially like to look back on why I sold a stock after it kept going up and what emotions were swirling around my reptile brain at the time.

In today's Trader Ten Minutes, I am reviewing some quotes by Barton Biggs:

"A personal investment diary is a step in the right direction."

"Such a diary has to be written in the heat of the moment, in the fire and agony of the time, not retroactively or retrospectively. Its value comes from reading your thoughts and emotions later in the context of events and seeing where you were right and wrong."  

"At the extreme moments of fear and greed, the power of the daily price momentum and the mood and passions of “the crowd” are tremendously important psychological influences on you. It takes a strong, self confident, emotionally mature person to stand firm against disdain, mockery, and repudiation when the market itself seems to be absolutely confirming that you are both mad and wrong. Also, be obsessive in making sure your facts are right and that you haven’t missed or misunderstood something. "

This page on Business Insider collects some more of Biggs's best quotes: http://www.businessinsider.com/11-insights-barton-biggs-2012-5?op=1

And of course, it's worth reading "Hedgehogging" by Biggs.  Why would a serious trader NOT read a successful money manager's thoughts when he makes them available for twenty bucks?

Potpourri of Quotes by Brilliant Traders

Today I reviewed my notes for ten minutes and found these great quotes from some brilliant traders.  What I want to hear when great traders speak at conferences is how they think, not their latest hot stock pitch.

Bill Ackman after losing $500M on JCP investment:

“I’m not emotional about investments. Investing is something where you have to be purely rational, and not let emotion affect your decision making — just the facts.”

“Investing is inherently probabilistic — not every investment is going to be profitable.”

Joel Greenblatt:

“My definition of value investing is figuring out what something is worth and paying a lot less for it.”

“When you are very concentrated, you have the chance to make 20, 30, 40% annualized returns.”

“One common characteristic of many of the stocks that we buy is that everyone hates them.”

“Even if you don’t know what the upside is – if you just know there’s upside – you can create scenarios where you have excellent risk/reward.”

“The difference between those who are successful and those who fail is perspective – the viewpoint of how they look at the market- understanding how to filter out the noise.”

“If you want to get good at investing, read a lot and practice a lot.”

Ray Dalio:

“The type of thinking that is necessary to succeed in the markets is entirely different from the type of thinking that is required to succeed in school….Most school education is a matter of following instructions—remember this; give it back; did you get the right answer? It teaches you that mistakes are bad instead of teaching you the importance of learning from mistakes. It doesn't address how to deal with what you don’t know. Anyone who has been involved in the markets knows that you can never be absolutely confident. There is never a trade that you know you are right on. If you approach trading that way, then you will always be looking at where you might be wrong. You don’t have a false confidence. You value what you don’t know. In order for me to form an opinion about anything involves a higher threshold than if I were involved in some profession other than trading. I’m so worried that I may be wrong that I work really hard at putting my ideas out in front of other people for them to shoot down and tell me where I may be wrong. That process helps me be right. You have to be both assertive and open-minded at the same time. The markets teach you that you have to be an independent thinker. And any time you are an independent thinker, there is a reasonable chance you are going to be wrong.” 

I agree strongly with Ray Dalio here.  Even in my highest conviction ideas, I am never more than about 60% confident that the trade will work out as hoped.

Howard Marks on being unconventional.

I saw Howard Marks at a conference a couple of years ago and jotted down some of his quotes.

“Are you willing to be different, and are you willing to be wrong?  In order to have a chance at great results, you have to be open to being both.”

“This just in: you can’t take the same actions as everyone else and expect to outperform.”

“Being different is absolutely essential if you want a chance at being superior.”

“Only if your behavior is unconventional is your performance likely to be unconventional and only if your judgments are superior is your performance likely to be above average.”

“…in terms of asset allocation, ‘can’t lose’ usually goes hand-in-hand with ‘can’t win.’”

“Establishing and maintaining an unconventional investment profile requires acceptance of uncomfortably idiosyncratic portfolios, which frequently appear downright imprudent in the eyes of conventional wisdom.”

“Most great investments begin in discomfort.” 

“You have to give yourself a chance to fail.”

“It’s important to play judiciously, to have more successes than failures, and to make more on your successes than you lose on your failures.  But it’s crippling to have to avoid all failures, and insisting on doing so can’t be a winning strategy.”

“Bottom line: not whether you dare to be different or to be wrong, but whether you dare to LOOK wrong.”

“In order to be a superior investor, you need the strength to diverge from the herd, stand by your convictions and maintain positions until events prove them right.”

“Unconventional behavior is the only road to superior investment results, but it isn't for everyone.  In addition to superior skill, successful investing requires the ability to look wrong for a while and survive some mistakes.”